In a most fundamental way, outsourcing could be understood as a business practice of hiring third parties to perform services or manufacture goods that was traditionally being managed by the in-house employees and staff of the company. Different businesses could have different outsourcing models and strategies depending on the nature of the business however, the key to outsourcing for a Company would be to concentrate on their main business and acquire from the third parties or vendors, goods or services which are ancillary in nature and not desired in-house. A good example for this could be any company sourcing out its Information Technology requirements to an IT company.

The one key reason for the organisations to outsource their functions is saving costs, of-course the decision to outsource is driven by various other factors as well viz improving the focus of the company on the core business/core strengths, gaining access to world class capabilities, releasing the existing internal resources and utilizing them for other functions to achieve optimal scalability. Similarly, Outsourcing can help companies to achieve quality improvement, quicker response, saving costs and increasing the know- how of the organization without the necessity of hiring skilled persons.

Outsourcing a business or a function should usually result into an organisation getting access to world class technology and innovation, economies of scale and specialized capabilities which would otherwise not be cost effective to match in-house. Outsourcing allows the organisation to focus more on the larger issues within the organization and typically, the specialized company that handles the outsourced activity boasts technological capabilities superior to the organization.

There are, however, some drawbacks and risks associated with outsourcing that need to be considered by the organisation before the decision to outsource is made. Firstly, the organisation seeking to outsource service (Customer) will provide its proprietary information, sensitive data, know-how, trade secrets and intellectual property (elaborated below) to the outsourcing service provider (Supplier) in order for the Supplier to prepare for or deliver the services to the Customer. There is an inherent risk of losing sensitive data and the compromise of confidentiality. Another primary downside amongst others is the possibility of loss of control of the outsourced activity and complete reliance on the Supplier. Hence the decision to outsource a function is a sensitive one and before taking the same, the Customer needs to evaluate a lot of parameters and factors.

The Customer and Supplier who desire to enter into an outsourcing arrangement must therefore be very careful when making the decision and make sure that they are able to mitigate the associated risks with the transaction while negotiating the provisions of the Outsourcing Service Agreement (Agreement) and must introduce into the Agreement such provisions to control and mitigate the possible risks or potential downsides to make it a win-win situation of the Parties.

Intellectual Property widely refers to creations of the mind: inventions; literary and artistic works; symbols, names and images used in commerce. Intellectual property may further be sub-categorised into Industrial Property which would include patents, trademarks, industrial designs and geographical indications as well as copyright which inter-alia protects original works of authorship including literary, dramatic, musical, and artistic works, such as poetry, novels, movies, songs, computer software, and architecture etc. Intellectual Property Rights are like any other property right and allows owners to monetize and benefit from their own work or investment in the creation of Intellectual Property. In a typical outsourcing arrangement, the Intellectual Property plays an extremely significant role from the perspective that such pre-existing Intellectual Property is likely to be shared amongst the Customer as well as the Supplier during performance of the outsourcing arrangement and further Intellectual property is likely to be created during such arrangement. Both these instances have their own inherent risks as well as complications which need to be addressed in the Agreement in order to ensure smooth operations during the validity of the Agreement and post expiry or early termination of the Agreement.

On one hand we have intellectual property that one party (either the Customer or Supplier) created and the other side has no rights prior to concluding the Agreement. On the other hand, after execution of the Agreement during the outsourcing arrangement, both sides will cooperate to either improve or create intellectual property. In the second instance both sides work together to create new Intellectual Property which needs protection. The right to this type of intellectual property is different and the two companies must decide how these rights are to be allocated.

The outsourcing agreement is the bible and plays the most vital role to deal with the afore-stated issues. Not only does the Agreement specify the limitations of dealing with the pre-existing Intellectual property but also with the Intellectual Property created during the performance of the Agreement. Ownership in respect of intellectual property is the biggest bone of contention between the Parties which has to be dealt with sensitively as well as strategically. It is therefore always advisable that before execution of the Agreement, the same should be preceded by an Intellectual Property due diligence. The scope of such due diligence should establish identification and ownership of all Intellectual Property Rights. The scrutiny should also cover within its ambit various contracts, licensing agreements or any other arrangements related to the intellectual property. All Intellectual Properties which are either licensed or assigned to either the Customer or the Supplier need to be taken note of to make sure that during the performance of the outsourcing activities there is no infringement of third-party Intellectual Property Rights and related indemnities are in place.

On the subject of software owned by the Customer, it has to be decided whether the Intellectual Property Rights in such software are to be assigned or transferred in favour of the Supplier to enable the Supplier to provide the services more effectively. The same may be managed by licensing the Customer owned software to the Supplier. Further, in software related issues, it will also be pertinent to note the IP rights in software which may differ from jurisdiction to jurisdiction. For example, USA recognises Patent protection for software whereas in India, there is no Patent protection available to software and have to be protected either as copyright in the literary work (via source code) or as confidential information.

Another issue that could arise would be, whether the software was developed by a third party, as in the said scenario, it would be required to be ascertained during the process of the due diligence or an audit, whether the Customer has adequate rights to license or sub-license the same to the Supplier, since, in the absence of such audit, the Supplier might also get embroiled in a potential infringement action. It would be pertinent to cover this aspect in the Representations and Warranties of the Agreement.

Most of the third-party software licenses have various restrictions and are non-transferable as per the standard terms which prohibit the transfer of the software, either in object or source code to anyone outside the licensee’s organisation. The use of the software is further regulated within the Customer’s internal team and prohibit the Customer’s use of the software to provide outsourced services to third parties. Therefore, the customer must have the licensor’s consent in order to legally transfer the software to the Supplier, failing which the same may tantamount to breach of license terms which shall have a huge impact on the Agreement. In case the licensor chooses to terminate the software license agreement it might be disastrous for the for the whole arrangement.

There could be different methodologies and approaches for the purpose of sharing ownership rights over Intellectual Property, which is either improved or created during an outsourcing relationship after the execution of the Agreement. In the first approach, the Customer could insist to own all IP improved or created during the outsourcing relationship, with the Supplier having the possibility of using the Intellectual Property through a negotiated license agreement. Another approach could be for the Supplier to own Intellectual Property, with the Customer taking a perpetual license. While another approach could also be for both the Customer and Supplier to jointly own the Intellectual Property created or improved upon after the execution of the Agreement. All the afore-noted approaches are complex and should be further evaluated and negotiated before entering into the Agreement. The Agreement needs to be carefully worded to reflect the real understanding between the Parties while dealing with ownership and use of the intellectual property both during the subsistence of the Agreement as well as after the expiry or early termination of the Agreement.

The Customer will at all times be interested in the intellectual property rights in its pre-existing works despite a scenario where the Supplier makes some improvements during the course of performing its services. On the other hand, the Supplier would be interested in claiming the intellectual property rights in the improvements and may also be interested in acquiring ownership of any part of the pre-existing work that is related to the improvements carried out by the Supplier during the course of providing services. This is a critical issue pertaining to Intellectual Property rights and either party’s approach in respect of the same could be dependent on various reasons and factors.

In case the intellectual property which is improved upon or modified from its original form or created is unique and specific to the Customer’s business, the Customer will claim its right over the same. However, if the intellectual property is generic to the outsourcing business activity or necessary for the Supplier to provide services to other entities, the Supplier will try to claim ownership. Ordinarily, Intellectual property Rights would vest in the Party who develops the same (usually the Supplier during the course of performing its services) or it could be interpreted as a work for hire, in which case it could be argued that Customer had employed the Supplier to create it and hence it belongs to the Customer. It will be important to bring out the intention of the parties in the Agreement, as to whether the work created is ‘contract of service’ or ‘contract for service’. In any case, during the course of the negotiations of the Agreement, if either side retains intellectual property rights in certain work, it is advisable that the other side should try to obtain a perpetual (exclusive/non-exclusive) license to use/ exploit that intellectual property for business continuity.

Another approach which could be adopted by the parties would be for both the Customer and the Supplier to own intellectual property rights jointly. Joint ownership in the intellectual property though sounds to be a fair and a logical approach however, it is a complex and complicated issue when it comes to practicalities. There could be various pitfalls of jointly owned Intellectual property Rights and in in order to mitigate the same, one needs to do an in depth analysis of the nature of Intellectual Property (whether it is a Patent, copyright or a design etc.), the governing laws, as well as the mode of enforcement in respect of the same. The biggest risk being that one of the joint owners could try to exploit the rights in Intellectual Property to the detriment of the other party for example to its competitor. Parties therefore must carefully evaluate the Agreement and ensure restrictions for such exploitation that may be detrimental to one of the joint owners of Intellectual Property. Whatever approach is adopted by the Customer and the Supplier, not only is it required to be evaluated in depth and negotiated, but the difficult part is to ensure that the same is adequately captured in the Agreement.

Parties need to capture their understandings, roles and responsibilities in the Agreement and must clearly encapsulate the Representations and Warranties, Indemnification provisions as well as international Law issues. There should be an unequivocal representation that the Licensor owns and has a right to use the concerned intellectual property and that the use does not infringe or conflict with the rights of others.

The Licensor must also give a warranty that no right, privilege or license has been granted to a third party with respect to the use or exploitation of the subject Intellectual Property. There is always a risk that provision of services by a Supplier may result in liability to third parties such as liability or losses as a result of infringing the intellectual property rights of a third party. Hence an indemnification provision in the outsource agreement would allow the innocent party to recover from the wrong doing party for any losses suffered from claims made by third parties. In the course of off-shore international outsourcing the parties must also consider the various laws and regulations which may be applicable to the licensor while transfer of intellectual property rights.

Further, what would happen to the intellectual Property at the time of early termination or expiry of the Agreement is a very pertinent consideration. Usually, the Parties would insist that they should have a royalty free perpetual license to use the Intellectual property and further protection under the indemnity provisions for breach or infringement of intellectual Property rights.

In order to mitigate all IP related issues and risks in an outsourcing arrangement it is always advisable to first conduct an Intellectual Property due diligence. The Agreement must capture complete details pertaining to ownership and usage of pre-existing Intellectual property rights as well as rights pertaining to Intellectual property created or improved during the performance of the Agreement. The Agreement must also encapsulate the details of dealing with the Intellectual Property after the expiry or early termination of the Agreement. Relevant warranties and indemnities should be carefully drafted and included in the agreement. As long as the Agreement is executed after meticulous diligence and accurate and unambiguous provisions pertaining to the above, it is likely to result in a win-win situation for both Customer as well as the Supplier.