UK: Employment Protections in U.K. Outsourcing Transactions

Council Directive 2001/23/EC of 12 March 2001 (which replaces earlier Directives) is a European Directive which is designed to safeguard the rights of employees if the business in which they work is transferred to a new owner. The Directive applies in the United Kingdom through the Transfer of Undertakings (Protection of Employment) Regulations 1981 ("TUPE"). TUPE must be construed to give effect to the purpose of the Directive. Contracting-out of TUPE is prohibited. The question of whether TUPE applies to specific transactions is a complex one. Practically speaking, there needs to be a continuation of a business in new hands.

Does it apply to outsourcing? This is a debate which has raged for at least 10 years and the European and English courts have not always been consistent in their decisions. What is clear, however, is that TUPE can apply to outsourcing situations. This article examines what this means. In any case, generally, the customer will want the vendor to take on those of its employees involved in the outsourced activity. If TUPE does not apply, then the customer will either have to find them work or dispense with their services and be responsible for the cost.

Set out below are the main principles:

1. Employees employed in the business to be outsourced (the customer of the outsourcing services) at the time of the transfer will transfer automatically to the new employer (the vendor of the outsourcing services) and with limited exceptions will enjoy the same terms and conditions as they enjoyed immediately prior to the transfer.
2. The vendor will inherit all pre-transfer rights and liabilities relating to those employees, with a few limited exceptions.
3. Employees dismissed either before or after the date of the outsource, but because of it or for a reason connected with it, will have a claim for automatic unfair dismissal, unless it can be shown that the principal reason for the dismissal is an "economic, technical, or organisational reason entailing changes in the workforce" (known as an "ETO reason").
4. The appropriate representatives of employees affected by the outsource (be they employees of the customer or the vendor) are entitled to be informed about the transfer. They are also entitled to be consulted on measures which are proposed as a result of the transfer.

There are generally three stages to be considered in establishing whether TUPE applies to outsourcing. The first is to consider whether there is an economic entity in existence which is capable of being transferred. The second stage is to look at whether or not enough of that entity has transferred to amount to a transfer to the vendor falling within TUPE (called a "relevant transfer"). The third is to identify the point at which the transfer takes place.

Establishing whether or not there is an underlying economic entity (without which there cannot be a relevant transfer) looks at how the business in question is organised before its transfer. In essence, that part of the business which is being transferred needs to be reasonably self-contained, identifiable, or distinguishable, with a degree of permanence. An English court is likely to distinguish between a department with its own operating structure, management, profit centre, etc. (which would be an economic entity) from a single supply contract, where parts of a business undertook a number of similar supply contracts and there was nothing to indicate that each contract was viewed as an economic entity.

Once an economic entity has been identified, the English courts will look at how much of that entity has, in fact, transferred. This involves looking at the key elements of the business and working out the extent to which they have been transferred or retained. Key elements of the business which will be considered are as follows:

1. The type of undertaking or business concerned
2. Whether assets, tangible or intangible, are transferred
3. Whether the majority of the employees are taken over by the transferee
4. Whether customers are transferred
5. The degree of similarity between activities carried on before and after the transfer and the period, if any, for which those activities are suspended

In evaluating this, the courts will take into account whether that entity is a labour-intensive business. A labour-intensive business is one where the only significant assets are the individuals themselves. Typical examples are contract cleaning and security guarding. In such circumstances, the courts will establish whether or not the majority of the employees have transferred, in order to determine whether or not there is a relevant transfer. Particular complexities arise where the employees could have transferred over, but the vendor has chosen not to take them. In those circumstances, the courts are likely to look at the vendor’s motives for rejecting the employees.

The time of the transfer is the point at which there is a change in the day-to-day management of the employees. There may be an issue if employees who transfer are immediately seconded back, as a court may consider either that those employees never really transferred or that there have, in effect, been two transfers, one out and one back. The reasoning is that a court will look at who is running the business on a day-to-day basis. If, therefore, employees are still working in the same place and on the same terms, it will be important to make it clear in practice that they are ultimately answerable to the vendor and not the customer and that the outsource contract reflects this.

In general terms, English employment tribunals have a wide-ranging discretion as to whether on the facts there has been a relevant transfer. It is very difficult for the appeal courts to overturn tribunal decisions. However, unless the operation being outsourced is merely one part of a larger operation (one supply contract out of many conducted by the customer, for example), it is likely that there will be an economic entity and employment tribunals will focus on the extent to which assets and employees have transferred.

TUPE only transfers over those of the customer’s employees who are employed immediately before the transfer and "whose contracts would otherwise have been terminated by the transfer." In an outsourcing scenario, it is often necessary to assess the extent to which an employee is "assigned" to the transferring business by looking at the time spent on the activity to be outsourced on a permanent basis, the value given by the employee, the terms of the contract of employment, and any cost allocation between businesses. An employee who divides his time between two or more parts of the undertaking, where some but not all of those parts are to be outsourced, will be covered by TUPE only if the employee is assigned to the part outsourced or was predominantly employed in that part.

However, employees cannot be transferred to the entity providing the outsourcing against their will. If an employee objects to the proposed transfer, the transfer will terminate the contract of employment. The employee can object to the proposed transfer for any reason. When the employee leaves employment, he or she will have no claims against the customer, unless there has also been a breach of contract. Employment will not transfer across to the vendor. Effectively it is as if the employee had resigned. However, if either the customer or the vendor breaks or threatens to break the employee’s contract, the employee can resign and claim constructive unfair dismissal and breach of contract.

Where the outsourcing is from the U.K. to an entity based offshore, e.g., in India, then the outsourcing raises additional considerations. If TUPE applies to the outsourcing, the customer, as the current employer, will have to comply with its requirements regardless of the destination of the transfer. There are then two possibilities. Either the employee’s rights would be governed by the local law, such as India, even if there is no TUPE equivalent, once the business had transferred; or TUPE only applies to the customer and not the vendor. There is currently no legal guidance on this question, but the better view seems to be the first of these options. In practice, the parties will offer voluntary redundancy instead and should expect a substantial rate of acceptance by employees. A redundancy situation will normally occur if an employee’s job can no longer be performed in the same place and the employee cannot be relocated. The customer then has to compensate the employee for the benefits that would have been received during the notice period and make a statutory payment based on the employee’s age, length of service and salary. The amount of this payment is capped but employers often have their own scheme offering a larger amount.

The effect of the Regulations on employment contracts in an outsourcing is that:

1. The contracts of those employees who are employed in the business being outsourced will automatically transfer to the vendor under the Regulations. The employees’ continuity of service is preserved.
2. The vendor inherits the employees on their existing terms and conditions along with all accrued rights and liabilities connected with the contract of employment of the transferred employees. Liabilities of an employee convicted of a criminal offence and liabilities relating solely to pension benefits under occupational pension schemes (although there is some lack of clarity about precisely what this means) do not transfer. Collective agreements between the customer and a recognised trade union which applies to these employees will also normally automatically transfer.
3. If the employees accept new varied terms as part of the transfer process and those terms are less attractive than those enjoyed prior to the transfer, the employees will have the right to revoke those new terms at any stage. The position is different if the old contract is terminated and replaced by agreement with a new one. In this case, the employee may have a claim for dismissal, but the vendor probably cannot claim the right to revert to the pre-transfer terms as it will have given up its rights under that contract.

The customer will often require the vendor to maintain its employees’ terms for a given period (usually between one and two years) to help it "sell" the outsourcing to its employees. If, however, there is a real need to change them at the time of the transfer, (for example, because they are tailored to the customer’s business and equivalent benefits cannot be offered), the consultation procedure outlined below will need to be used.

Staff who are transferred across on a relevant transfer are given enhanced protection from dismissal. Dismissals connected with the transfer will be automatically unfair unless they are for an economic, technical, or organisational reason entailing a change in the workforce. Broadly speaking, this means that the operative reason for the dismissal must be a genuine redundancy. Even if the dismissal is for an ETO reason, it must still be carried out in a procedurally fair manner, otherwise the employee can claim ordinary unfair dismissal. Responsibility for these dismissals can be with either the customer or the vendor, depending on the circumstances. In practice, the parties will divide up the economic risks through indemnities.

The employer of any employees affected by the outsource (whether customer or vendor) must provide certain information to the appropriate representatives of those employees. The information is to be given long enough before the outsource takes place to enable consultations to take place between the employer and those representatives. The relevant information covers:

• the fact that an outsource involving a relevant transfer is to take place;
• when it is to take place;
• the reasons for it;
• the legal, economic, and social implications of the outsource for affected employees;
• the measures which it envisages taking in relation to those employees (and if no measures are envisaged, that fact); and
• if the employer is the customer, the measures which the vendor envisages that it will take in relation to those employees who are to be automatically assigned to it on the outsource. If no measures are envisaged, then the vendor must say so expressly. The vendor must provide the customer with the necessary information to enable it to comply with this requirement.

The term "measures" will include any proposed changes to the terms and conditions, working practices, or discretionary policies of the customer by the vendor, as well as the size of the workforce. 

The term "appropriate representatives" means representatives of any recognised trade union for those employees covered by union recognition or where there is none, employee representatives elected for the purpose of consultation. If there are no employee representatives in place, the customer will need to offer the affected employees the opportunity to elect representatives, but if there are only a few such employees, they may all prefer to be involved.

Where either the vendor or customer envisages that it will take measures (discussed above) in relation to any of the affected employees, it must enter into consultation with their appropriate representatives in good faith and with a view to seeking their agreement. Consultation involves considering and replying to any representations made by the representatives and, where representations are rejected, stating the reasons for rejection. Some evidence will be needed, however, of the attempt to reach agreement with the representatives.

There is no specific timeframe for when this consultation has to start or for how long it has to continue. The parties should allow sufficient time to allow for a proper dialogue and to resolve any outstanding issues. The shorter the time-frame, the greater is the risk that the customer will be found not to have complied with its obligations.

Unlike the rules for collective redundancies, there is no minimum number of affected employees before consultation is required. Where an employer fails to inform or consult, the trade union, employee representatives, or the employees, as appropriate, may complain to an Employment Tribunal. Where a complaint succeeds, the Tribunal will make a declaration and may order the employer to pay compensation of up to 13 weeks’ pay per affected employee.

There are limited "special circumstances" defences open to an employer who has failed to consult. These only apply very rarely where the customer is in dire and unforeseen financial straights. This will invariably not happen as an outsourcing.

What happens to the employees who transferred from the customer to the vendor on the termination of the outsource agreement? The parties can either leave this to be decided in accordance with the law prevailing at the time of termination or insert provisions (e.g., indemnities) to cover the situation. Whilst the latter helps to promote certainty, the law may change the position in the interim.

The principles outlined above apply equally whether there is a change of vendor or where the customer takes the outsourced service back in-house.

In the latter situation, the terms on which it does can be a matter for direct negotiation in the outsource agreement. For a variety of reasons, the situation becomes more complicated where there is a change of vendor:

• a disgruntled outgoing vendor may want to get rid of its underperforming employees and argue that TUPE applies when it may not;
• the incoming vendor may end up inheriting employees it does not need and on expensive terms of employment and will have no information about them or their qualities;
• the customer may be forced to give the incoming vendor an indemnity against such matters as part of the price for accepting the outsource contract and may have no corresponding indemnity from the outgoing vendor.

These matters will need to be considered when negotiating the original outsource agreement and are usually covered by it.

It is common to include indemnities covering the following issues in the outsource agreement:

• the liabilities before and after the transfer, so that the customer is liable pre-transfer and the vendor is liable post-transfer or pre-transfer if it has caused the problem;
• the obligation to inform and consult with the employees concerned and regularise who has that liability;
• the situation in which for some unforeseen reason the intended employees do not transfer or the wrong employees inadvertently transfer.
• what is to happen at the end of the outsource agreement. At the very least, the vendor should be required to provide information on the employees working on the outsource contract.

When this legislation was originally implemented in the United Kingdom in the early 1980s, outsourcing in the manner common today was not envisaged. However, it is clear that TUPE must be considered in outsourcing situations, and that it will apply if there is a transfer of an economic entity. Three key points to remember are that:

• the contracts of those employed in the transferring business automatically transfer along with associated liabilities;
• there is limited scope for changing terms of employment and dismissing employees fairly; and
• it is essential to have a proper communication programme for the affected employees, not only for legal reasons but also to secure their "buy-in" to the outsource contract as some of them may be critical to its success.

Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

Mayer Brown is a combination of two limited liability partnerships: one named Mayer Brown LLP, established in Illinois, USA; and one named Mayer Brown International LLP, incorporated in England.