in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, wThe trend towards outsourcing will continue to grow as market pressures force corporations to be more tightly focused on core business functions, gaining competitive advantage and reducing costs. Outsourcing is an attractive alternative in good times and bad times. Shifting back end administrative and business functions to an external provider in good times, may be a means for quicker time to market and focusing resources on core business activities to grow the business. In bad times, outsourcing is a means for streamlining the enterprise by eliminating functions, which create a drag on capital and/or do not provide any competitive advantage.

In the current economic environment, concerns over, shrinking margins, liquidity and the need to reduce operating cost structures is accelerating a trend towards shifting certain back office administrative functions to outside suppliers. This trend is seen as a major paradigm shift within enterprises, which have realigned their internal corporate infrastructure to focus on more strategic areas of their core business.

Although the human resources (HR) function is viewed as critical within corporations, increasingly, small, medium and even large corporations are moving to outsource this service.

The case for outsourcing has three basic rationales. First the regulatory compliance obligations imposed under ERISA, COBRA and IRS regulations, have become extremely burdensome and expensive for companies. Consequently, avoiding major legal problems and financial liability requires substantial investment in resources and capital in an area outside of the core business of most companies. This makes outsourcing a viable option even if it does not necessarily result in a cost savings in the near term. Second, the need to upgrade HR systems and invest in new technology is increasingly difficult when companies are hard pressed to invest in functions aligned with the core competency of the enterprise. HR outsourcing service providers are better positioned to invest in new technologies and software more likely to conform to “best practices” for delivery of the service. Third, for companies with global operations, employee self-service can substantially reduce costs and improve employee satisfaction with the service. However, this requires integration of all processes- HRIS, payroll and benefits administration- across the entire HR operation including its global ones.

Because of the business exigencies driving the shift towards HR outsourcing, the industry is expected to grow to $37.7 Billion in 2003. Currently HR outsourcing services fall primarily within three categories: Professional Employer Organization (PEO), Business Processing Outsourcing (BPO) and Application Service Providers (ASPs).4 PEOs assume and take full responsibility for the human resources administration, including the legal liability for the company’s workers. It becomes in essence a coemployer with final say over, hiring, firing, and compensation decisions. The PEO becomes a partner, in the non-legal sense, with ownership of the HR function while the company retains responsibility over all business matters.

BPO refers to all business processes and not just HR. Typically this involves transferring the entire function to a service provider and is differentiated from PEOs because it usually involves introducing new technologies and processes to bear in the HR service. Because of the complexity of HR systems in large corporations, shifting to BPO may be more expensive in the short term. However, long term it can result in benefits because large HR outsource providers will invest in systems and technology viewed as prohibitively expensive within a firm where this function lies outside of its core business.

The BPO services market is growing rapidly with analyst projecting revenues of $128 billion this year and growth to $234 billion by 2005.

Finally, ASPs host software on the web and rent it to users. The most commonly known of these packages is “People Soft”. The latter application and other packages are used to manage payroll, benefits, head count and other HR processes.

Each of the HR outsourcing services described has advantages and disadvantages for particular enterprises depending, on the number of employees, affordability of the service, type of business and the degree to which an enterprise desires to retain control of this function in-house.

This paper will briefly cover the legal aspects of HR outsourcing and will discuss some of the most common contract issues faced in outsourcing relationships, essential items that ought to be considered by the parties and key provisions within outsourcing service agreements.

As previously discussed, companies facing pressure to reduce costs or address the personnel shortages due to corporate down sizing have several different outsourcing alternatives available to them to delegate back-end administrative functions. Typically, the first alternative firms look to before looking outside, is to retain control of the function in-house and reduce employment related costs (taxes, benefits, headcount), by using contingent staff or (temporary workers) or persons classified as “independent contractors” (IC) to perform the work. Though this may be an appealing solution for many firms, given the legal and economic benefits, improper classification of someone as an IC, consultant or temporary worker, who is later deemed an “employee” carries serious financial risks.

Friction has developed between the growing use of contract workers in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, wh

ns, have become extremely burdensome and expensive for companies. Consequently, avoiding major legal problems and financial liability requires substantial investment in resources and capital in an area outside of the core business of most companies. This makes outsourcing a viable option even if it does not necessarily result in a cost savings in the near term. Second, the need to upgrade HR systems and invest in new technology is increasingly difficult when companies are hard pressed to invest in functions aligned with the core competency of the enterprise. HR outsourcing service providers are better positioned to invest in new technologies and software more likely to conform to “best practices” for delivery of the service. Third, for companies with global operations, employee self-service can substantially reduce costs and improve employee satisfaction with the service. However, this requires integration of all processes- HRIS, payroll and benefits administration- across the entire HR operation including its global ones.

Because of the business exigencies driving the shift towards HR outsourcing, the industry is expected to grow to $37.7 Billion in 2003. Currently HR outsourcing services fall primarily within three categories: Professional Employer Organization (PEO), Business Processing Outsourcing (BPO) and Application Service Providers (ASPs).4 PEOs assume and take full responsibility for the human resources administration, including the legal liability for the company’s workers. It becomes in essence a coemployer with final say over, hiring, firing, and compensation decisions. The PEO becomes a partner, in the non-legal sense, with ownership of the HR function while the company retains responsibility over all business matters.

BPO refers to all business processes and not just HR. Typically this involves transferring the entire function to a service provider and is differentiated from PEOs because it usually involves introducing new technologies and processes to bear in the HR service. Because of the complexity of HR systems in large corporations, shifting to BPO may be more expensive in the short term. However, long term it can result in benefits because large HR outsource providers will invest in systems and technology viewed as prohibitively expensive within a firm where this function lies outside of its core business.

The BPO services market is growing rapidly with analyst projecting revenues of $128 billion this year and growth to $234 billion by 2005.

Finally, ASPs host software on the web and rent it to users. The most commonly known of these packages is “People Soft”. The latter application and other packages are used to manage payroll, benefits, head count and other HR processes.

Each of the HR outsourcing services described has advantages and disadvantages for particular enterprises depending, on the number of employees, affordability of the service, type of business and the degree to which an enterprise desires to retain control of this function in-house.

This paper will briefly cover the legal aspects of HR outsourcing and will discuss some of the most common contract issues faced in outsourcing relationships, essential items that ought to be considered by the parties and key provisions within outsourcing service agreements.

As previously discussed, companies facing pressure to reduce costs or address the personnel shortages due to corporate down sizing have several different outsourcing alternatives available to them to delegate back-end administrative functions. Typically, the first alternative firms look to before looking outside, is to retain control of the function in-house and reduce employment related costs (taxes, benefits, headcount), by using contingent staff or (temporary workers) or persons classified as “independent contractors” (IC) to perform the work. Though this may be an appealing solution for many firms, given the legal and economic benefits, improper classification of someone as an IC, consultant or temporary worker, who is later deemed an “employee” carries serious financial risks.

Friction has developed between the growing use of contract workers in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, w

ll responsibility for the human resources administration, including the legal liability for the company’s workers. It becomes in essence a coemployer with final say over, hiring, firing, and compensation decisions. The PEO becomes a partner, in the non-legal sense, with ownership of the HR function while the company retains responsibility over all business matters.

BPO refers to all business processes and not just HR. Typically this involves transferring the entire function to a service provider and is differentiated from PEOs because it usually involves introducing new technologies and processes to bear in the HR service. Because of the complexity of HR systems in large corporations, shifting to BPO may be more expensive in the short term. However, long term it can result in benefits because large HR outsource providers will invest in systems and technology viewed as prohibitively expensive within a firm where this function lies outside of its core business.

The BPO services market is growing rapidly with analyst projecting revenues of $128 billion this year and growth to $234 billion by 2005.

Finally, ASPs host software on the web and rent it to users. The most commonly known of these packages is “People Soft”. The latter application and other packages are used to manage payroll, benefits, head count and other HR processes.

Each of the HR outsourcing services described has advantages and disadvantages for particular enterprises depending, on the number of employees, affordability of the service, type of business and the degree to which an enterprise desires to retain control of this function in-house.

This paper will briefly cover the legal aspects of HR outsourcing and will discuss some of the most common contract issues faced in outsourcing relationships, essential items that ought to be considered by the parties and key provisions within outsourcing service agreements.

As previously discussed, companies facing pressure to reduce costs or address the personnel shortages due to corporate down sizing have several different outsourcing alternatives available to them to delegate back-end administrative functions. Typically, the first alternative firms look to before looking outside, is to retain control of the function in-house and reduce employment related costs (taxes, benefits, headcount), by using contingent staff or (temporary workers) or persons classified as “independent contractors” (IC) to perform the work. Though this may be an appealing solution for many firms, given the legal and economic benefits, improper classification of someone as an IC, consultant or temporary worker, who is later deemed an “employee” carries serious financial risks.

Friction has developed between the growing use of contract workers in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, w

s described has advantages and disadvantages for particular enterprises depending, on the number of employees, affordability of the service, type of business and the degree to which an enterprise desires to retain control of this function in-house.

This paper will briefly cover the legal aspects of HR outsourcing and will discuss some of the most common contract issues faced in outsourcing relationships, essential items that ought to be considered by the parties and key provisions within outsourcing service agreements.

As previously discussed, companies facing pressure to reduce costs or address the personnel shortages due to corporate down sizing have several different outsourcing alternatives available to them to delegate back-end administrative functions. Typically, the first alternative firms look to before looking outside, is to retain control of the function in-house and reduce employment related costs (taxes, benefits, headcount), by using contingent staff or (temporary workers) or persons classified as “independent contractors” (IC) to perform the work. Though this may be an appealing solution for many firms, given the legal and economic benefits, improper classification of someone as an IC, consultant or temporary worker, who is later deemed an “employee” carries serious financial risks.

Friction has developed between the growing use of contract workers in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, w

in lieu of full time employees and, the public policy aims of providing workers with protections under federal labor laws to take the Employment Retirement Income Security Act (“ERISA”) and state law employee remedial measures. In addition to the tax risk of an IRS audit, the risks are higher today that workers will bring claims for social security, workman’s compensation or other actions challenging the misclassification, so that they may participate in lucrative benefit programs provided by the employer. The case that brought these issues to the fore was Vizcaino v. Microsoft Corporation (“Microsoft I”) and its progeny of cases. In Microsoft I, plaintiffs, employees designated as temporary workers or “free lancers”, brought an action against the corporation to recover savings benefits under ERISA and for stock option benefits offered through a stock purchase plan, that were available to regular employees.6 The Court framed the legal and public policy issues in the opinion’s opening statement: “Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits. This practice has understandably led to a number of problems, legal and otherwise. One of the legal issues that sometimes arises is exemplified in this lawsuit. The named plaintiffs, who were classified by Microsoft as independent contractors seek to strip that label of its protective covering to obtain for themselves certain benefits that the company provided to all of its regular or permanent employees.”

The problems for Microsoft arose as a result of an IRS tax audit for tax years 1989 and 1990. The IRS examined the company’s employment records to determine if it was in compliance with tax laws. Applying the common-law principles defining the employer-employee relationship, the IRS concluded Mircosoft’s “freelancers” were not independent contractors but employees for withholding and tax purposes. In reaching this conclusion, the IRS applied the test set out under the common law of agency, which requires, in determining if a hired party is an “employee”, consideration of the hiring party’s right to control the manner and means by which the product is accomplished. The IRS applies a 20 factor “control test” to “assess all of the incidents of the relationship” with no one factor being determinative of the employment relationship of the parties.9 The US Supreme Court reached asimilion conclusion in Nationwide Mutual Insurance Company vs. Darden party not to adopt the IRS factors and, instead applied a twelve factors that it considered. In assessing the relationship of the parties the court decided for determining whether an individual qualifies as a “common law employee”.

Microsoft, on first impression, appeared to have taken the appropriate measures to avoid stumbling into an employer-employee relationship- the workers were told they were freelancers and signed various agreements classifying them as independent contractors, that included provisions that the workers would be responsible for paying their own taxes and benefits. However, after having taken these steps with respect to the form of the relationship, the court found that Microsoft had fully integrated these workers into its workforce, placing them alongside regular employees, sharing the same supervisors, performing identical functions and working the same core hours. Because Microsoft required them to work on site, they were given admittance keys, office equipment and supplies of the company.

Even after the IRS determined that plaintiffs were “common law employees”, Microsoft attempted to use a temporary agency to “house” these workers as employees of the agency, so that it could continue to use them in the same manner previously described. On review in Vizcaino v. U.S. Dist. Court for Western District of Washington, 173 F.3d 713 (9th Cir. 1999) (“Microsoft III”), the Court in striking down the District Court’s modification of the class of plaintiffs, which it deemed a contravention of its order on remand, rejected the lower court’s assertion that the eligibility for benefits of these temporary agency workers turned on whether they were employees of the Company or the agency. The District Court’s view precluded the possibility that the agency and Microsoft could jointly employ the plaintiff. The Court held that at common law it was possible for the plaintiff’s to be employees of both the temporary agency and of the recipient of their services (Microsoft), if, based on a determination using the Darden factors, an employee-employer relationship existed. In essence the agency and Microsoft were joint employers and the triangular relationship that Microsoft created was not viewed as precluding or as being mutually exclusive of a two- party relationship that existed between the company and the temporary workers. So what are the lessons gleaned from the Microsoft cases?

• Review the language in the company’s benefit plans to ensure “covered employees” is properly defined within the plan and not left to statutory or judicial interpretation.

• The mere classification of workers as independent contractors is not sufficient, and behavioral, financial and the type of relationship between the hiring party and the workers must support the classification.

• Users of outsourcing services should apply the 20 IRS factors to conduct a selfassessment of the relationship between the parties.

• Consider using only ICs that are incorporated so that the relationship is between entities and not an individual and an entity.

• Ensure that the agreement reflects the 20 factors, so for example: allow the IC to determine the means and the methods for delivery, limit the agreement to the project, and ensure the contract calls for the IC to cover its expenses and benefits.

• Require that the IC submit an invoice prior to receiving any payments.

• Avoid placing IC in situations where work is subject to the direct supervision of a company employee.

• Avoid imposing administrative requirements on the IC, which are applicable to employees.

• Allow the IC to hire and delegate the work to its employees subject to the requirements of the project.

In particular, the fact that a worker is employed by a temporary agency, or similar entity is not a guarantee against misclassification under the joint employer rule applied by the Ninth Cir. Court in Microsoft III. If a misclassification does occur a firm may qualify for an IRS Section 530 “safe harbor” exception if it can show the following:

1. Reasonable basis for classification of individuals as ICs based on:

• Reliance on a relevant court case, the advice of a qualified accountant or attorney, or IRS ruling;

• The IRS did not reclassify the same or similar workers in a previous audit;

• It is standard industry practice to tr