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Application outsourcing refers to the practice of licensing business software applications - such as spreadsheets, email messaging, word processing, billing, or benefits administration - from an Application Service Provider (ASP). ASPs often bill their clients monthly, which in turn can save a business owner from acquiring the hardware, software and personnel needed to maintain these systems in-house. Small start-up companies which may not have the capital needed to run such operations in-house, or that are under significant pressure to get their products and services quickly to market, are finding that using applications from an ASP to be an attractive option. Similarly, large companies are also taking advantage of the services provided by ASPs, as outsourcing can be an inexpensive means to get the job done with the least amount of headache.
Not All ASPs are Alike
While ASPs are often lumped together under a single category, ASPs differ in the way that they provide their services. Several large software providers have entered into partnerships with Web hosting companies so both the software provider and web host can jointly market and provide application outsourcing services. For example, Microsoft has partnered with Qwest Communications to offer its Microsoft Office suite over the Internet via the Microsoft Network Portal. Other software companies prefer to maintain control over their product(s) and are creating their own ASP business. Still others ASPs, use their own software products. There is also room for niche ASPs: VAR DocMan Technologies will reportedly offer a document management service for law firms that is accessed via the Internet.
Application outsourcing also offers features designed to help businesses run more smoothly. In this area, some ASPs provide access to customer data to third parties selected by the customer. For example, ABC, Inc.'s human resources administrator could have direct access to the data he needs to assist ABC Inc. in its pension administration needs, without first having to make a phone call to ABC, Inc. or wait for a paper or electronic copy of such data to arrive from ABC, Inc.
New Issues Presented By the ASP Model
Because the ASP runs the software at its own facility, and maintains and updates such software with its own equipment and personnel, the ASP can spare the ASP user from some of the more cumbersome legal issues surrounding the transfer of a customer's assets and personnel that may arise in outsourcing agreements involving hardware located at a customer's facility that was previously operated by the customer. On the other hand, a myriad of other complex issues arise.
Before entering into any ASP Agreement, consider the following Nine (9) Issues.
1. Analyze the Software License Provided to the ASP
A potential customer should request to analyze each software license granted to the ASP regarding its scope of use, confidentiality obligations, term, and any restrictions which could impede the customer's use of the software application. If the customer will be using third party software provided by the ASP, the license granted from the third party provider to the ASP may include restrictions regarding certain uses or access to certain information about the software that the customer may not be aware of when entering into an outsourcing agreement. Accordingly, subject to any confidentiality restrictions, the customer should analyze the pertinent software licenses granted to the ASP. If confidentiality restrictions in the license agreement between the ASP and the third party software provider prohibit the prospective customer from performing an analysis, then the customer should demand that the ASP represent and warrant that nothing in its licenses with the third party software provider will impede the customer's planned use of the software application in question.
2. Make Sure These Basic Clauses Exist
The license agreement between the ASP and the customer should address substantive terms such as the fee for the license, the scope of customer's use of the software, and the ASP's responsibilities to the customer regarding maintenance and updates. In the event that the fee structure is to be "fixed", the parties should clearly set forth in the agreement the scope and amount of services to be covered under that fee to avoid future disputes. In the event the ASP will be providing access to customer data for third parties selected by the customer (as discussed above), the agreement should clearly define the scope of such access. For example, different data might be available to different users depending upon the role and affiliation of a given user. The ASP must also be careful to protect its proprietary applications.
3. Keep Your Proprietary Rights
The customer subscribing to such ASP services, should also recognize that it will not have any rights in the software to which it has been granted a license. Thus, if the outsourcing relationship is terminated before the end of the license term, the customer may be left in a precarious position. Accordingly, the customer should ensure that a provision in the license agreement provides for continuity of use in the event of a breach by the ASP. The customer should also ensure that the license agreement specify that the customer owns any data it submits to the ASP and also any data produced by the ASP for the customer under the agreement. The customer will also want the license agreement to specify that the customer has a right to recover its data in the event of termination for any reason.
4. Ensure the Scope of Services is Clearly Defined
The outsourcing agreement should contain a statement of work with a detailed description of the services and functions to be performed by each party. If not properly addressed, disputes may arise as to whether a particular request is outside the scope of the basic services and subject to additional fees. If the statement of work is ambiguous, the ASP may experience "scope creep" in that it will have to perform additional services which it did not intend.
5. Address the Need to Manage the Relationship and Adapt to Change
The outsourcing agreement requires a high level of cooperation between the parties and careful monitoring of the progress of the relationship. Therefore the agreement should set forth specific guidelines and procedures for managing the relationship. For example, the parties should consider establishing formal committees which meet regularly to discuss a written status report of the progress of their projects, as well as any problem resolution issues.
The parties to the transaction should also adopt a flexible attitude towards change because as technology evolves, the business needs of the parties will evolve with it. Accordingly, certain facets of the agreement will almost certainly require modification. The agreement should therefore establish clear guidelines and procedures to address the need for change. Where appropriate, and depending upon the size and complexity of the transaction, the parties might wish to consider drafting a set of guiding principles to take them through the contract process itself. Such guiding principles can serve as a roadmap and create a constructive win-win business environment.
6. Set Forth Performance Guarantees
The outsourcing agreement should contain performance goals for the ASP during the term of the agreement. To the extent possible, the performance goals should be objectively measurable and may include both penalties for under performance and incentives for superlative performance. The customer will likely try to obtain warranties from the ASP with respect to software defects. In response, the ASP will probably want to negotiate a broadly constructed force majeure claus absolving it of any liability for "unforeseeable" forces beyond its control. The ASP should be careful that any performance credits are not overly oppressive. When the penalties and incentives for performance are extreme, the parties are placed in an adversarial position from the outset. This may ultimately undercut the partnership relationship which should form the basis of an outsourcing transaction.
7. Address the Term of the Agreement
The parties should also address issues surrounding the term of the agreement, in particular, whether there should be an automatic renewal of the agreement. The ASP will typically wish to have the agreement renew automatically, subject to price modifications. The customer will typically prefer to have the option of renewal upon notice based on the same pricing structure.
8. Require Confidentiality and Security Obligations
With respect to confidentiality obligations, the ASP should be treated as an independent consultant who is likely to learn confidential information regarding the customer, its business and financial information, customer lists, and intellectual property. To ensure the integrity of the customer's confidential information is preserved, the customer should insist that the ASP bind its employees, and all third parties who might have access to customer's confidential information. The outsourcing agreement should also provide specific details regarding the manner in which the data is to be stored and secured at all times. Finally, the outsourcing agreement should allow the customer to audit the facilities where the data is housed to ensure that it is being secured in accordance with the terms and conditions of the agreement.
9. Disaster Recovery
The outsourcing agreement should address contingency plans for disaster recovery in the event an emergency damages or destroys the customer's data. The customer should negotiate provisions in the agreement for back-up copies of its data to be made on a regular basis, and perhaps stored in a separate facility. The customer may also want to address issues relating to the procedures to be followed in the event such an emergency occurs (e.g. response times). As the ASP will likely have more than one customer to attend to in the event of an emergency, the customer should seek to have the agreement specify the priority with which its data, as opposed to that of other companies, will be handled. The customer may also want to ensure that the ASP maintains adequate levels of insurance with respect to such disasters and that the customer is specifically added as an insured under such a policy. Finally, the customer should obtain the right to terminate the agreement and pursue service options with another ASP in the event of any service interruptions beyond a specified period of time.
Many companies can gain a significant advantage by using the services provided by an ASP. Doing so can free up valuable time and resources, which can then be refocused on core business strategies. However, as the use of ASP services is still infrequent, these agreements should be negotiated, prepared, and reviewed with great care.
© 2001 Melissa C. Marsh. All Rights Reserved.
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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.