Outsourcing, IT Outsourcing and Intellectual Property Rights issues.

By Christiana Aristidou,
DEMOCRITOS ARISTIDOU & CO LAW FIRM

-INTRODUCTION – OUTSOURCING
-INTELLECTUAL PROPERTY – INTELLECTUAL CAPITAL
-INTELLECUAL PROPERTY CREATED – INTELLECTUAL PROPERTY TO BE
IMPROVED AND/OR TO BE CREATED
-NEGOTIATING THE OUTSOURCING AGREEMENT – ISSUES AND CONCERNS –
INTELLECTUAL PROPERTY DUE DILIGENCE – INTELLECTUAL PROPERTY AUDIT
-IT OUTSOURCING AND INTELLECTUAL PROPERTY RIGHTS
-SOFTWARE OWNED BY CUSTOMER – ISSUES AND CONCERNS
SPECIAL CONCERNS REGARDING THE INTELLECTUAL PROPERTY THAT IS
IMPROVED OR CREATED/INVENTED DURING THE OUTSOURCING AGREEMENT
-CONCLUSION

INTRODUCTION – OUTSOURCING

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.

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. [F1] Therefore, the customer and the outsourcing provider
must discuss these issues or it can be very damaging to both sides.

INTELLECUAL 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. [F2] 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. [F3]

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.[F4]
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. [F5] 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.
[F7]
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. [F8] 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. [F9] 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.

CONCLUSION

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.

FOOTNOTES:

[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”, Practising 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

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