By August 1, 1997 Read More →

Navigating Past the Legal Pitfalls | Article

The European Theater is primed and ready for growth in Information Technology (IT) outsourcing. Total European IT outsourcing is estimated at around $15 billion in 1997, and with firms fueled by the need to concentrate on their core competencies, that figure is expected to rise to around $27 billion in 2001.

The most active markets are found in the UK, France and Italy, with the value of the IT outsourcing market in the UK alone estimated to be $3.7 billion. Analysts expect that figure to rise to $7.6 billion by 2000.

As rosy as the future looks in the European sector, vendors and multinational corporations eyeing that market should be aware that the path to success is not necessarily a smooth one. Potential entrants must arm themselves with a basic knowledge of the legal issues which affect deals operated in the European theater.

Key to consider are the following:

  1. basic contractual issues and how they differ from country to country within Europe,
  2. financial considerations including the forthcoming impact of EMU and introduction of the Eurodollar,
  3. employment issues,
  4. European public procurement rules, and
  5. industry and country specific laws and regulations.

Beginning with the basics, one of the first legal issues to be decided is which law should apply to the outsourcing contract. Although the choice often is dictated by the location of the customer’s main base, this decision can be more complex than it sounds. With a US-based vendor and a customer with offices across Europe, there is considerable opportunity for disagreement. Whatever the choice, lawyers from the relevant countries should be involved at an early stage.Think also about the style of contract which you are used to negotiating and the approach with which you are comfortable. Civil law contracts tend to be far shorter, as many obligations are implied by commercial codes and less is recorded in writing.

If you are a US entrant into the market, you are likely to feel more comfortable in an English law contract than in a civil law contract governed a civil law jurisdiction such as France or Germany. Even in an English law agreement, you will find many areas where basic issues of contract (the do’s and don’ts of contract law) will vary from the US perspective. Be prepared for that. For example:

  1. Don’t include a service point regime without checking that it is enforceable. Under English law, penalty payments which do not amount to a genuine pre-estimate of the customer’s loss will be struck down. The general view is that service incentives (a feature which European deals now take increasingly from their US counterparts) are regarded as enforceable.
  2. Don’t use US precedents for liability clauses. Many of these provisions are not enforceable in a number of European jurisdictions because of the so-called “reasonableness test” which is applied in deciding whether liability has been unreasonably excluded between parties.
  3. Don’t use phrases like “commercially best efforts” too freely. Not only are the concepts unlikely to be used in the same way as they are in the US, they also are likely to have near equivalents with similar meanings which should be used in their place.
  4. Do find attorneys in Europe who speak the same language as you. A constant complaint, especially about lawyers in continental Europe, is that they do not perform to the standards of US corporations or their advisers. Consider selecting an attorney based on recommendations from people whose judgment you trust. Choosing the right attorney can position you to exploit the lawyer-intensive contract issues.

As with any other business deal, pricing is an important consideration in an outsourcing relationship. Any outsourcing contract — whether domestic or international — will contain mechanisms for price adjustments. Where deals cross different European states, however, another layer of complexity may be added as the mechanism may need to vary on a country-by-country basis. The cost of providing services in Portugal, for example, is likely to be lower than providing those same services in Sweden.

How do you protect yourself in that situation? Make sure you have dotted all the i’s and crossed all the t’s by reaching agreement on:

  1. the currency in which payments are to be made,
  2. who will bear the risk of fluctuating exchange rates, and
  3. how charges will be index-linked where there are different inflation rates operating between European states.

The possible introduction of a single or common European currency in 1999 adds a further complication to financial negotiations in medium to long term European outsourcing deals. Certain countries may meet the agreed-upon criteria for so-called “convergence” of a currency within European Monetary Union (EMU). Others, such as the UK, are taking a more back seat approach to the issue and are almost certain to be outside EMU in 1999.

The final financial consideration is tax liability. Tax liabilities imposed in connection with outsourcing transactions are often substantial and may vary considerably according to local taxation laws. A ruling by the European Court of Justice this past June has cast doubt on the taxable status of outsourced check and payment card processing operations. Accountants have warned that this could result in a sharp increase in industry costs for outsourced services.

Employment law can be one of the most complicated areas in a European outsourcing transaction. Customers and vendors who have no experience with European transactions will need to gain an understanding of the European Union (EU) Acquired Rights Directive, which aims to protect employees’ rights when the business in which they work is transferred to a new owner. Where the directive applies, employees are automatically transferred to the new owner of the business on the same employment terms as those existing before the transfer.

Outsourcing transactions are often regarded as a transfer of a business from the customer to the vendor. That means that the Directive may apply to your transaction and, in so doing, create a new set of rules for the vendor. In Europe, for example, companies commonly provide their employees with benefits such as cars or subsidized sports club membership. If this is the case, the vendor usually will be required to provide the same or comparable benefits after the transfer.

The legal interpretation of the Acquired Rights Directive is constantly evolving. A case decided by the European Court of Justice earlier this year is likely to have a profound effect on outsourcing deals in Europe. Lawyers have always known that the directive often acts automatically to transfer employees of the customer to the vendor under an outsourcing contract. Until a few months ago, it was also assumed that those employment contracts stayed with the vendor only through the period of the outsourcing contract. If the vendor contract was not renewed but awarded to a second generation vendor, the assumption was that the contracts of employment would again be transferred, this time from the old to the new vendor. The 1997 case has turned this view on its head. Now it is possible that, in some situations, the second generation vendor will not be required to take over the employees of the first contractor. This could mean that the outgoing vendor may face the double headache of having to make redundancy payments to workers who no longer have a function.

Like the US, Europe is beginning to experience the outsourcing of non-core services by government and other public organizations. In the UK, external suppliers have been invited to bid for functions ranging from street cleaning to tax collection. The majority of the IT function of the UK National Health Service and large parts of the Inland Revenue (the UK equivalent of the IRS) computer systems have been outsourced. EDS has been particularly successful in winning major government business in the UK, including the significant Inland Revenue contract.

If vendors wish to break into this growing public sector market, they must understand the detailed public procurement rules which operate in the EU. Public procurement is the procedure by which a public authority selects a contractor to provide it with supplies, works or services. Outsourcing contracts often fall within these categories, although transactions below a certain threshold value are exempt. The underlying rationale for the EU procurement rules is contained in the Treaty of Rome, which provides that there must be no discrimination on the grounds of nationality. The purpose of the rules is to prevent contractors in one EU country gaining an unfair advantage over those in another.

When a public sector body covered by the EU procurement rules wishes to outsource a service, it must follow a set procedure. This has a major advantage for the vendor community in that they will, if vigilant, be able to spot new opportunities in the Official Journal of the European Communities (known as the OJEC).

When in Rome, do as the Romans do. That old adage also applies to doing business in another country. If you are considering a particular European country, in which you have no experience, you will need to become familiar with that country’s particular laws and regulations. To some extent, the last few years of European Directives from Brussels have helped to harmonize rules on basic matters such as protection of copyright for computer software and fundamental principles of company law.

Be warned, however, that data regulation rules, import/export controls and relocation procedures can all vary dramatically from one country to the next. For example, German laws require that official permission be granted before relocating a data center from a customer to a vendor site. Many countries even require a customer to obtain official consent before allowing a third party to process its data.

Preparing for Success

Although pitfalls exist, the European markets are an attractive proposition for US vendors and customers looking to exploit the benefits of outsourcing. The path to success is preparation. Good local advisers offer an understanding of law and practice. With them, your venture into the European markets is more likely to live up to the potential you envision. Without them, a host of foreign issues could prove to be potential traps in a deal. Those pitfalls can easily be avoided at the outset, with awareness of the issues and careful preparation.

Lessons from the Outsourcing Primer:

  • Beware of varying contract issues.
  • Cover all the variables on price adjustment mechanisms.
  • Understand the EU Acquired Rights Directive pertaining to employment.
  • 4. Become familiar with each country’s laws and regulations

Richard Lister is the head of the IT Outsourcing Group at Berwin Leighton, a leading London law firm which specializes in a wide range of public and private sector outsourcing and projects based work. In addition to negotiating many computer outsourcing contracts, he has led project teams for different parts of government in the UK, including the Cabinet Office and the Department of Trade & Industry.

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