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