Allocating the Risks of Outsourcing Human Resource Functions

Most companies find it difficult to part with any function that directly touches their clients or employees because the staff and customers are often considered a company's most important assets, says Attorney David Guedry, a partner at Hughes & Luce, L.L.P., with offices in Dallas, Houston and Austin, Texas. Therefore it is very rare for a company to outsource its sales and marketing functions. And the same thing can be said of the human resources (HR) department.

"It is hard to let go of that responsibility," Guedry says. "We are not talking about outsourcing computers here; we are talking about a function that deals directly with individuals and how they are governed. But if the proper procedures are followed it shouldn't be much different than any other outsourcing arrangement."

The HR department is involved with safety regulations, pension plans, health and life insurance, sexual harassment issues, EEOC matters, hours and wages, taxes, etc. These are critical issues and in most cases the outsourcing client is going to be liable to its employees for the actions of the HR functions, even if they are handed off to a vendor. So management of these types of outsourcing arrangements are key because a company is dealing with employees and their physical and financial health.

"Just because you have outsourced your HR function doesn't mean you can just wash your hands of it," says Attorney Jim Birch, partner at Hughes and Luce, L.L.P.

Managing the Agreement

Monitoring of the contract is imperative. First, a company must make sure the initial outsourcing agreement clarifies what services the outsourcer is going to provide. The service levels in the contract should be fairly descriptive so that when a company measures the performance of the outsourcer it will be objective. Then the customer can include a risk allocation agreement in the contract. This indemnifies the customer in case the outsourcer creates a liability because of its failure to properly perform those services. It is also a good idea for the customer to audit the vendor.

"You might ask your internal or external auditors to periodically review the function to see if there are any problems," Birch says. "The auditors would go through and look at all the policies and procedures, to see if they are current with the present status of the law."

Specific monetary penalties can be included in the contract for noncompliance, or even the right to terminate the agreement if the nonperformance is egregious enough.

Another thing that a company can do is to require its outsourcing provider to periodically provide the company with written reports on their performance, Birch says. In other words, the customer may ask the vendor to provide reports on how it is progressing with, for example, an affirmative action plan, employee grievances, terminations, etc.

Additional Security

There are also insurance policies available that can provide a company some security in the HR area, Birch says. The predominant one is called Employer Practices Liability Insurance (EPLI), which has become more prevalent in the last two years because it is more accepted now in the business community. Basically the insurance policy provides coverage to the employer in the event of a claim by an employee or a subcontractor, who is deemed to be a joint employee.

The policy covers EEOC violations, sexual harassment charges and wrongful terminations under certain circumstances, he continues. Most of those policies do exclude claims for Occupational Safety and Health Act (OSHA) violations and wage and hour violations. Typically it will cover some claims in the benefits area if it's a claim that a fiduciary has breached as a whole. But it typically excludes straight benefits claims, such as pensions or health claims that are not paid or not paid properly. And depending on the policy, it may not cover any punitive damages. These policies are not part of general liability policies, they are separate; so it would be highly unlikely that a company would have the policy and not know it.

Allocating the risk to other parties doesn't make the risk go away, it only moves it from one side of the table to the other, Guedry says. So proper management is key to ensure that neither side is at risk and no employees are treated unfairly or improperly.

A Transferable Process

Outsourcing the HR function shouldn't be that much different than outsourcing any other department, Birch says. "It really depends on what the company's corporate philosophy is, what the goals are that it hopes to gain, what economic benefits does the company get from it, and does it advance the overall corporate strategy. If a company answers yes to all these questions in a way that is favorable to them the decision may be right to do it.

Obviously employees that are in house have a better grasp of the corporate philosophy, Birch continues. But as far as compliance issues, they are pretty transferable from company to company. So it is very possible that a company can successfully outsource the HR function or parts of it from a compliance stand point.

"Basically what you are looking at is making sure that your HR provider has the requisite training, skills and programs to ensure that it maintains compliance," he says. "And I think the legal issues can be overcome by proper writing and drafting of the agreement, along with proper implementation."