Outsourcing is big business, particularly during an economic downturn. Managers, eager to cut costs and improve service, are attracted to the idea of sub-contracting non-core activities such as information technology support, facilities management, catering and cleaning.

However, some of the outsourcing pioneers, particularly in the UK, are encountering problems as contracts come up for retendering. These problems were never envisaged when the agreements were negotiated. The lack of legislation to deal with them is causing some users, and contractors serious concern, The source of many of these retendering problems is the constantly evolving application of the European Acquired Rights Directive. When the first outsourcing agreements were negotiated in the UK, it was assumed that the Transfer of Undertakings (Protection of Employment) Regulations 1981 (Tupe), which is the UK legislative expression of the Acquired Rights Directive, did not apply to the outsourcing of non-core business activities. Case law and amendments to the Tupe regulations have now made clear that this assumption is wrong.

Tupe broadly provides that when an undertaking (an information technology support service, say) is transferred to another party that accepts day-to-day responsibility for its management and control, and that undertaking retains its distinct identity, the staff employed by it as at the date of transfer become employees of the acquirer.

The new employer steps into the old employer's shoes; he inherits responsibility for any outstanding liabilities such as arrears of pay. In addition, the transferred employees' terms and conditions of employment (save currently those rights relating to occupational pensions) are protected against a change for a reason connected with the transfer.

In practical terms, Tupe means that when an outsourcing contract is retendered with broadly the same specifications, the departing contractor's employees, together with all liabilities relating to them, will usually become the new contractor's responsibility.

The new contractor could therefore find himself taking on a service saddled with a bloated workforce, which is employed on terms and conditions more favourable than those enjoyed by his own workforce. This problem is becoming more acute, particularly in the IT sector. Until the recent downturn, depart- ing contractors were often keen to retain the skilled workforce in order to deploy them elsewhere. However, many contractors now have no other work for the employees to do and want to transfer responsibility for the inevitable redundancy costs to the new contractor.

When a business is sold or an activity is first outsourced, the parties can quantify these risks through due diligence and then deal with them by means of warranties and indemnities. But in a retendering situation there is no contractual relationship between the rival contractors - the contract is with the user - and there is no way of establishing accurately the liabilities that the incoming contractor may inherit.

This means that unless the departing contractor has agreed something to the contrary with the user in the original agreement, he is under no obligation, for example, to provide any information about the work- force. The government has put forward consultation proposals under which a departing contractor would have to provide information but it is unclear what the sanction would be for non- compliance and when the proposals would become law.

In the UK, outsourcing agreements' termination provisions are now being negotiated in the knowledge that Tupe applies. The departing contractor typically has to provide information on the composition and terms of employment of his workforce. He is usually prohibited from redeploying employees or changing their terms and conditions within a set period before the termination date. And he remains contractually liable for any of his actions relating to the employees before the transfer date, a point that is usually sufficient to cover issues such as arrears of pay.

The lack of termination provisions in some of the agreements now coming up for renewal plays into incumbent contractors' hands. Unless the user can put commercial pressure on them, perhaps by threatening. to exclude them from any retendering, they have little incentive to co-operate. Anything that helps rival contractors may prejudice their chances of winning a contract renewal.

Executives responsible for managing outsourced contracts would be well advised to consider the termination provisions before the contract comes up for renewal. If they are inadequate, it may be possible at this stage to get the contractor to agree to sensible termination provisions well before any retendering. If the problem is allowed to drift until retendering, the difficulties are likely to be magnified. Potential bidders are likely to be deterred if they are likely to have to take on a large workforce that they know little about.

If contractors proceed with a tender, the likelihood is that any bid will include a healthy mark-up to reflect the potential unknown employment costs they may inherit. All of this adds to the incumbent's advantages. In the end the user suffers, either by bearing the additional costs imposed by the incoming contractor to cover the risk or by continuing with a contractor with whom he is not entirely happy.

Clearly, if the user continues with the current contractor, it is essential to ensure that the new contract's employment-related provisions are not defective.

After a long delay, revised draft Tupe regulations should be published later in the year. These will, in part at least, tackle the issue of the supply of employee information to new contractors. But current indications are that they are unlikely to resolve all the problems that an increasing number of outsourcers are beginning to encounter.

First published in The Times on 18/3/02.

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