IP Rights for the Next Wave of HRO

To build a better provider-buyer relationship, hash out the intellectual property rights as part of the pre-deal negotiations. Buyers will need to decide if retaining IP rights is a priority.

by Kenneth Adler, Robin Rosenberg

In the next wave of HRO, customers will be more sophisticated, having either prior HRO or ITO experience. Likewise, providers will have more experience as the industry matures. This provides an opportunity for both customers and providers to refocus on an often-overlooked part of HRO transactions: the intellectual property rights of the parties.

If intellectual property issues are not addressed properly in the HRO agreement, the assumptions of the parties may be misaligned, which may lead to the
parties being left without the rights needed to meet critical business objectives and cause the economics of the HRO relationship not to make sense.

One Size Does Not Fit All
While customers and providers alike have standard starting negotiating positions regarding IP, there is no single solution as to how intellectual property rights should be allocated between the parties. The appropriate allocation will depend on the details of the specific arrangement and the needs and expectations of the parties. Also, the division of the intellectual property rights may directly relate to or be an integral factor in the economics of the relationship. As such, different types of HRO transactions may require different allocations of IP rights.

For example, the IP rights allocation in a relationship in which IP previously belonged to the supplier will likely be different from an arrangement in which the supplier runs the customer’s “homegrown” or third-party software or provides a customized software solution. The supplier has an investment in its pre-existing IP and will use that IP to “go to market.” If the supplier is developing a customized solution, the customer may want to own those customizations, in which case the supplier may be less concerned about retaining ownership. However, each party may desire to own
customizations to the supplier’s prior IP, particularly if the customer perceives a competitive advantage in the marketplace by having exclusive use of the solution.

In addition, in certain situations, a party may desire to retain the right to use software or other intellectual property of the other party after termination of the outsourcing relationship. The buyer may want to continue to use the supplier’s software to maintain consistency in its business, and the supplier may want the right to offer to other customers a custom solution it created as part of its general service/product offerings. Such post-termination rights should be dealt with in the initial allocation of rights so that the economics of the deal may be adjusted to address the agreed allocation.

In many outsourcing arrangements, each party adopts the starting position that it desires to own all of the intellectual property; however the parties may take a different position after carefully considering their actual needs and the economics of the deal. For example, a customer may initially take the position that it should own customizations the supplier makes to the supplier’s solution, particularly when it pays the entire cost
of development.

But upon consideration, the customer may determine that it is in its best interest for such a customization to be owned by the supplier and become part of the supplier’s standard product and covered by its standard maintenance and upgrade service offerings. Also, if the buyer retains ownership, it might not be afforded the benefit of supplier’s efforts to enhance its standard product and might incur additional costs to use new versions or enhancements to the technology. These could include costs for projects to make the customizations operate with new versions of the standard product.

Ultimately, the allocation of IP rights will be the result of the negotiation of the parties. The following considerations should be addressed by the parties in the course of their discussions regarding an appropriate allocation of intellectual property rights in their
HRO arrangement:
• Consider business needs. Since an appropriate allocation of rights depends on the needs of the parties, each party should realistically consider and understand its actual requirements with respect to the IP involved in the applicable HRO arrangement, for both the life of the HRO relationship and after the term.

To understand these requirements, a party will need to examine its needs with respect to each portion of applicable intellectual property and the underlying IP rights related to such property (such as copyrights, patents rights, and trade secret rights, and which rights can be addressed and divided independently) because its requirements may differ for different portions. As part of this exercise, each party should:

• Have an understanding of the underlying IP rights, so that it will have the knowledge necessary to properly address and allocate such rights;

• Consider what structures will allow the party to meet its needs and which of the underlying rights it will require to meet those needs; and

• Consider whether certain intellectual property and/or the underlying IP rights should be addressed differently in different jurisdictions. For example, a party must consider whether its needs can be met through appropriate licensed rights of use rather than outright ownership or whether the contemplated commercial advantage compels ownership of the IP.

• Pay attention to involvement of third parties. If some or all of the intellectual property (and/or related rights) involved in the applicable HRO arrangement are owned by third parties, each party must consider the impact of such ownership on the allocation of IP rights. The parties should consider the use and re-use rights needed in the third-party intellectual property and whether any additional consents will be required to allocate the rights as contemplated.

Because third-party rights are involved, the IP rights to be allocated may require review separate from the other IP to determine whether the rights can be allocated in a manner consistent with the goals of the parties with respect to the other IP involved. For example, the customer may require rights to use or modify third-party IP that exceed the rights that the provider is permitted to pass along to the customer, which may necessitate involvement of the third party in the IP discussions or a direct agreement between the customer and the third-party IP owner.

•Focus on the business deal. Before starting the negotiation of specific contract language regarding the intellectual property rights allocation, the parties should focus on the business deal as it relates to the allocation. If the parties attempt to negotiate contract language surrounding the intellectual property issues before the parties have discussed these issues, they may be distracted from their focus on finding the appropriate allocation based on their actual business needs.

• Review allocation for economic viability.
Since the allocation of the intellectual property rights may affect the economics of the relationship, the allocation must be considered in relation to the economic viability of the HRO arrangement as a whole. After the parties have come to an initial understanding with respect to a proposed allocation of intellectual property rights, each party should evaluate the terms of the proposed allocation to make sure that the economics of the proposed arrangement still make sense in light of the allocation, which may lead to renegotiation of other aspects of the transaction, including fees to be paid.

• Build flexibility into the contract.
Even where the parties have agreed on an allocation of intellectual property rights that they both believe address their needs and have determined that the negotiated deal creates an economically viable relationship, the parties will want to provide enough flexibility in the outsourcing contract to address new ownership issues and other similar circumstances that arise during the term of the outsourcing relationship. One way to achieve this flexibility is by contractually agreeing on a process for the parties to discuss ownership of future deliverables or make changes to existing IP ownership allocations.

There are many different ways in which intellectual property issues can be addressed and intellectual property rights divided. By taking the time up front to understand the intellectual property issues and deal with the respective needs of the parties, the agreement can take care of the current and future needs of the parties and create an appropriate IP rights allocation. This process will help to realistically shape the outsourcing relationship and avoid unnecessary surprises.

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