What is a Third-Party Contract?
In business, a third-party contract is an agreement between a company and an external entity to carry out a task or service that either empowers efficiency, productivity, or helps mitigate risk. These contracts can be known by various names, such as sales contracts, service agreements, or liability waivers. They are unsuitable in situations where an employer employs a worker directly and also when a business tries to use a contractor who does not have the requisite insurance and other qualifications. Industries that most commonly utilize third-party contracts include the healthcare, manufacturing, technology, and assistance-based industries . For example, medical practitioners in the healthcare industry may enter into third-party contracts with health insurance companies. Similarly, a factory may execute one with a materials supplier or an IT expert in the technology sector may be contracted by a manufacturer seeking assistance with its computer systems. The importance of third-party contracts cannot be overemphasized. In closing, they form the basis for business relationships and shield a company against the fallout from fraud. They outline the rights and responsibilities of each party under the contract, as well as what to do if a dispute arises.
Different Types of Third Party Contracts
As there are many ways that external parties can supply goods, services, or skills, there are many types of third-party contracts. Below are several possibilities of the types of contracts.
1. Service Agreement
Service agreements, or service level agreements (also known as SLAs), can be business-to-business, business-to-customers, or customers-to-subcontractors. The use of service agreements is far-reaching. They can be used in conjunction with:
Human resource teams to define what management teams and employees can expect from each other, as well as what employees can expect from the organization as they carry out their jobs
Sales teams to set expectations around sales, delivery, and payment, so that all parties involved know the minimum standards that each person must meet in order to maintain a good working relationship
Government agencies and private contractors to make sure that each person involved agrees on the scope of work that needs to done by each party involved
2. Supply Contract
The agreement that lays out the expectations between a business and a supplier. For example, suppliers may provide raw materials or necessary operational support like utilities. A supply agreement will lay out such details, including:
3. Outsourcing Agreements
These types of agreements are used when a company outsources work to a third party. It’s important to note that outsourcing agreements are usually not needed for contracts that occur on a one-time basis or that do not involve a significant amount of work or commitment. Often the company will provide samples, design specifications, product specifications, models, and prototypes to the contractor who will manufacture the goods. Outsourcing agreements provide clarity regarding the scope of work, the terms of the contract, the cost, delivery, testing, and acceptance of the goods supplied by the contractor to the organization.
Core Elements of a Third Party Contract
Every solid third-party contract needs a strong scope of work at the base level of its structure. This section ensures both the provider and the requester clearly understand exactly what services are being rendered, as well as helping avoid scope creep that could provide an unnecessarily poor outcome. Be sure to include a comprehensive, specific list of key deliverables in the scope of work, along with the anticipated timeline for project completion.
Another thing that should be included in every third-party contract is a compliance clause. When signing a contract with a third-party, the requesting party is trusting that the provider will be following all of the guidelines and laws set forth by the government. To keep the peace between yourself and the provider you hire, talk with a business lawyer about laying out a detailed clause covering all relevant state and federal laws the provider must follow while securing a contract with your company.
It’s always best for any third-party provider to incorporate a confidentiality clause into the agreement. This clause dictates which party has access to your personal information, what they’re allowed to do with it, and how long they’re allowed to have access to it. In order to keep your trade secrets secure, make sure you include a detailed confidentiality or Nondisclosure Agreement (NDA) that the third-party has to sign in order to receive any of your company information.
One of the most important aspects of securing an effective third-party contract is making sure there’s preventative measures in place in order to end the contract if the need arises. There could be a variety of reasons your business would need to sever the contract, whether at the request of the provider or a failure for the provider to secure results in line with your company standards. To this end, you should always include a specific termination clause that states whether it’s termination at will, or that they have to break one of the contract terms before it can be terminated.
A comprehensive understanding of all the above mentioned clauses of third-party contracts will allow you to move forward with confidence in the plan you have down in writing.
Third Party Contract Risks and Challenges
When entering into a contract, consider these common risks and challenges related to third-party contracts: Compliance risks and legal implications. One of the main risks with any contract is compliance with the terms and specific agreements made. In the case of a third-party contract, issues may range from failing to provide a product on time or to the correct specifications all the way to violating the law or proprietary information. To reduce these risks, there are certain provisions that are common in third-party contracts that can protect all parties involved. Security: Another potential issue with third-party contracts is ensuring proper security. In some contracts, the product or service being provided may need to interface with existing components of a business’ infrastructure. This can introduce security vulnerabilities if proper measures aren’t taken. Data privacy: Maintaining the privacy of sensitive data is also an area for concern in third-party contracts. The two parties must define how information is collected, reviewed, stored and used to ensure it doesn’t fall into the wrong hands. Liability claims. When issues arise with third-party contracts, the parties can often find themselves in disputes over who is responsible for what. That’s why it’s important to address these issues in the contract before it gets signed so that everyone has a clear understanding of what’s expected from them and that contracts are enforced according to the expectations set. Business climate changes. Changes in the business climate, such as a company merging with another or going through bankruptcy, can also affect third-party contracts. In these situations, it’s important to identify who will be responsible for the contract and what obligations either party may have to meet.
Third Party Contract Best Practices
Due diligence with each third party is critical. You must ensure that the individual or business with whom you are contracting is reputable. The internet has made this relatively easy to accomplish. Moreover, many industries have established licensing and certification requirements that third parties are required to meet. First, check to make sure that the party with whom you intend to enter into an agreement is licensed and that their license is in good standing. Next, conduct an internet search on the third party’s name, corporate status, and address. The last step in due diligence is to contact references. Check to see if the third party has a list of references that you can contact. Reputable third parties will be able to provide a list of references. If they are not able to, then walk away from the deal before it is too late.
The second best practice to keep in mind when drafting a third party contract is to be clear and concise. Define all terms used in the agreement. When doing so, the parties should examine any terms that are frequently used in the industry. For example , if you are contracting with a software company to create an online ordering platform, be sure to define what CMS, FTP and SKU are in the agreement. Likewise, the parties should also define in the agreement what constitutes "delivery" or "acceptance."
Once the agreement is drafted, read it through and make sure that it makes sense. If it doesn’t, then rewrite it or ask the third party to rewrite the contract.
The third best practice is to revisit the agreement on a regular basis (e.g. quarterly, annually, etc.). Third party contracts should be treated as living documents. Circumstances change and the agreement should account for those changes. Moreover, the agreement should also be reviewed in order to confirm that the third party is complying with the contract.
Finally, third party contracts should always include a dispute resolution mechanism, such as mediation and arbitration. This will allow the parties to resolve disputes in a way that costs less time and less money, than a litigation in court.
Legal Considerations for Third Party Contracts
Third-party contracts must also take into account legal obligations, especially when the third-party is a government agency. It is important that any agreement be compliant with the laws of the relevant jurisdiction(s) and that compliance with the law itself is specifically addressed in the terms of the contract. Whether or not the agreement itself is valid under applicable law, most regulations require that contracting parties ("Contractors") be professional and registered. For example, Contractors who do business with the United States government have to adhere to the requirements set forth by the Federal Acquisition Regulation (the "FAR"), and comply with all applicable laws governing the agency in the event of a dispute. Additionally, Contractors must comply with laws dictating fair, healthy, and safe working conditions, which vary from state to state.
If the Contractor is an overseas company, that company must also adhere to the Foreign Corrupt Practices Act ("FCPA") that governs how U.S. companies are required to conduct themselves. FCPA provides for potentially severe penalties for U.S. Companies that make payments or exert other improper influence upon foreign officials. The FCPA applies to all U.S. persons and entities and their foreign affiliates. A U.S. person or entity include: (1) any citizen, national, or resident of the U.S., (2) any domestic concern (any individual who is a citizen, national, or resident of the U.S. or any business entity which is created under the laws of the U.S.); (3) any corporation, partnership, association, joint venture, business trust, cooperatives, or other form of business enterprise organized under the laws of an states or territory of the U.S., the District of Columbia, or any commonwealth, possession, or other territory of the U.S.; and (4) any individual acting within the scope of his or her employment for a domestic concern. The FCPA prohibits corrupt payments to foreign government officials and certain other individuals.
Examples of a Third Party Contract
To illustrate the real-world applications of third-party contracts, it is useful to look at several case studies of how they were structured and the outcomes they facilitated.
One of the most common uses for third-party contracts is for a language services company to have its translators sign a contract to protect the company and the confidential information of its customers. These contracts are relatively straightforward but can vary in length and nuance depending on how heavily a provider wants to protect the information that they have access to. A very strong language service provider, such as Lingoport, will have no problem obtaining signed contracts from their translators because the extent of language service providers’ management of client confidentiality is not widely known. Due to this oversight, many interpreters and translators believe that the work they are performing is done under a traditional employment agreement, where confidentiality is inherently protected by virtue of the employment.
Another example can be seen in a recent story of a NYC startup soliciting translators for quick jobs. While this company was clearly getting its project done more cheaply than the usual rate, its operations could have been vastly improved with a simple NDA. By having no confidentiality protection in place, the company suffered several losses to competitors who had access to their work product. In other words , the language service provider that had a simple inventory of approved contractors was winning business and scaling at a faster rate than this NYC company, because each employee had Hamger’s MDAs, non-compete and confidentiality agreements in place and incentive plans to keep them around.
A third example is a broader one. FedEx makes a great deal of its business by outsourcing its delivery drivers at the country’s Post Offices. By having these contracts in place, FedEx protects itself from many regulatory threats, such as being responsible for the payroll costs of temporary Postal employees. In exchange for its service, FedEx is able to bill the U.S. Government at greater rates for its deliveries.
Another common example can be seen in the use of outsourcing, which has a broad range of application in today’s economy. It is rather ubiquitous for many industries, though within the language services space, outbound telemarketing is dominant. Many outbound telemarketers are contracted to Manage a publisher’s subscription renewals. The publishers then turn over its renewal pipeline for a few hundred-thousand dollars to the lead generation services company. With this arrangement between the two companies in place, the publisher’s employees can focus on more value-added activities than making calls. In this particular arrangement, there are many Third-Party contracts at play, including MDA, NDAs, confidentiality agreements, and sometimes non-competes.