Using Negative Incentives in Outsourcing Agreements to Drive Performance

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It’s increasingly necessary to use negative, compensation-reducing mechanisms to prevent vendors from intentional or negligent breach of contract that may damage your company or brand. This is particularly true in international business or contracting for foreign outsourcing services.

In foreign business outsourcing contracts, the courts may not be very helpful in providing effective relief. For example, a Texas litigation attorney may successfully get a judgement against a foreign entity for breach of contract, but collecting the money on the judgement from a foreign debtor is often difficult.

Incentives in Outsourcing Agreement Contracts

Because courts might not provide enough protection for international business outsourcing, part of structuring security into your business contracts should include processes and mechanisms that handle problems mid-stream. For example, many IT contracts have clauses that reduce compensation when performance temporarily falters or declines in quality.

However, it’s important to remember that these mechanisms are essentially “liquidated damages,” and will be unenforceable if they are merely penalties. They must have a reasonable relationship to damages or loss. For each negative financial incentive you build into your contract, develop a formula that demonstrates a reasonable forecast of potential losses.

Outsourcing Project Payment Structure

Another important risk to hedge is the inclination that a vender may have to underperform toward the end of their contract. This is especially true if the vender knows that the contract will not be renewed. To prevent your vender from breaching the contract or underperforming at the end of the contract cycle, it’s sometimes a good idea to use compensation retention mechanism with your price structure, allowing you to withhold sums from each payment (perhaps 10% – 15%) as security for full performance of the contract terms. This security deposit can protect you from any damages, losses, or sudden breaches that may occur, and can be refunded to the vendor at the end of the contract.

Above all, it’s important to engage a contract attorney who can identify other hidden risks and custom tailor contractual solutions that prevent problems from emerging. The Blake Law Firm counsels medium and small businesses in both domestic and international outsourcing matters. Contact our Austin business law firm today to ensure that your company is not subject to problems and risks that could arise in your outsourcing agreements.

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