Domestic Outsourcing: Lowering The Risk Of Employment Litigation

One of the attractive features of outsourcing is that the outsourcing company ("outsourcer") gets the benefit of the work without the headache of managing the people who do it. But outsourcers should be aware that outsourcing, like any other business decision where employees face job loss, has its share of legal risk. Post-transaction, a joint employer relationship with the company to which the work is outsourced ("vendor") may be created inadvertently.1 Pre-transaction, if the outsourcing company decides to lay off all affected employees, the legal risks are the same as with any other decision to reduce staff. But if the vendor hires some or all of the affected employees, legal risk for both parties to the transaction is lowered by anticipating, and responding to, the affected employees' concerns. Keeping affected employees economically whole reduces the risk of litigation, or at least, liability. This article explores ways to address some of the most common employee concerns in a domestic outsourcing.

What's Going On?

The Worker Adjustment and Retraining Notification Act ('WARN")2 generally requires covered employers to give at least 60 days' notice prior to certain plant closings or layoffs; some states have similar laws. The sale of a business which does not cause an actual (as opposed to technical) loss of employment is excepted.3 This exception has been extended to the assignment of a contract, where the court reasoned that "sale" means a transfer of property for consideration and not only the sale of all or part of a business.4 If assets are transferred as part of the outsourcing agreement, it is possible that the transaction would not trigger WARN unless there is an actual covered job loss.But even if WARN does not apply, affected employees should be given advance notice to stop the productivity-sapping rumor mill.

What Happens To Compensation?

Any individual employment agreements should be reviewed to determine contractual obligations concerning compensation, as well as other employer obligations. Employees-at-will do not usually have legal recourse merely because the vendor's compensation is lower than the outsourcer's. Nevertheless, the vendor may be prevailed upon to match the outsourcer's compensation levels or to develop a commission plan that is expected to yield approximately the same results. In addition to easing the transition for both vendors and employees, this benefits outsourcers whose severance plans are keyed to the equivalency of compensation where employment continues after a corporate transaction.

Outsourced employees may claim payment under the outsourcer's annual bonus and quarterly or annual incentive compensation, especially if the date of the transaction is close to a payout date. Outsourcers should consider paying all or part of those items, or requiring the vendor to pay them, to avoid possible breach of contract claims. Review company practices and compensation plan language to assess these risks.

What Happens To Pension Benefits?

Outsourcers must consider the transaction's impact on pension benefits. The Supreme Court has allowed outsourced employees to maintain a claim for interference with benefits under the Employee Retirement Income Security Act ("ERISA").5 Recently, Honeywell defeated a claim for intentional interference with ERISA rights brought by outsourced employees who lost benefits accrual and retiree medical benefits under Honeywell's plans, even though they were employed by the vendor with similar pay and benefits when Honeywell outsourced their work.6

The Eighth Circuit determined that Honeywell had a legitimate business reason for the outsourcing: improving its competitive position for a contract bid. Despite evidence that pension costs were given some consideration, the court's decision was influenced by the fact that Honeywell had taken proactive steps to mitigate any economic loss to the outsourced employees. Honeywell had insisted that the contractor give the outsourced employees an equivalent benefits and compensation package. Honeywell also amended its pension plan to provide for unpaid "bridge" leaves of absence, thereby enabling more than half of the outsourced employees who were close to retirement to vest. Register illustrates why outsourcers should seriously consider helping employees reach retirement vesting thresholds, as well as paying the cash equivalent of any unvested pension or 401(k) plan benefits.

What About Welfare Benefits, Vacation And Severance?

Outsourcers should consider negotiating with the vendor to protect the level of severance pay for employees who are terminated (other than for "cause") within some specified period of time after the transaction. This is prudent because severance plans, which may be ERISA welfare plans, are grist for interference claims. Claims for benefits such as severance under state law contract theories are generally preempted by ERISA.7 Some outsourcers agree with the vendor to pay severance in accordance with their plans for a specified period after the transaction; others may pay any difference between its plan and the vendor's. In drafting such an agreement, it is important to resolve any ambiguity by fixing the effective date of the plan which will be used to make the comparison.

The outsourcer has several options if it chooses to provide relief for gaps in health insurance coverage if the vendor's group health plan has waiting periods and/or exclusionary periods for pre-existing conditions. The outsourcer can offer health plan coverage under COBRA8 at reduced rate or no charge during a specified period. The outsourcer must modify the terms of its group health plan to reflect this change. In addition, if the outsourcer is self-insured, the plan as modified must pass anti-discrimination testing. Second, the outsourcer can reimburse covered employees for COBRA premiums, or pay them directly, by creating a separate group health plan, which again may be subject to anti-discrimination testing. A third option is to give a lump sum of money as part of the separation package, intended but not required to be used toward health insurance coverage. This would create a separate severance plan which might be subject to ERISA compliance. Unlike the other two options, this lump sum is taxable to the employee.

Claims for vacation accrual may be litigated under state contract law or wage payment statutes. Review the company's policy and any applicable state law concerning vacation accrual. Unless prohibited by state law, the vendor may be persuaded to carry over unused accrued vacation.

The vendor should be encouraged to recognize service with the outsourcer for various purposes, including pension benefits (in some cases, this may even be statutorily required), severance, and vacation eligibility. The outsourcer benefits from a reduced risk of liability, and the vendor gains the goodwill of its new employees.9

What Happens To Employees On Leaves Of Absence?

Company leave policies should be reviewed, and an inventory made of affected employees who are out on leave. In addition to any rights given by company policy, two federal statutes (and any corresponding state laws) may apply: the Family and Medical Leave Act ("FMLA"),10 and the Uniform Services Employment and Reemployment Rights Act ("USERRA").11 Each of these statutes requires a successor employer to grant reemployment rights to employees returning from covered maternity, medical, or military leave granted by its predecessor. "Successor" is defined by proposed regulations under USERRA12 and by regulations under FMLA.13 The definitions are almost identical. Under either statue, successorship is found if, inter alia, there is substantial continuity of business operations and the workforce, and working conditions remain similar.

Note that, where one vendor replaces another, at least one court has ruled that there must be an actual transfer of assets before the successor analysis can be applied under USERRA,14 while another has ruled the opposite way under FMLA15 Because this point of law is unsettled, especially as applied to the initial outsourcing transaction, both parties to the transaction should treat employees on leave the same as active employees, except that any job offers can be made subject to reinstatement rights under the applicable statute. Regulations require a successor employer to honor statutory reinstatement rights even if previously unaware of the employee's existence.16

Can The Union Do Anything

An employer may have a duty to bargain over its decision to subcontract (or outsource) work that is currently performed by members of the bargaining unit, but the Supreme Court has specifically declined to create a broad rule applicable to all subcontracting situations.17 Courts employ a balancing test to determine whether the "benefit, for labor-management relations and the collective-bargaining process, outweighs the burden placed on the conduct of the business."18 A decision based on labor costs usually must be bargained.19 Even if there is no duty to bargain over a decision to subcontract, there is a duty to give reasonable notice and an opportunity to bargain over the effects of such a decision, unless waived by the union.20 Accordingly, project planning for the outsourcing must factor in time for any notice and bargaining obligations.

Are They Trying To Get Rid Of Me?

If the vendor hires only some of the outsourcer's affected employees, the vendor may be subject to discrimination claims by those who are not selected. The outsourcer might also be targeted by an employee who is not hired by the vendor, but that individual has the burden of proving that the outsourcer influenced the vendor not to hire him for an unlawful reason.21 Both the outsourcer and the vendor may be subject to disparate impact claims, including a disparate impact claim under the Age Discrimination in Employment Act ("ADEA"),22 depending on the demographics of the affected employees.


To maintain good employee relations, both with departing employees and those who are watching them go (and wondering if their jobs are next), outsourcers should try to keep affected employees whole to the extent possible. Although not guaranteed to avoid litigation, this should greatly reduce the risk of liability. Happily, employer virtue in the outsourcing context may be more than its own reward.

1See Judith A. Moldover, " Outsourcing: Who's the Boss?," New York Law Journal, Apr. 4, 2005 at 9; GC New York, May 9, 2005 at 16.

229 U.S.C. § 2101 et seq.

329 U.S.C. § 2101(b)(1).

4 Headrick v. Rockwell Intern'l Corp., 24F.3d 1272 (9th Cir. 1994); Intern'l Alliance of Theatrical and Stage Employees and Moving Picture Mach. Operators, AFL-CIO v. Compact Video Services, 50 F.3d 1464 (9th Cir. 1995) (sale of assets).

5ERISA §510, 29 U.S.C.A. § 1140; Intermodal Rail Employees Ass'n v. Atchison, Topeka and Santa Fe RR Co., 520 U.S. 510 (1997).

6 Register v. Honeywell Fed. Mfg. & Technologies, LLC, 397 F.3d 1130 (8th Cir. 2005).

7See, e.g., Engler v. Cendant Corp., 380 F.Supp. 2d 136 (E.D.N.Y. 2005).

8Consolidated Omnibus Budget Reconciliation Act of 1985, 29 U.S.C. § 1161 et seq.

9See, e.g. Headrick v. Rockwell Int'l. Corp., supra.

10 29 U.S.C. §2601 et seq.

1138 U.S.C. §4301 et seq.

12Proposed 20 C.F.R. . § 1002.35 .

13 29 C.F.R. §825.107.

14 Coffman v. Chugach Support Services Inc., 411 F.3d 1231 (11th Cir. 2005 ).

15 Slaughter v. American Bld'g Maint. Co. of New York, 64 F.Supp.2d 319 (S.D.N.Y. 1999).

16 29 C.F.R. § 825.107(a) (FMLA); Proposed 20 C.F.R. § 1002.36 (USERRA).

17 Fibreboard Paper Prods. Corp. v. NLRB, 379 U.S. 203 (1964) .

18 First Nat'l Maint. Corp. v. NLRB, 452 U.S. 666, 679 (1981).

19 NLRB v. Plymouth Stamping Div., 870 F.2d 1112 (6th Cir. 1989).

20 NLRB v. Oklahoma Fixture Co., 79 F.3d 1030 (10th Cir. 1996) .

21 Robinson v. Time Warner Inc., 92 F.Supp. 2d (S.D.N.Y. 2000)(race discrimination).

22 29 U.S.C. §621 et seq.

Published November 1, 2005.