| The trend towards outsourcing will continue to grow | | | | worker is employed by a temporary agency, or similar |
| as market pressures force corporations to be more | | | | entity |
| tightly focused on core business functions, gaining | | | | is not a guarantee against misclassification under the |
| competitive advantage and reducing costs. | | | | joint employer rule applied by the |
| Outsourcing is an attractive alternative in good times | | | | Ninth Cir. Court in Microsoft III. If a misclassification |
| and bad times. Shifting back end administrative and | | | | does occur a firm may qualify for |
| business functions to an external provider in good | | | | an IRS Section 530 "safe harbor" exception if it can |
| times, may be a means for quicker time to market and | | | | show the following:1. Reasonable basis for classification |
| focusing resources on core business activities to grow | | | | of individuals as ICs based on:- Reliance on a relevant |
| the business. In bad times, outsourcing is a means for | | | | court case, the advice of a qualified accountant or |
| streamlining the enterprise by eliminating functions, | | | | attorney, |
| which create a drag on capital and/or do not provide | | | | or IRS ruling;- The IRS did not reclassify the same or |
| any competitive advantage.In the current economic | | | | similar workers in a previous audit;- It is standard |
| environment, concerns over, shrinking margins, liquidity | | | | industry practice to treat the particular workers as |
| and the | | | | ICs.2. Consistently treated same or similar workers as |
| need to reduce operating cost structures is | | | | ICs in the past.3. Consistently filed federal tax forms |
| accelerating a trend towards shifting certain | | | | 1099 on these same or similar workers.Outsourcing |
| back office administrative functions to outside | | | | any critical business function and especially one like HR |
| suppliers. This trend is seen as a major | | | | must be carefully |
| paradigm shift within enterprises, which have realigned | | | | planned and executed to be an economic and |
| their internal corporate | | | | strategic success. HR operations require |
| infrastructure to focus on more strategic areas of | | | | trained and specialized personnel to handle complex |
| their core business.Although the human resources (HR) | | | | processes and manage the |
| function is viewed as critical within corporations, | | | | compliance responsibilities created under the myriad |
| increasingly, small, medium and even large | | | | of federal and state employment |
| corporations are moving to outsource this | | | | regulations. Outsourcing of this function carries the risk |
| service.The case for outsourcing has three basic | | | | of losing qualified personnel and |
| rationales. First the regulatory | | | | a degradation of the function. A firm can ill afford the |
| compliance obligations imposed under ERISA, COBRA | | | | risk of entering into a relationship |
| and IRS regulations, have | | | | with a vendor whose lack of expertise in payroll and |
| become extremely burdensome and expensive for | | | | benefit administration causes |
| companies. Consequently, avoiding | | | | disruptions and a loss of efficiency. This may, in the |
| major legal problems and financial liability requires | | | | worst case, demoralize the work |
| substantial investment in resources | | | | force and expose the firm to significant legal liability. |
| and capital in an area outside of the core business of | | | | Partial success in this area can |
| most companies. This makes | | | | mean total failure and the loss of strategic |
| outsourcing a viable option even if it does not | | | | initiative.Contracting of the outsource service is a |
| necessarily result in a cost savings in the | | | | process which requires inputs from all of the |
| near term. Second, the need to upgrade HR systems | | | | stakeholders (HR personnel, users of the service, and |
| and invest in new technology is | | | | the management team) and those |
| increasingly difficult when companies are hard | | | | persons within or outside of the organization with |
| pressed to invest in functions aligned with | | | | expertise in the function. Before talks |
| the core competency of the enterprise. HR | | | | are ever initiated with a vendor, the key goal is to |
| outsourcing service providers are better | | | | define the scope of the service and the |
| positioned to invest in new technologies and software | | | | performance metrics, which will be applied to measure |
| more likely to conform to "best | | | | success. The use of metrics will |
| practices" for delivery of the service. Third, for | | | | be covered in greater detail below in respect to |
| companies with global operations, | | | | Service Level Agreements (SLAs).Important to both |
| employee self-service can substantially reduce costs | | | | parties in the transaction, is defining the kind of |
| and improve employee satisfaction | | | | relationship, which |
| with the service. However, this requires integration of | | | | must be established for the arrangement to succeed. |
| all processes- HRIS, payroll and | | | | If the entire HR Dept function is to |
| benefits administration- across the entire HR operation | | | | be outsourced then it will be in the interest of both |
| including its global ones.Because of the business | | | | parties to enter into a long-term |
| exigencies driving the shift towards HR outsourcing, | | | | relationship that will justify the up-front costs and |
| the industry | | | | investments that will be required of |
| is expected to grow to $37.7 Billion in 2003. | | | | each of them. This type of arrangement as previously |
| Currently HR outsourcing services fall primarily within | | | | mentioned is subject to the firms |
| three categories: Professional | | | | particular circumstances, and will probably result in |
| Employer Organization (PEO), Business Processing | | | | selecting either the BPO or PEO |
| Outsourcing (BPO) and Application | | | | alternative because of the broad scope of the |
| Service Providers (ASPs).4 | | | | outsourced service. For the buyer this type |
| PEOs assume and take full responsibility for the | | | | of wholesale delegation is expensive, complex and |
| human resources administration, | | | | risky. If it doesn't work out, the |
| including the legal liability for the company's workers. It | | | | buyers will incur significant costs and, disruption to the |
| becomes in essence a coemployer | | | | business in replacing the vendor |
| with final say over, hiring, firing, and compensation | | | | or in bringing the function back in-house.Typically, total |
| decisions. The PEO | | | | outsourcing of a function is a major undertaking with |
| becomes a partner, in the non-legal sense, with | | | | broad implications |
| ownership of the HR function while the | | | | for both the buyer and vendor. In this situation the |
| company retains responsibility over all business | | | | preferred relationship is one that is |
| matters.BPO refers to all business processes and not | | | | more of a partnership, in the non-legal sense, where |
| just HR. Typically this involves transferring | | | | the parties view their interests as |
| the entire function to a service provider and is | | | | mutually benefited by the relationship.On the other end |
| differentiated from PEOs because it | | | | of the continuum is the outsourcing of processes, like |
| usually involves introducing new technologies and | | | | payroll, which is |
| processes to bear in the HR service. | | | | very specific and straightforward and can be |
| Because of the complexity of HR systems in large | | | | executed on a short-term basis. |
| corporations, shifting to BPO may be | | | | Normally, in the HR area, firms will retain part of the |
| more expensive in the short term. However, long term | | | | function in-house, and delegate |
| it can result in benefits because | | | | those functions to an ASP or BPO, which require |
| large HR outsource providers will invest in systems | | | | major investments in technology or |
| and technology viewed as | | | | software. An outside supplier whose core compency |
| prohibitively expensive within a firm where this function | | | | lies within function is better able to |
| lies outside of its core business.The BPO services | | | | absorb the costs, based on economies of scale. This |
| market is growing rapidly with analyst projecting | | | | type of arrangement will generally |
| revenues of $128 | | | | result in an intermediate term relationship where the |
| billion this year and growth to $234 billion by | | | | parties will have to develop close |
| 2005.Finally, ASPs host software on the web and rent | | | | collaboration but will not have to incur the high costs, |
| it to users. The most commonly known | | | | and investment of resources |
| of these packages is "People Soft". The latter | | | | required in a long-term relationship.Partnership |
| application and other packages are used to | | | | arrangements require provisions that maximize the |
| manage payroll, benefits, head count and other HR | | | | flexibility of the vendor in |
| processes.Each of the HR outsourcing services | | | | performing the service. Typically because such |
| described has advantages and disadvantages for | | | | relationships are appropriate in contracts |
| particular enterprises depending, on the number of | | | | with long terms of duration, typically five to seven |
| employees, affordability of the | | | | years, and complex service |
| service, type of business and the degree to which an | | | | arrangements, the approach ought to be less |
| enterprise desires to retain control of | | | | prescriptive with respect to the scope and |
| this function in-house.This paper will briefly cover the | | | | level of service. |
| legal aspects of HR outsourcing and will discuss some | | | | In shorter-term arrangements more typical of supplier |
| of the most common contract issues faced in | | | | purchaser relationships, contracts |
| outsourcing relationships, essential items | | | | need to be more prescriptive in defining the scope of |
| that ought to be considered by the parties and key | | | | the services and the client |
| provisions within outsourcing service | | | | requirements.Generally contracts ought to build in |
| agreements.As previously discussed, companies | | | | some level of flexibility to allow for changes in:business |
| facing pressure to reduce costs or address the | | | | circumstances, |
| personnel shortages due to corporate down sizing | | | | technology |
| have several different outsourcing | | | | and the needs of the buyer.Transfer of Personnel |
| alternatives available to them to delegate back-end | | | | and Assets:Outsourcing arrangements may require the |
| administrative functions. Typically, | | | | transfer of assets and personnel to the vendor. |
| the first alternative firms look to before looking outside, | | | | Defining the terms covering the transfer of affected |
| is to retain control of the | | | | personnel will generally have |
| function in-house and reduce employment related | | | | important implications for the buyer and its employees |
| costs (taxes, benefits, headcount), by | | | | with respect to employment or |
| using contingent staff or (temporary workers) or | | | | employment rights. When wholesale outsourcing of |
| persons classified as "independent | | | | groups or functions occur, it is |
| contractors" (IC) to perform the work. Though this | | | | important for firms to take measures to preserve the |
| may be an appealing solution for | | | | general morale, of those remaining |
| many firms, given the legal and economic benefits, | | | | and communicate openly and honestly with those |
| improper classification of someone as | | | | persons transferred under the |
| an IC, consultant or temporary worker, who is later | | | | outsourcing agreement. Contract terms need to |
| deemed an "employee" carries | | | | address how the outsourcing of the |
| serious financial risks.Friction has developed between | | | | function and subsequent transfer will affect benefits, |
| the growing use of contract workers in lieu of full time | | | | pensions and pay of personnel |
| employees and, the public policy aims of providing | | | | moved to the service provider. Consideration should |
| workers with protections under | | | | also be given to the rights, if any, |
| federal labor laws to take the Employment | | | | the transferring firm may have to either enforce |
| Retirement Income Security Act ("ERISA") | | | | special terms affecting transferred |
| and state law employee remedial measures. In | | | | employees or the right to retain these employees in |
| addition to the tax risk of an IRS audit, the | | | | the event of contract termination. |
| risks are higher today that workers will bring claims | | | | With respect to equipment and other assets, terms |
| for social security, workman's | | | | governing the use by the vendor of any |
| compensation or other actions challenging the | | | | equipment made available to it by the buyer should |
| misclassification, so that they may | | | | specify rights of ownership and other |
| participate in lucrative benefit programs provided by | | | | matters related to the transfer of equipment or other |
| the employer. | | | | items of value.Defining the rights to intellectual property |
| The case that brought these issues to the fore was | | | | (IP) is critical in all outsourcing agreements. |
| Vizcaino v. Microsoft Corporation | | | | Typically the vendor will want to retain rights in any IP |
| ("Microsoft I") and its progeny of cases. In Microsoft I, | | | | developed by it in the course of |
| plaintiffs, employees designated | | | | the arrangement. The thought being that it is providing |
| as temporary workers or "free lancers", brought an | | | | a service and not being paid to |
| action against the corporation to | | | | develop IP. The buyer on the other hand will want all |
| recover savings benefits under ERISA and for stock | | | | rights to IP developed based on the |
| option benefits offered through a | | | | transfer of proprietary or confidential information to |
| stock purchase plan, that were available to regular | | | | the vendor and any work product |
| employees.6 The Court framed the | | | | developed in performing the service. This issue will |
| legal and public policy issues in the opinion's opening | | | | usually be resolved through |
| statement: | | | | negotiation. |
| "Large corporations have increasingly adopted the | | | | Related to this are confidentiality provisions, which |
| practice of hiring temporary employees or | | | | provide important contractual |
| independent contractors as a means of avoiding | | | | protections with respect to each party's right's in and |
| payment of employee benefits, and thereby | | | | use of IP in the arrangement.Services |
| increasing their profits. This practice has | | | | This is will probably be set out in a schedule and |
| understandably led to a number of problems, legal and | | | | negotiated based on the scope of the |
| otherwise. One of the legal issues that sometimes | | | | services and the functions or processes that will be |
| arises is exemplified in this lawsuit. The named | | | | outsourced. As stated previously, the |
| plaintiffs, who were classified by Microsoft as | | | | nature of the relationship, partnership or supplier |
| independent contractors seek to strip that label of | | | | purchaser will determine how detailed |
| its protective covering to obtain for themselves | | | | and specific this ought to be.In any event there should |
| certain benefits that the company provided to all of | | | | be sufficient clarity and definition for the parties to be |
| its regular or permanent employees."The problems for | | | | able to |
| Microsoft arose as a result of an IRS tax audit for tax | | | | set mutual expectations and understand the |
| years 1989 and | | | | deliverables that must be produced under the |
| 1990. The IRS examined the company's employment | | | | agreement. |
| records to determine if it was in | | | | Termination |
| compliance with tax laws. Applying the common-law | | | | Defining the terms for exiting an arrangement is one |
| principles defining the employer-employee relationship, | | | | of the most critical issues in an |
| the IRS concluded Mircosoft's "freelancers" were not | | | | outsource agreement. Generally, early termination |
| independent contractors but employees for | | | | provisions, which set out rights and |
| withholding and tax purposes. | | | | applicable penalties due in such event, should be a |
| In reaching this conclusion, the IRS applied the test set | | | | matter of last resort except in cases, of |
| out under the common law of | | | | material breach or force majeure.Default provisions |
| agency, which requires, in determining if a hired party | | | | should set out escalation clauses and a reasonable |
| is an "employee", consideration of | | | | cure period to |
| the hiring party's right to control the manner and | | | | ensure the parties have procedures for resolving |
| means by which the product is | | | | disputes and issues related to the |
| accomplished. The IRS applies a 20 factor "control | | | | performance of their respective obligations. |
| test" to "assess all of the incidents | | | | There should also be provisions governing the |
| of the relationship" with no one factor being | | | | management of the exit. These should |
| determinative of the employment | | | | include the vendor cooperation in facilitating the |
| relationship of the parties.9 The US Supreme Court | | | | transfer of the service to another vendor |
| reached asimilion conclusion in | | | | and the return of any equipment or other items to the |
| Nationwide Mutual Insurance Company vs. Darden | | | | buyer, which were used by vendor |
| party not to adopt the IRS factors | | | | during the contract. |
| and, instead applied a twelve factors that it | | | | Consideration should be given to other provisions, |
| considered. In assessing the relationship of | | | | which might help to reduce the level |
| the parties the court decided for determining whether | | | | of disruption to the buyer's operations as a result of |
| an individual qualifies as a | | | | the termination of the agreement.What is a Service |
| "common law employee".Microsoft, on first impression, | | | | Level Agreement (SLA)?SLAs in an outsourcing |
| appeared to have taken the appropriate measures to | | | | arrangement identify the service levels or |
| avoid | | | | performance standards |
| stumbling into an employer-employee relationship- the | | | | that the vendor must meet or exceed. The SLA also |
| workers were told they were | | | | specifies consequences for failing to |
| freelancers and signed various agreements classifying | | | | achieve the minimum service level set by the buyer. |
| them as independent contractors, | | | | SLAs should be applied to the key parts of the |
| that included provisions that the workers would be | | | | outsourced service and not necessarily to |
| responsible for paying their own taxes | | | | every aspect. The purpose of SLAs is to ensure the |
| and benefits. However, after having taken these | | | | buyer has the means to control the |
| steps with respect to the form of the | | | | level and the consistency of the service received |
| relationship, the court found that Microsoft had fully | | | | from the provider. |
| integrated these workers into its | | | | Generally, the minimum level that ought to be set is |
| workforce, placing them alongside regular employees, | | | | that which is required to support the |
| sharing the same supervisors, | | | | buyer's on-going business operations and HR |
| performing identical functions and working the same | | | | requirements. An important rationale for |
| core hours. Because Microsoft | | | | outsourcing should be to improve the level and quality |
| required them to work on site, they were given | | | | of the function that is being |
| admittance keys, office equipment and | | | | outsourced. Therefore the minimum level of service |
| supplies of the company.Even after the IRS | | | | should be at least equal to the level |
| determined that plaintiffs were "common law | | | | that existed before the function was outsourced to |
| employees", Microsoft | | | | the provider. |
| attempted to use a temporary agency to "house" | | | | In the HR area metrics are difficult to establish |
| these workers as employees of the | | | | because much of what is being measured |
| agency, so that it could continue to use them in the | | | | is intangible. For example if buyer wants to determine |
| same manner previously described. | | | | the success of a web based |
| On review in Vizcaino v. U.S. Dist. Court for Western | | | | application for benefits, this can only be ascertained |
| District of Washington, 173 F.3d | | | | by surveying user satisfaction. As |
| 713 (9th Cir. 1999) ("Microsoft III"), the Court in striking | | | | such questionnaires and employee satisfaction |
| down the District Court's | | | | surveys become essential tools for |
| modification of the class of plaintiffs, which it deemed | | | | measuring the performance of the vendor.SLAS must |
| a contravention of its order on | | | | reflect the agreement understanding of the parties as |
| remand, rejected the lower court's assertion that the | | | | to what constitutes a |
| eligibility for benefits of these | | | | good result and with respect to measuring |
| temporary agency workers turned on whether they | | | | performance, their agreement on the |
| were employees of the Company or | | | | mechanisms used to measure the result. |
| the agency. The District Court's view precluded the | | | | The SLA should also cover what constitutes the best |
| possibility that the agency and | | | | and the worst-case level of service. |
| Microsoft could jointly employ the plaintiff. The Court | | | | In this regard the buyer will want to incorporate |
| held that at common law it was | | | | service credits, which may become |
| possible for the plaintiff's to be employees of both the | | | | applicable in the event the vendor fails to meet |
| temporary agency and of the | | | | minimum service levels. At the same time |
| recipient of their services (Microsoft), if, based on a | | | | it is also appropriate to consider incentives or bonuses, |
| determination using the Darden | | | | which the vendor can receive for |
| factors, an employee-employer relationship existed. In | | | | achieving the best-case level of service.The point of |
| essence the agency and Microsoft | | | | any negotiation ought to be that it is in the interest of |
| were joint employers and the triangular relationship | | | | both parties that the |
| that Microsoft created was not | | | | vendor meet or exceed the service levels set in the |
| viewed as precluding or as being mutually exclusive of | | | | SLA. The buyers should not exploit |
| a two- party relationship that | | | | the use of SLAs, to reduce costs through the |
| existed between the company and the temporary | | | | application of credits or penalties, because |
| workers. So what are the lessons gleaned from the | | | | this will only inject an unnecessary level of contention |
| Microsoft cases?- Review the language in the | | | | into the relationship that will |
| company's benefit plans to ensure "covered | | | | under cut the development of a partnership between |
| employees" is properly defined within the plan and not | | | | the parties. |
| left to statutory or judicial | | | | SLAs should not have a distorting effect on behavior, |
| interpretation.- The mere classification of workers as | | | | where the vendor becomes focused |
| independent contractors is not sufficient, | | | | only on those aspects of the service, that are |
| and behavioral, financial and the type of relationship | | | | measured, at the expense of other aspects, |
| between the hiring party and | | | | which may not be weighted as heavily in the |
| the workers must support the classification.- Users of | | | | evaluation process. The vendor's goal |
| outsourcing services should apply the 20 IRS factors | | | | should be to meet, or exceed expectations in every |
| to conduct a selfassessment | | | | area covered by service.Born in Havana, Cuba, Mr. |
| of the relationship between the parties.- Consider | | | | Rojas immigrated to the United States in 1961 and lived |
| using only ICs that are incorporated so that the | | | | in Ohio and the U.S. Virgin Islands before settling in |
| relationship is between | | | | Florida in 1967. He studied computer programming for |
| entities and not an individual and an entity.- Ensure that | | | | three years in a high school "magnet" program and |
| the agreement reflects the 20 factors, so for example: | | | | earned his B.A. in English and Philosophy from the |
| allow the IC to | | | | University of Florida in 1978, with honors in Philosophy. |
| determine the means and the methods for delivery, | | | | Mr. Rojas then attended law school at the University |
| limit the agreement to the | | | | of Miami where he received his J.D., with honors, in |
| project, and ensure the contract calls for the IC to | | | | 1981. In law school, Mr. Rojas was an Articles and |
| cover its expenses and benefits.- Require that the IC | | | | Comments Editor of the school's International Law |
| submit an invoice prior to receiving any payments.- | | | | Review and served as a member of the Moot Court |
| Avoid placing IC in situations where work is subject to | | | | Board.Mr. Rojas holds the highest ratings assigned by |
| the direct supervision of a | | | | Martindale-Hubbell, and he is listed in several "Who's |
| company employee.- Avoid imposing administrative | | | | Who" publications including Marquis' Who's Who in |
| requirements on the IC, which are applicable to | | | | American Law, Who's Who In Florida's Latin |
| employees.- Allow the IC to hire and delegate the | | | | Community, Who's Who In Intellectual Property, and |
| work to its employees subject to the | | | | Who's Who in International E-Commerce. He is fluent in |
| requirements of the project.In particular, the fact that a | | | | Spanish. |