In 2000 the prison was ranked among the worst in the country for overcrowding, in a Prison Service report based on Home Office figures.
A plan will have to be submitted to the Commissioner for Correctional Services outlining how they intend to improve things, and Waton bosses will be given top-level support to introduce the improvements.
But if they fail to deliver an adequate plan within six months, the Prison Service will contract the prison out.
The news was announced today by Prisons Minister Hilary Benn after performance analysis branded Liverpool a "failing prison".
It was named along with HMP Dartmoor as being in drastic need of help.
Mr Benn said: "They should see this as a positive opportunit y to improve performance and I hope they will grasp this challenge.
"Performance testing will ensure the prisons real ly are working towards delivering improvements which will mean better treatment of prisoners and more opportunity to reduce offending."
A special board will be set up to evaluate HMP Liverpool's performance.
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