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By: James E. Meadows and Terese M. Connolly, Culhane Meadows PLLC
This article discusses special issues that may arise in the context of Human Resources Outsourcing (HRO). HRO is a form of business process outsourcing (BPO) focused on the functions that have typically been performed or managed through a company’s human resources (HR) or personnel department. The accepted industry definition of an HRO transaction is that it includes a minimum of three HR functions and service to more than 3,000 employees.
CONTRACTING WITH A MANAGEMENT SERVICES COMPANY to process the company’s payroll is not considered outsourcing, even though some of the concepts discussed may be relevant to a customer’s hiring of such a company. The issues that customers should address in connection with the outsourcing of HR functions can be broadly grouped into three types: compliance, contractual, and operational. This article explores these issues and provides best practices for how to address them so that the HRO deal is successful.
An HRO deal involves the management and processing of people, so the issues likely to be encountered in such a transaction, and the solutions designed to address them, are specific to this type of deal. Contractual issues are typically addressed in the agreement itself, or the legal front end of the statement of work (i.e., not the business-specific schedules thereto). Operational issues are often addressed in the back end of the statement of work and certainly in the schedules thereto. Compliance issues are a subset of each of the foregoing two issue types and are focused on the heavily regulated nature of the subject matter.
The key to the success of any type of outsourcing deal is establishing a review process for gaining an in-depth understanding of the tasks or functions that are within the scope for outsourcing. This is particularly the case in an HRO transaction where the tasks and functions were previously a part of a worker’s job description. Sometimes the review will lead to an expansion or contraction of the scope as more is learned, but such an in-depth review will always allow the customer to include in its requirements (e.g., in a request for proposal) precisely what the customer is seeking to procure and the desired standards to be achieved. This indepth understanding will allow the customer to discuss such requirements with the prospective service provider(s) to ensure that a meeting of the minds is achieved at the outset. The customer will also be able to document such requirements, and the methodology by which the requirements will evolve, in a definitive contract.
Compliance issues are identified through a detailed understanding of the subject matter of the proposed outsourcing. The purpose of this section is to describe select subject matter types (often called functional areas) that might be encountered in a particular HRO deal in order to facilitate spotting compliance issues. The next section, on contractual issues, identifies the general approach to the compliance-withlaw topics in the main agreement. In general, the customer looks to the service provider to propose industry best practices for the customer’s review and approval, based upon the service provider’s domain expertise.
Staffing or recruiting is defined by developing candidate pools, assessing and selecting candidates, managing the administration of the staffing process, and developing related strategies. Staffing services include the administration of third-party service providers, management of logistics, and assessment of sourcing strategies. The process involves staffing activities in accordance with organizational policies, government regulations, and equal employment opportunity (EEO) compliance, and includes electronic sourcing of applicants, electronic data capture of applicant information, applicant screening, interviewing, and related activities. If the service provider uses algorithms to process large amounts of data from applicant pools, then best practice dictates that the parties work together to develop inputs that focus on job descriptions, rather than personal characteristics, in order to minimize the risk that human biases will continue to be embedded in the algorithm’s outputs and result in disparate impact. If the service provider alone determines the inputs, then any liability stemming from the same should be allocated appropriately. This is a point of negotiation between the parties that must be considered.
New hire/onboarding is the assimilation of a new employee, a rehire, reinstatement, or a transfer. A variety of tasks are involved, including HR, payroll data, and benefits enrollment. This process includes IT access, facilities, equipment assignment, ID badges, etc., which the service provider will often facilitate through tools, programs, and materials that it will design and implement on the customer’s behalf. The responsibilities may include the integration of the process with related processes (e.g., strategic staffing), together with technical integration among various tools that support recruiting, new hire, and computer system security (e.g., implementation of access controls and security credentials). Many onboarding documents, such as job applications, offer letters, and job descriptions (among others) must comply with various federal, state, and local laws and regulations.
Employee and Manager Self-Service (HR Portal)
Employee and manager self-service generally encompasses those activities that employees/managers can perform directly through online system capabilities or services and information that employees/managers can access through online vehicles. Within many organizations, these vehicles are spread among numerous (often not connected) systems and applications, and an HRO service provider may be engaged to create an integrated HR portal to deliver access to HR information and services via direct access vehicles (e.g., interactive voice response, web, direct access). To accomplish the integration, the service provider will leverage web technology to enable customer employees to view and maintain their personal HR information, including pay stubs, open enrollment, life change events, benefit enrollment data, etc. The service provider will also leverage web technology to enable managers to view and manage information on their employees, such as salary planning, approving pay increases, submitting open position requests, approving time worked and paid time off (PTO), etc.
HR Service Center
HR Service Center refers to all activities associated with the processes that deliver query and issue-resolution services to customer employees, whether such services are delivered via a call center or through other business HR functions. The primary reason that an external service provider is engaged is to establish an integrated one point-of-contact for all functions and processes, robust case management technology and processes, and increased service center technology capability.
Payroll services include computing, reconciling, and filing all payroll-related taxes, withholdings, and employerpaid tax liabilities; online access to tax forms and W-2s; managing compulsory deductions; and performing accounting transactions related to labor distribution at a detailed level, including general ledger interfaces. Payroll services also include responsibility for interfaces to and from the payroll process (relating to payroll-required or derived data). From a payroll perspective, the service provider is generally replicating all of the payroll services that the customer is currently performing internally or through an existing payroll-services vendor. Enhanced tools to capture and track time and attendance data are often part of the mix. The goal is to have one repository to track information on PTO, sick pay, Family and Medical Leave Act leaves, jury duty, bereavement, emergency leaves, etc., allowing employees to request days off and managers to approve those requests and track what has been earned and taken. By having this data available, PTO pay-outs upon termination can be automated and management reporting and trend analysis can be performed.
When it comes to compliance, of all the functional areas, this one is fraught with problems. Employers must comply with a plethora of wage-and-hour laws and regulations at the federal, state, and local level across all 50 states. For example, pay stubs must contain certain information. Each state’s laws on this are different, and the costs of getting pay practices wrong can be very high. One strategy is to comply with the most comprehensive state’s laws and be overinclusive as opposed to underinclusive. Another strategy is for the customer to provide a pay practices chart containing all requirements in each jurisdiction where the customer operates. The chart should be updated regularly. The agreement should include this pay practices chart in a schedule, requiring the service provider to comply. If no such chart is contemplated, then the liability for compliance should be negotiated between the parties and outlined in the agreement.
Benefits includes a benefits strategy definition, benefit plan design, benefits administration, and the communication of benefits plans/programs to the employees, as well as administering, managing, and monitoring internal and external delivery of benefits administration services. The customer generally retains responsibility for defining its benefits, strategies, and policies and will maintain responsibility for designing and developing plans in support of such strategies and policies. The customer will also determine the appropriate competitive level and mix of benefits that will be offered and retain responsibility for establishing the fiduciary and business requirements to govern the plans and/or providers. The service provider, on the other hand, is often looked to for automating the process as much as possible, including via the HR portal, where employees/managers can process all self-service transactions and find benefits-related information.
Compensation includes the development of global compensation strategies, philosophies, and programs, and the effective communication and administration of those issues. In essence, the service provider becomes a consultant to the customer, applying its expertise and experience (across its broad customer base) to advise the customer on industry practices. It also includes the management and administration of the customer’s:
To the extent that the service provider uses algorithms to process large amounts of data for any of the above areas, best practice dictates that the parties develop inputs that minimize the risk that human biases will continue to be embedded in the algorithm’s outputs and result in unequal pay practices in violation of the law.
Employee data administration/employee records management, or data administration, is defined as the performance of all activities necessary to capture, track, modify, and report employee-related electronic and physical data. Employee data includes data on active employees and inactive employees and limited electronic data on a segment of retired employees. This aspect of the deal will typically trigger an extensive privacy and data protection discussion. The service provider will typically have (or will design and deliver) tools, programs, and materials to assist in the deployment or change of processes, systems, or tools, often resulting in an information technology (IT) component added to the deal.
As part of the pre-deal review process, the customer should review the types of data being outsourced and set time frames around retention and destruction of same with the assistance of legal counsel. Not all data should be retained indefinitely. Additionally, the customer should establish a detailed litigation-hold process.
Learning is a popular addition to the scope of many HRO deals. It involves building out and/or deploying the customer’s learning management system to the relevant employee population and ensuring consistency for the company’s technical and non-technical training offerings. Enhanced portal functionality is often a goal of this aspect of the deal, including personal learning plans, choice of language, targeted messages based on business unit, and various search capabilities and security access controls applied to output reports. Program logistics (from travel to production of training materials) will be managed by the service provider, along with employee enrollments. The employee enrollments may be by invitation only, with passive managerial approval, or they may be open, with the service provider managing employee transcripts per the customer’s directions.
There are many federal, state, and local laws and regulations that require specific types of employee training. Such training is typically required on a yearly basis. All such training should be administered in accordance with the applicable laws and regulations.
The customer’s employee relations department is responsible for developing, disseminating, managing, and interpreting the customer’s employment policies and for ensuring the appropriate resolution of employee-related issues. Customer employees are provided several avenues through which to raise concerns, including the HR service center established by the service provider, which must ensure that the service center is trained and prepared to receive and document employee calls or emails raising concerns and refer the issues appropriately. The service provider is often in a position to provide tools to improve the customer’s ability to document and monitor such issues. To the extent a customer has subsidiaries, affiliates, and other operations outside the United States, it should ensure that the service provider’s HR service center is compliant with local laws and is culturally appropriate. This will be especially important in the area of data protection and data retention.
Many large companies conduct employee engagement surveys periodically, seeking input on all or a significant cross section of its employees. If this function is part of the HRO deal, the service provider will take over the management, development, and administration of the survey, even though most (if not all) of the components of the design and communication of the survey will generally be maintained by the customer. The tracking of the survey and compilation of the results will be managed by the service provider. A key customer expectation is the possibility for greater data manipulation and analysis–broken out by any of a wide range of categories–than might currently exist (prior to the HRO). Discuss whether and how to keep such survey results anonymous. The administration of the survey will be integrated within the HR portal, discussed above.
Performance management and succession management have been identified as problem areas in many companies. Performance management includes appraisals, reviews, goal setting, competency assessment, and development planning. Succession management includes assessment of potential and leadership competencies, talent reviews, and development. Often, companies turn to external resources, including HRO service providers, to transform the process, providing greater portal functionality, such as cascading of goals from organizational to business to individual, linkage of development plans from business goals/review results to the learning management system, and utilization of integrated system technology and processes to create user-ready talent profiles to eliminate the need for manual paperwork during talent reviews.
Relocation refers to all functions associated with relocating existing employees or new hires from one geographical location to another, including policy development, employee education and communication, third-party service provider administration, transferee expense processing, third-party service provider bill paying, cost tracking, and issue resolution. The service provider is generally expected to provide expanded systemic support to manage the workflows involved in initiating and tracking relocation activity for both the manager and employee.
Expatriate relocation and administration includes the design, processing, and monitoring of expatriate employee policies, management of the special needs of the expatriate employee population, tax preparation services, and administration of expatriate employee relocation programs. This includes:
To avoid the usual expat assignment problems, such as accidentally creating a permanent establishment in the foreign jurisdiction, legal counsel should evaluate all expat assignments.
Termination is the administration and execution of employee terminations. This process includes the preparation of termination documents; establishing eligibility for benefits, pension, and Consolidated Omnibus Budget Reconciliation Act issues; partnering with third-party service providers for data feeds and processing final payment in conformance with all applicable laws, etc.; and customer guidelines. Unfortunately, final pay practices are often areas where compliance is difficult, and even the best service providers can get this wrong. The costs of getting it wrong can be high. Best practice dictates that the customer should provide a final pay chart containing all requirements in each jurisdiction where the customer operates, and the chart should be updated regularly. The agreement should include this chart in a schedule, requiring the service provider to comply. If no such chart is contemplated, then the liability for compliance should be negotiated between the parties and outlined in the agreement.
Compliance with Laws
It is essential that a service provider commits to complying with all laws applicable to its performance of the designated services. However, one of the most contentious points in many negotiations on this topic surrounds the service provider’s responsibility for complying with all laws specifically applicable to the portion of the customer’s operations that are performed by the service provider as part of the services, just as if the customer had performed the services itself (customer compliance requirements). Furthermore, the customer will want to ensure its own ability to interpret and augment compliance with this body of laws.
In perhaps no other outsourcing type is this issue more important or more relevant than in an HRO deal. This is because the employees managed through the in-scope processes are the customer’s employees, so the law places the legal obligation on the customer. There are a wide range of laws on the state, local, national, and international levels that are applicable to the employer-employee relationship. Therefore, the shifting of this responsibility should be made very clear in any agreement governing an HRO transaction.
Changes in Laws
The service provider is generally obligated, with the customer’s approval (where there is a potential impact to the customer) and at the service provider’s expense, to conform the services in a timely manner to any changes in the compliance matters applicable to the service provider’s performance of the designated services. The service provider should also be obligated, with the customer’s approval, to conform the services in a timely manner to any change in customer compliance requirements. Conformance of the services under this latter requirement may also be at the service provider’s expense with respect to changes in customer compliance requirements that are applicable to the service provider’s other customers for services that are the same as or similar to the services or relevant components or modules of the services (e.g., changes in withholding percentages, etc.). With respect to new or revised customer compliance requirements that are unique to the customer (which is generally not the case in HRO deals) and require sustained, substantive changes in the services or increases in the resources required to perform the services, a mechanism can be established to adjust the charges. The mechanism is subject to a requirement that such changes and adjustments can be integrated in a cost-effective manner and without disruption of the customer’s ongoing operations, as modified by such changes.
A common requirement under most outsourcing agreements involves the service provider’s maintenance of a procedures manual. Like compliance with laws, this requirement is uniquely important in HRO deals to ensure that the customer has an adequate understanding of the support it is receiving at any given point in time, especially upon termination. The initial procedures manual is typically developed during transition and is subject to review and written approval of the customer. Note that this review and approval is generally not contentious, as the purpose of the document is not to expand or alter the scope of the services or the parties’ respective responsibilities, but to capture how the support will actually be provided. The service provider is responsible for the preparation, accuracy, maintenance, and currency of the procedures manual and should be required to propose updates as necessary to reflect any substantive changes within a reasonable time prior to the implementation of such changes. The processes and procedures contained in the procedures manual should be of such quality as to reasonably ensure that the services are performed accurately and in a timely manner. The procedures manual, and any derivatives thereof, should be deemed work product to be owned by the customer and to enable the customer’s use of the materials, including following the termination of the relationship.
Employee Data and Information
Employee information generally refers to records, files, reports, and other data relating to the customer’s past, present, or prospective employees that are provided to the service provider by or on behalf of the customer, or otherwise collected or obtained by the service provider, in connection with the services, as well as any information derived therefrom. Depending on the services, employee information may also include such records, files, reports, and other data relating to the customer’s retirees and, as applicable, to their respective applicants for employment. This information is extremely sensitive, both to the customer and to the individual persons to which the information relates; therefore, great care must be taken to protect this information contractually, including:
As an adjunct to the sensitivity of any employee information from a contractual perspective, the service provider should also commit to complying in all respects with all relevant laws (domestic and international) relating to the holding, processing, and protection of data. In the event that any transfer of personal information is subject to the EU Data Directive or any implementing legislation, then the parties may need to enter into a processor agreement, as mandated by such laws. The customer and service provider should agree to endeavor in good faith to determine whether execution of the processor agreement is necessary with respect to any given data flow into the United States, both at inception and over the duration of the contract, as the laws in this area tend to shift frequently. The customer and service provider should enter into such agreement, to the extent necessary and required pursuant to the contract’s terms, within specific time frames specified in the contract. The scope of the processor agreement should be limited to the subject matter required under the applicable laws and not necessarily to other unregulated data, to ensure that it will not have any unintended impact on any transfers of other data.
Service Levels and Customer Satisfaction Surveys
As in most large outsourcing deals, the service levels to be measured in an HRO transaction will likely be extensive, ranging from IT system-type measurements (like uptime/ availability for the HR portal) to BPO-type measurements (such as the accuracy and timeliness of the service provider’s performance of various tasks), and measurements tied to the customer’s objectives in entering into the HRO deal in the first place (like shortening the cycle time for filling vacant positions). These latter two categories are often measured by percentage of success over the course of a month for the service provider to have a population to measure against and to ensure that a single blip (as might be used with event-based measurements) does not detract from the service provider’s overall performance. An example in the payroll context might be the percentage of payroll checks issued within the lesser of the customer-defined timeframes or legislation-required timeframes. Hopefully, the answer to this measurement is 100%.
One of the other key service level measurements in an HRO deal, which by definition is focused on the customer’s personnel, is whether the service provider is achieving the desired benefits, both from an employee perspective and from a management perspective. To measure this somewhat subjective element, the service provider is often required to administer employee- and manager-satisfaction surveys tailored to each of the functional areas to which the customer is providing support. The surveys should cover, at a minimum, a representative sampling of employees and senior management of the customer, as applicable, and in each case as specified by the customer. The timing, content, scope, and method of the surveys should be as directed by the customer, with the customer having the right to audit the service provider’s administration of the surveys and all data associated with the administration of such surveys, including the raw data comprising the survey results.
Access to Facilities
Because of the high-touch nature of many of the HRO services, such services may be performed from the customer’s location. Accordingly, the HRO contract needs to provide for such access, ensuring that the service provider follows any applicable regulations, lease restrictions, rules of conduct, and security procedures of the customer’s facility. The customer will generally agree to supply water, sewer, heat, lights, air conditioning, electricity, janitorial services, mail services, office equipment, and furniture for any contemplated supplier employees, although the service provider will generally be required to supply cell phones, personal computers, and other materials for its personnel. Office space should be in accordance with the customer’s space standards, which the customer should reserve the right to revise from time to time in its sole discretion.
The service provider should be solely responsible for the conduct, welfare, and safety of its employees, subcontractors, and agents while in customer facilities. Additionally, the service provider should undertake all necessary precautions to prevent the occurrence of any injury to persons or property or any interference with the customer’s operations while occupying such space. The service provider should contractually commit on behalf of its employees, agents, and representatives to submit to any security requirements of the customer and to comply with all rules and regulations established by the customer, including physical security requirements like badging and respect for restricted access areas.
Furthermore, the service provider should be prohibited from providing or marketing services to any third party from any customer facility or location.
Governance is important in any outsourcing deal because the corporate objectives, management objectives, competitive challenges of the marketplace, and the technologies and value propositions available for the duration of a long-term deal are all subject to change. This is particularly the case in an HRO deal. Thus, it is important that a well-considered governance structure and operational governance principles be established at the outset in order to be responsive to the changes occurring over time to meet the customer’s objectives, which may include some of the following:
The reporting requirements associated with an HRO deal are extensive, just as they likely were imposed on the internal HR department prior to the outsourcing. These requirements often lead to one of the more detailed schedules to the agreement, defining each report the service provider is required to produce and when it is to be produced (periodically or on demand). The type of reporting may generally fall into the following categories:
If a service provider will be using algorithms to handle any of the functional areas where it is providing services, the details surrounding the use of algorithms must be a high-priority item during negotiations. The parties must consult legal counsel to determine how much, if any, control each wants or should have with respect to the algorithm inputs. Additionally, because the algorithms can potentially yield outputs that have an adverse impact, carefully review the liability surrounding the same.
James E. Meadows is a managing partner and chair of the Outsourcing Practice Group in Culhane Meadows’ New York City office. Jim has over 30 years of experience focused almost exclusively on outsourcing and technology transactions and related legal matters, including counseling clients on structuring (or terminating) long-term or strategic information technology or business process outsourcing relationships. His clients are among the largest companies in the world, spanning a wide range of industries, including financial services and insurance, energy, transportation and logistics, travel, telecommunications, technology and related services, manufacturing and media services. Terese M. Connolly is a partner in the Labor and Employment Practice Group in Culhane Meadows’ Chicago office. Terri has over a decade of experience focused exclusively in the area of domestic and international labor and employment. She regularly assists clients and manages international counsel in providing advice and counseling on domestic and cross-border transaction issues involved in mergers and acquisitions, corporate reorganizations, outsourcing, and privacy transactions, as well as post-acquisition integration, global audits, and global codes of conduct.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Commercial Transactions > Outsourcing > Negotiating and Drafting the Outsourcing Agreement > Practice Notes
For an overview of the process of finding an outsourcing partner, see
> THE OUTSOURCING PROCUREMENT SOLICITATION PROCESS
RESEARCH PATH: Commercial Transactions > Outsourcing > Planning and Procurement in Outsourcing > Practice Notes
To learn more about drafting an outsourcing agreement, see
> DRAFTING AN OUTSOURCING MASTER SERVICES AGREEMENT
RESEARCH PATH: Commercial Transactions >. Outsourcing > Negotiating and Drafting the Outsourcing Agreement > Practice Notes
For a discussion of tracking performance in an outsourcing agreement, see
> ESTABLISHING A SERVICE LEVEL METHODOLOGY IN OUTSOURCING
For information on the importance of governance provisions in an outsourcing agreement, see
> GOVERNANCE IN OUTSOURCING
For a detailed discussion on privacy concerns and data safeguards for outsourcing projects, see
> PRIVACY AND DATA SECURITY IN OUTSOURCING
RESEARCH PATH: Commercial Transactions > Outsourcing > Risk, Disputes and Termination in Outsourcing > Practice Notes