Legislation regarding a “Transfer of an Undertaking, or a Part of an Enterprise”, which was intended for classic takeovers of assets, can also be applicable on outsourcing transactions. The basic purpose of the legislation is to protect employees if the entrepreneur of the business in which they are employed changes. Therefore, if a specific case of outsourcing constitutes a Transfer of Undertaking, all employees involved in the outsourced activities automatically transfer to the acquirer, whilst in principle being entitled to their existing terms and conditions.

A party that for the first time outsources activities usually no longer needs the employees involved. Therefore, the Request for Proposals often already explicitly requires the service provider to take over most of the employees involved.

However, in case of second and further generation outsourcing (e.g. where services transfer from the first service provider to a new service provider) the principle usually no longer requires that the new service provider takes over the employees from its predecessor. The reason being that by changing the service provider the client often intends to obtain an improvement in quality and/or a reduction of costs by a smarter use of fewer or at least less expensive employees. These objectives could be put at risk if the new service provider were obliged to take over all its predecessor’s employees. Therefore, the question whether or not succeeding generations of outsourcing will constitute a Transfer of Undertaking can cause difficult discussions. When does the employee follow the work – and particularly when not?

When is there a Transfer of Undertaking?

According to the European Court of Justice the question whether there is a Transfer of Undertaking must be answered based on the criterion of whether the undertaking has retained its identity after a change of entrepreneur. Retention of identity is shown by making an overall assessment whereby a number of factors play a role, such as the type of the undertaking, whether tangible and/or intangible assets are transferred, whether a (substantial) part of the employees are transferred, whether or not customers are transferred, and the degree of similarity between the activities carried out before and after the transfer.

In 1992, the European Court of Justice ruled that the legislation can also be applicable to outsourcing! Only gradually the differences between classic takeovers and outsourcing, which is about awarding a contract during a limited number of years, are acknowledged. The retention of identity must also be evident from other factors than solely the loss of a contract to another party, for which reason certainly re-outsourcing will not always constitute a Transfer of Undertaking.

Labour Intensive Activities

According to case law of the European Court of Justice the decisive factor in the overall assessment depends greatly on the nature of the activities performed. If labour is the main factor in production (for example, in the cleaning sector), a transfer could especially be qualified as a Transfer of Undertaking if the new service provider not only continues the activities (which alone is not enough), but also takes over the majority – in terms of their numbers and/or skills – of the employees who previously carried out the services.

Capital Intensive Activities

On the other hand, if labour is not the main factor of production, but the presence of tangible assets is characteristic of an undertaking by its nature, that undertaking cannot maintain its identity if it is transferred without those assets. For example, in a case of bus transport busses were considered essential to carry out the activities. So there was no Transfer of Undertaking without a transfer of the busses.

Mixed Activities

The distinction between capital and labour intensive activities is, of course, not always clear. The nature of the activities performed can also have a mixed character. An example of mixed activities may be catering activities that require a great deal of specific equipment in the kitchen on site. In a case whereby the new service provider had taken over the on-site kitchen equipment and continued to make use of the customer base on location, but did not took over the employees, the European Court ruled that the commercial entity had retained its identity. Consequently, all employees involved automatically transferred to the acquirer, whilst being entitled to their existing terms and conditions.

The nature of ICT Services

The European Court of Justice has not given any decisions on the outsourcing of ICT services, but in most cases ICT services will be (more) labour intensive. This means that if after the termination of an outsourcing contract the majority of the employees (or the key employees) of a service provider transfer to the new service provider it would easily be deduced from this that the undertaking has retained its identity.

However, if the new service provider wishes the activities to be carried out (in large part) by its own employees, most likely such transfer of ICT services will not constitute a Transfer of Undertaking, certainly if the new service provider also has a different procedure and organization of the work and/or the activities will be performed out of a new location. In that case the employees would not automatically follow the work, let alone be able to demand a continuation of their terms and conditions.

Conclusion

This article is a brief introduction to a complex piece of EU and national legislation. Specialized legal knowledge of European and local laws, as well as specific European and local case law is required to answer the question whether in a particular case of (re-)outsourcing there is a Transfer of Undertaking, or not. Certainly not all transfers can be qualified as a Transfer of undertaking! Especially in a case of mixed activities, every argument will count!

After all, it should be pointed out here that in case the employees do not transfer, which will happen more often in case of 2nd and further generation outsourcing, this does not necessarily mean that this is detrimental to the employees. The employer that loses a contact (by contrast to classic takeovers) will usually continue to have remaining activities as a part of its undertaking or will be able to acquire new work which would safeguard jobs for the employees. If not, employees will usually be able to claim reasonable compensation on termination of their employment. Moreover, a transfer may not be advantageous for the employee, if for instance the new service provider does not have any work for the employee or has fewer financial resources to pay severance payment etc.

Especially now that 2nd and further outsourcing contracts may not constitute a Transfer of Undertaking, suppliers are therefore advised to provide for financial exit provisions in their outsourcing contracts.

This entry was originally published in Outsource Magazine.