INTRODUCTION – OUTSOURCING OVERVIEW
The most frequently quoted reason for outsourcing is cost savings. As the technology industry is highly competitive and grows rapidly, organizations focus on reducing costs in a bid to strive to retain and/or gain the competitive advantage. The improvement of services and added value that third party expertise can bring cannot be doubt. By outsourcing one or more non-core activities/functions of the organization, management gets the chance to focus resources on core competencies of the organization allowing in that way the organization to achieve the highest possible level of services and meet its own customers' needs, thus effectively protecting its market share from other organizations wishing to enter the market.
By outsourcing, organizations have immediate access to the innovations, the economies of scale and the specialized capabilities of the service provider which, would otherwise be costly to achieve internally. Indeed, service providers can acquire new technology more quickly and can spread the cost over a number of customers/organizations. The fact that many organizations share the service provider's investment between them reduces the risk which would otherwise be born by a single organization.
The use of a third party service provider improves access to new technology, new methodologies and workers/staff that are capable of evaluating and implementing new technology more rapidly than within the organization. It is important to know –and this is a great advantage of outsourcing- that, service providers are often able to negotiate discounts from the price of new technology products.
There are, however, some disadvantages and risks associated with outsourcing that worth to be considered. These include losing control over the activity/service outsourced and increasing reliance on the service provider.
During an outsourcing agreement the customer will provide its proprietary information and intellectual property to the outsourcing provider in order for the outsourcing provider to prepare for or deliver services to the customer. However, while the outsourcing provider has access to use the enterprise customer's data which are generally entitled to copyright protection or to use techniques and processes that have been patented, the outsourcing provider's service delivery platform will contain software and technological processes that are works of authorship and thus entitled to copyright or techniques and processes that may be patentable. In addition, in most of the outsourcing transactions the outsourcing provider's employees and the enterprises personnel work under the same trademark which may be proved damaging if, for example, the outsourcing provider fails to perform as required.
There is a possibility, that, a careless drafted outsourcing agreement, instead of achieving costs reduction increases customers' costs. This may happen in cases where the required services and services levels and standards are not specifically defined in the contract, enabling the service provider/supplier to demand additional charges to provide services or services levels that were not specifically provided for or included in the outsourcing agreement.
The outsourcing of an IT activity/function usually involves the transfer of skilled staff and expertise to the service provider, the latter often being left without any person with the necessary technical skills to run that function; In such cases, should the customer seek to change service provider or bringing the IT operation back in house will find it very difficult or even impossible to do that and will probably be forced to rely on the service provider and continue the outsourcing relationship with that service provider.
Therefore, parties who wish to enter into an outsourcing arrangement must be very careful when negotiating the provisions of such contract and must introduce into the contract such provisions to control and/or minimize any of the abovementioned possible risks or potential downsides.
INTELLECTUAL PROPERTY – INTELLECTUAL CAPITAL
Intellectual Property is not just copyrights, patents and trademarks it is also processes and techniques, methodology and talent described by many experts as intellectual capital. This intellectual capital, these intellectual property assets in other words, will need to be shared between the customer and the outsourcing provider. Sharing involves risks such as challenges in monitoring and/or dealing effectively with various types of breaches of contract clauses, theft or misappropriation of trade secrets, as above mentioned, misuse or loss of other types of intellectual property rights, poor or inconsistent quality of goods and services and enforcement of intellectual property rights.1 Therefore, the customer and the outsourcing provider must discuss these issues or it can be very damaging to both sides.
INTELLECTUAL PROPERTY CREATED – INTELLECTUAL PROPERTY TO BE IMPROVED AND/OR TO BE CREATED
There are two kinds of intellectual property that a company has to consider; on the one hand, is the intellectual property that one company created and the other side has no rights to it. These are intellectual property assets that come into the relationship prior to concluding the agreement. On the other hand, during the outsourcing relationship both sides will cooperatively improve or create intellectual property. In this case, since both sides work together to create new patents or know-how, this is going to be protected by trade secrets. The right to this type of intellectual property is different and the two companies must decide how these rights are distributed.
NEGOTIATING THE OUTSOURCING AGREEMENT – ISSUES AND CONCERNS – INTELLECTUAL PROPERTY DUE DILIGENCE – INTELLECTUAL PROPERTY AUDIT
The outsourcing agreement therefore, will need to deal with these issues and specify ownership of intellectual property rights. Ownership of intellectual property may be a sticking point. Both parties must exercise great caution. They must properly administer their intellectual property in order to mitigate intellectual property-related risks, and improve the competitiveness of the product or service offered by the enterprise. Therefore, an intellectual property due diligence enquiry and an intellectual property audit should be undertaken before the final outsourcing plan is communicated by the customer to the potential outsourcing providers. The intellectual property rights must be identified and documented, the inventors, creators or authors of the intellectual property must be identified and the owners of those intellectual property rights be specified. Contracts or other agreements such as licensing agreements associated with the intellectual property must be identified. Any assigned or licensed intellectual property used by the interested organisation and any intellectual property rights of third parties or of employees must be identified and ascertained. Furthermore it is important to identify any existing or alleged breaches and or infringements of such assignments or licenses. It is also important not to omit to determine jurisdiction and enforcement of intellectual property rights in case of any dispute that will arise and will need to be resolved. Termination of the outsourcing agreement and relevant exit clauses must always be considered by the parties and whether any indemnity against infringement will be provided for.
IT OUTSOURCING AND INTELLECTUAL PROPERTY RIGHTS
Intellectual property rights are absolutely critical in IT/IS outsourcing. An IT outsourcing inevitably involves the taking over of the service from the customer's IT in-house function by the service provider which actually means the taking over of the know-how, software and hardware that currently provide those services. "Knowledge economy" and intellectual property economy are very closely related, if not the same.2 Knowledge in the intellectual property industry has a particularly significant value. Therefore, all that knowledge, computing operating systems, software, information and data they process (customer data, training materials, tools and other technology, customer guidelines and procedures, processes and methodologies used by the customer and any improvements on those that the customer or provider make) are protected by intellectual property rights which must be safeguarded. It is usual that some of these intellectual property rights belong to third parties. Furthermore, it is important to consider whether different intellectual property rights apply simultaneously to one " product" such as software. Therefore, specifying ownership is vital.3
SOFTWARE OWNED BY CUSTOMER – ISSUES AND CONCERNS
Regarding software that is owned by the customer, it must be pointed out that, if the customer is the owner of the intellectual property rights in the bespoke software then it will have to decide whether those rights should and can be transferred to the service provider. In case those rights are transferred, the customer will require a license to use the service provider's software. At a minimum the customer may need to use a client-side version of the provider's software on its own computers to receive the services.4
If software is to belong to the customer, however, questions arise as to whether such intellectual property asset is been properly transferred or assigned to the company. If the software was produced by a third party, or by contractors rather than employees, ownership will only reside in the customer if the relevant contacts so provide. It is therefore important for the customer to conduct a due diligence enquiry to determine who owns the relevant intellectual property rights and keep proper records. Where the customer possesses rights to use software, an important question is whether the license permits its transfer to the service provider. Unless the customer had agreed with third party software licensors specific rights for the customer to transfer that software to the service provider or allow the provider to use that software as a sub-licensee, the customer cannot transfer, or sub-license the use of the software as this would amount to an infringement of the licensor's intellectual property rights.
Most third party software licenses are subject to many restrictions and are often non-transferable. Usually, they include standard terms which prohibit the transfer of the software, either in object or source code to anyone outside the licensee's organisation, restrict the use of the software to the customer's internal business purposes, expressly prohibit the customer's use of the software to provide data processing or outsourced services to third parties, impose confidentiality obligations on the customer so as to prevent the customer disclosing the software to third parties.5 Therefore, the customer must have the licensor's consent in order to legally transfer the software to the outsourcing provider. If the customer transfers the licensor's software to the outsourcing provider without the licensor's consent, will most probably be in breach of the licensor's license terms. Consequently this will affect the outsourcing agreement negatively or kill it; the licensor may successfully manage to obtain an order by the court to prevent the transfer of the software from the customer/licensee to the outsourcing provider or even prevent the use of the software by the outsourcing provider. In addition the licensor may successfully claim damages from the customer/licensee for breaches of the terms of the software license and/or claim damages from the customer/licensee and the outsourcing provider for the infringement of its intellectual property right. Furthermore, the licensor may choose to terminate the software license which will prove to be catastrophic for the outsourcing customer/licensee.
For the above reasons, the customer must approach third party software licensors as early as possible to secure their consent to assigning the software to the service provider or to allow the service provider to use it. The same will apply with regard to any third party data as software licenses very often restrict the licensee from using the software to process third party data. Normally this involves the customer/licensee paying additional license fees to the licensor/software owner and that is one of the main reasons that any attempt to secure third parties' consent must take place at an early stage even prior to the official beginning of the negotiations.
As indicated above, the most effective way of identifying third party intellectual property issues and specify third party intellectual property rights is, to initiate a full due diligence procedure as early as possible.
A question arises as to how the existing software licenses will transfer to the outsourcing service provider. It is argued that the most effective form of transfer is novation. The software license agreement between the customer licensee and the software licensor terminates and a new software license agreement starts between the software licensor and the outsourcing provider on the same terms. In such cases the question of who is to be held liable for historic liabilities in relation to the novated agreement is critical and must be agreed before the agreement is novated. Transfer by novation of the software license may involve also some other extra payments required by the third party software licensor and therefore the parties need to agree on whether and how these payments will be shared between them. Furthermore the outsourcing customer, on the one hand, will probably be asked to warrant that it has fulfilled all obligations and liabilities up to the date of novation and will demand to be assured that the outsourcing service provider will be responsible for any problem that may arise after that date. The service provider may require indemnities from the customer to cover any breaches of copyright or infringement of any license terms prior to the transfer.6
In any case, if the parties fail to get the third party software licensor's consent before the commencement date of the outsourcing then they may agree to postpone the commencement date of the outsourcing agreement or not to transfer the relevant software licenses. Another available option to the parties would be to agree to defer the transfer of the particular software licenses. Any such option, however, should be provided for in the outsourcing contract.
SPECIAL CONCERNS REGARDING THE INTELLECTUAL PROPERTY THAT IS IMPROVED OR CREATED/INVENTED DURING THE OUTSOURCING AGREEMENT
The other kind of intellectual property that a company has to consider is the intellectual property that is improved or created/invented, during the outsourcing relationship. It is crucial for both parties to discuss this issue and include relevant provisions in their agreement.
Obviously, the customer will try not to lose intellectual property ownership in its pre-existing works just because the outsourcing service provider made some improvements. On the other hand the outsourcing provider will probably demand the intellectual property ownership in the improvements and will also attempt to acquire ownership of any part of the pre-existing work that is related to the improvements. 7
Each party's approach on this important issue will depend upon several factors; if the intellectual property that is improved or modified or created is unique and specific to the customer's business, the customer will want to own it. However, if the intellectual property is generic to the outsourcing business or necessary for the provider to provide services to others, the service provider will typically try to retain its ownership. If either side retains ownership of certain intellectual property, the other side should try to obtain a license to use/exploit that intellectual asset.
It is important for the customer to know whether the service provider is planning to use the software for serving more customers. If that is the case and if the customer believes that by serving other customers, the customer will eventually lose their competitive advantage then the customer must try to prevent the software being used to service its competitors by refusing to grant to the service provider any such license to use it.
Another approach would be for both the customer and the service provider to own jointly the developed intellectual property.8 Joint ownership in the intellectual property sounds to be a fair approach in cases where the customer and the service provider worked together to create, improve or develop it. For example in relation to copyright works, such as software, joint ownership may be agreed to exist where an improvement resulted in the creation of co-authorship, where each author have created copyrightable subject matter in the work. Therefore determining whether ownership will be exclusive to one party or another or held jointly is an issue which must be very carefully considered. It is indeed a complex and complicated issue and one of the most difficult areas in the area of intellectual property.
Each approach should be carefully evaluated and negotiated by the parties before entering into the outsourcing agreement. Whatever is agreed must be reflected in the agreement in detail. Furthermore, the agreement should include detailed termination provisions with regard to intellectual property rights. What will happen with intellectual property when the contract comes to an end or what will happen in case of early termination? Usually under an expected termination both sides have greater rights to intellectual property. For example the customer may seek to obtain a royalty free license to use the intellectual property accompanied by an indemnity in the customer's favor against infringement of third party rights.9 Under an early termination (breach of the agreement) the parties should expect to have fewer rights or no rights at all. Therefore relevant provisions must be included in the contract dealing with issues like where the customer does not wish to continue with the particular service provider and wish to transfer rights to other service provide. At such case, for example, the ownership and use restrictions relating to the software are critical and it is of considerable importance to the customer to achieve a satisfactory solution here. Therefore, the customer must never lose sight of its business objectives; using the service provider skill and resources to facilitate migration to new operating systems, applications and technology. As it is pointed out above, if the intellectual property is unique and specific to the customer's need then the customer must try to retain ownership. It is, however, advisable to the customer to avoid agreeing to joint ownership of intellectual property assets as this would cause difficulties in the event of early termination of the outsourcing relationship, but again if, detailed provisions regarding the management of the intellectual property which is jointly owned, are expressly provided by the outsourcing contract, then the problems are minimized. If for example, the service provider is to own any software used to perform services to the customer, the contract should ensure that the customer will have all rights necessary to ensure the continuing use of the software to perform its IT functions after the contract ends. It is generally preferable for one party to own the rights and grant appropriate rights to the other party.
An outsourcing business strategy, if well implemented by following an exhaustive Intellectual property due diligence, will mitigate intellectual property related risks.
The agreement must be detailed, and, amongst other things should deal with ownership and use of the intellectual property assets both during termination and after the outsourcing relationship is terminate or comes to the end. Both parties must focus on structuring a relationship that gives them sufficient protection. Relevant warranties and indemnities should be carefully drafted and included in the agreement. As Nagel and Murphy point out, the keys to a successful relationship are comprehensive planning, rigorous evaluation and attention to detail.
1 Donna Ghelfi, Program Officer, SMEs Division, WIPO " The Outsourcing Offshore Conundrum: An intellectual Property Perpective" Page 4 http://wipo.int/sme/en/documents/outsourcing.htm
2 Kenneth Brown, Outsourcing and the Devaluation of Intellectual Property, page 2 http:// darwinmag.com/read/writeon/column.html?ArticleID=1072
3 Tabenbaum WA, "The Outsourcing Revolution: Protecting critical business Functions Using Outsourcing, ASP & Web Service Agreements Outsourcing specific business Application Functions: Critical issues in information technology and business process outsourcing", Practicing Law Institute Order No. GO-0163, October, 2002 724 PLI/Pat 125. Page 22
4 ibid., page 21
5 Angel J, Technology Outsourcing, A Practitioner's Guide, The Law Society 2003, Page 118
6 Anassutzi M, "Issues to be considered in outsourcing contracts", ICCLR 2002, 13 (5), 205-210, page 3
7 Tabenbaum WA, "The Outsourcing Revolution: Protecting critical business Functions Using Outsourcing, ASP & Web Service Agreements Outsourcing specific business Application Functions: Critical issues in information technology and business process outsourcing", Practising Law Institute Order No. GO-0163, October, 2002 724 PLI/Pat 125. Page 22
8 ibid., page 23
9 Anassutzi M, "Issues to be considered in outsourcing contracts", ICCLR 2002, 13 (5), 205-210, page 6
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.