An American company decided to outsource sensitive software development to a prominent Israeli firm. The outsourcing contract clearly stated that if a dispute arose, all judicial action would take place in New York City, the buyer’s domicile.
Sure enough, a dispute arose. When the buyer’s attorney began to file a lawsuit in Manhattan, the supplier’s attorney discovered the contract did not specify New York as “the sole and exclusive” jurisdiction. In Israel, all cases involving Israeli companies must be tried in Israel unless the contract specifies the sole and exclusive jurisdiction is elsewhere.
So the American buyer had to litigate the case in Israel. The litigation costs skyrocketed because the American attorneys had to set up shop in Tel Aviv. And now they had to play by someone else’s rules, which included learning the rules.
How do buyers protect their interests when they outsource crucial functions to offshore vendors? That may be the 10 million dollar question for American buyers.
Outright theft is the first concern. Protecting your intellectual assets is one of the major difficulties in outsourcing offshore, points out Franklin Blackstone, a lawyer with the New York firm of Arter Hadden. This becomes a real worry for companies who are providing original source code or a proprietary process to their outsourcing providers.
Handling International Disputes
Blackstone says outsourcing to companies in Asia is even more difficult because that culture views software ownership differently than businesses in the United States. “We view their actions as stealing our intellectual property. But that’s not how they look at,” says Blackstone. For example, Chinese law does not recognize business patents.
His advice: Have your attorney check out the local intellectual property laws that govern the supplier’s actions.
Before signing an outsourcing contract, Blackstone says buyers should have their attorneys also check to make sure the vendor’s country has signed the Berne Convention. This body of law governs intellectual property; its participants agree to recognize the existence and the ownership of intellectual property and not to use it in an unauthorized manner.
The best way to protect your intellectual property is to write all your concerns and demands into the outsourcing agreement. State those demands strongly. “You have to make it clear this code is yours,” says Blackstone emphatically.
Buyers must also include how disputes in the outsourcing contract will be handled. Important questions to ask before entering an offshore contract include:
- Whose laws are governing the dispute?
- Are U.S. laws enforceable in the dispute?
- Where will the dispute be adjudicated?
Offshore outsourcers often don’t want the dispute resolved in the U.S. judicial system. Blackstone says one successful dispute technique is to agree in advance to submit the dispute to an international arbitration group. London, Brussels and Geneva are popular places for multinational arbitration.
If the supplier is uncooperative, the attorney suggests checking to see if it has an American subsidiary. If it does, put pressure on that unit. Fortunately, this business entity must conform to U.S. law. If the buyer receives a judgement against the offshore outsourcing provider, it can enforce that lien against the outsourcer’s U.S. assets, according to the attorney.
Another method of protecting buyer rights is to demand a performance bond. The attorney also advises paying the supplier in U.S. dollars instead of its local currency so the cost is clear.
Blackstone says buyers should never pay the bulk of their outsourcing fees up front. Instead, he suggests loading the majority of payment into the back end after the vendor has delivered the work satisfactorily. This ties performance to payment. “The outsourcer can violate the agreement with impunity if you pay in advance,” says the counselor.
An Offshore Horror Story
He cites the case of one company that outsourced it Y2K updating to an Indian firm. All the outsourcing vendor had to do was change the dates in the source code. The American firm paid most of the outsourcing fee in advance.
The American company sent its source code to India. The Indians performed the work and brought the new code back to the American company to test. Unfortunately, the Indian company wrote bad code which included a bug; this infected the original source code making the application unusable.
The Indians refused to accept responsibility for the problem. To make matters worse, they refused to share the original source code with the buyer. The American firm made its first mistake by not keeping a copy of its original source code. And it should never have paid for services until they were done according to the its standards.
To resolve the issue, the American company put pressure on the Indian developer’s U.S. subsidiary. Finally, the offshore group agreed to fix the code. But the American firm ended up paying double for the job.
The final legal issue is immigration. If the offshore vendor wants to send staff to the buyer’s site to install software that only they know how to install, the buyer will have to work with the Immigration and Naturalization Service to secure the proper visas. Blackstone says most companies don’t think about this until the specialists are ready to get on an airplane. However, these visas can take months. ‘Think ahead’ is his sage advice.
Lessons from the Outsourcing Primer:
- Write all protections into the outsourcing contract. Be clear and forceful so there are no misunderstandings.
- Protect your intellectual property or proprietary process.
- Do not pay the offshore outsourcer in advance. Instead, pay the bulk of the fee at the end of the contract after the work has been performed to your specifications.