Labor and Employment Law Issues in UK and EU Outsourcing Transactions, Part 2: A Conversation with Lee Harding | Morgan Lewis – Technology and Procurement

Welcome to the conclusion of our two-part Spotlight article with Lee Harding in which we discuss the main employment/labour and employment law issues in relation to outsourcing transactions in the UK and EU. In Part 1we’ve talked about the main initial considerations and the specific timelines involved.

Lee, welcome back. We understand that the issues you raised last week can affect both the supplier and the customer. Are there key differences in what each company should consider?

Each outsourcing transaction is unique, but certain themes will be particularly important for each type of business, depending on whether it is the supplier or the contractor.

For the client, a key consideration will often be to ensure that the outsourcing transaction can be handled smoothly in a way that does not create disruption or inconvenience to its business and does not affect, for example, its ability to provide products and services. There may be industry-specific considerations. For example, if the client is a regulated financial services firm, it may be necessary to make certain notifications to regulators or ensure that additional planning is in place to protect consumers.

The client will often want to ensure that the costs associated with the outsourcing transaction are kept to a minimum. There will sometimes be a tension here between the needs of the supplier and those of the customer. For example, deciding that the principle of automatic transfer does not apply in a given country could lead to lower costs for the supplier supporting these services. On the other hand, such an outcome could lead to significant costs for the client if it has to go through a large-scale restructuring exercise with undesirable personnel.

Even though cost savings can be found in an outsourcing solution, the client may want to provide certain protections to their staff in order to convince internal and external stakeholders that the client cares about their staff. Investors are increasingly focusing on this issue as part of a holistic assessment of environmental, sustainability and governance objectives.

The Client may also want to prescribe the manner in which any personnel working on the Services are engaged. For example, in the UK, restrictions on suppliers seeking to hire non-standard workers, such as independent contractors, have been significantly tightened given the non-payroll work rules introduced in the private sector. Simply put, these rules are designed to make the end user more responsible for taxes and social security contributions when engaging these workers through an intermediary. There are some exceptions to these restrictions, but many customers take a conservative approach within market practice and insist that suppliers employ employees.

Another issue that can often arise is ensuring that the provider performs all necessary background and screening checks on personnel engaged in the services. For the customer, this may be important if he has promised to meet these obligations to his own customers and must pass on these obligations to suppliers.

From the supplier’s perspective, one of the main considerations will be to ensure that they have full visibility into any potential liability, both when entering into the contract and after any exit from the services. Often, the provider will want to avoid what is known as stranded liabilities at the end of the contract, i.e. being left with all the staff costs but none of the revenue from their services. The supplier will need to ensure that these costs are properly incorporated into their business model and that appropriate commercial protection is provided.

How are these potential issues typically handled? Are there both contractual and operational considerations?

Where the principle of automatic transfer applies, it is common for the client to be largely responsible for any employment-related liabilities that arise in the course of the client’s management of the services (i.e. before the transfer date), and that the provider is globally responsible for all employment-related liabilities that arise in connection with the provider’s operation of the service (i.e. after the transfer date). If there are deviations from this principle, there should be a good business justification for doing so. To take one example, it is not uncommon for a customer to take responsibility for any unfunded pension liabilities that pass through to the provider (even when those liabilities were not triggered prior to the transfer date) on the grounds that these costs have not been factored into the supplier’s business model.

To take another example, there could be a situation where so-called out-of-scope employees claim that they have been transferred from the customer to the supplier. These people are the people that neither party planned to transfer and who were not considered to be assigned to the transferring services.

First, employment considerations are taken into account through appropriate guarantees and indemnities. Generally, Customer may indemnify Supplier for any employment-related liability that arises prior to the transfer, while Supplier may be liable for any liability that arises after the transfer.

There will be some exceptions to this principle. If, for example, a supplier fails to comply with its obligations to inform and consult employee representatives due to the fault of the supplier (perhaps insufficient information was provided by the customer or the previous supplier), the parties may agree that the client should be responsible for this failure.

There will also be other scenarios to consider. Sometimes liability can arise when neither party is at fault, for example if an employee claims that he was transferred under the principle of automatic transfer when neither party expected this person is transferred. In this situation, it is common to agree on a dispute resolution process that is fair to both parties.

In addition to contractual arrangements, there will be important operational considerations. Those responsible for managing the contract should be aware of the various obligations that may apply. There may be regular reporting obligations or the supplier may be prohibited from taking such actions at certain times, such as redeploying staff or changing terms and conditions without the customer’s prior written consent.

Additionally, in many countries, the supplier will need to manage the project staff in a dedicated and organized way to show the supplier that these staff are properly assigned to the services and should therefore automatically be transferred with the services at the end of the contract. . If the contract is run more as a shared service for a number of different customers, those people can stay with the supplier under the law, which would then amount to stranded employment liabilities. In other words, the supplier may be responsible for all redundancy costs associated with any undesirable personnel.

Are there other transactions where clients should consider labor and employment issues?

Yes, for most transactions, labor and employment law issues will need to be considered to a greater or lesser extent.

For an intellectual property (IP) rich company, it may be necessary to ensure that any intellectual property created by staff has been properly attributed to the target company being acquired. Sometimes intellectual property will be assigned to a different company for tax or other reasons. Similarly, the buyer may wish to be assured that any intellectual property or confidential information used by the company was legally developed by staff. There are high profile examples where this did not happen, and the buyer then had to settle costly trade secret lawsuits with third parties and effectively shut down the business.

If a target business has significant staff or employee relationships, the buyer will want to ensure that the right business protections are in place, such as appropriately worded notices, garden holidays, and restrictive covenants. Likewise, key employees will need to be incentivized to stay through appropriate retention agreements that align the interests of those employees with the future growth and success of the acquired business.

Increasingly, clients are looking at broader cultural issues to ensure the right match between the buyer and the business being acquired. These questions of corporate culture will be essential to any future integration to achieve the desired synergy.

We thank Lee for sharing his thoughts and insights on labor and employment issues in technology transactions.

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