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The legal minds behind many of the top HRO contracts of our time share their views on recent legal developments, the mistakes that providers make, and what drives buyers.

This article is many peoples' worst nightmare. After all, it is about five lawyers. "Legal eagles," we call them. But these five are not just any members of the Bar. They are the men (yes, they happen to all be men) who have worked on many of the top 40 largest HR Outsourcing contracts of our time. One of them owns the best Internet address in outsourcing law, which is, of course, www.outsourcing-law.com (William Bierce). One went from being provider of outsourced legal advisor for outsource providers to being in-house general counsel for an outsourcing provider (Brian Copple). Another was nominated unanimously by five major HRO providers to be included on the 100 Superstars list

(J. Ross Docksey). Yet another literally wrote the book on Business Process Outsourcing (BPO) contracts (John Halvey). And one of them we called "the HRO lawyer's lawyer" in the 100 Superstars of HR Outsourcing list in our November 2002 issue (Robert Zahler).

We asked these guys (yes, it is legally acceptable to call them guys…we looked it up on Lexus/Nexus) what they see as the biggest mistakes that outsourcers make. We also asked about legal or legislative developments that they each see that will impact HRO buyers or providers. And we are interested to know which factors they see driving HRO buyers. Is it cost savings, focus, risk reduction, or leveraging the expertise of providers?

Like many lawyers, they all started our interviews with some hot-air-filled disclaimer that sounded something like: "The statements I am about to make represent my personal opinion and do not reflect the views of my clients, firms, or anyone resembling my clients or my firm...." That's why, instead of just reprinting their prepositional phrase-bloated written responses to our questions, we interviewed them with an eye to unveiling something that might actually be useful to you. We can only hope we succeeded. But there is one thing we are sure of: even though the advice you will read here may be valuable, none of these legal eagles will send you a bill.-J.W.

WILLIAM BIERCE

For William Bierce, of the New York City law firm Bierce & Kenerson, HRO all started with the Professional Employer Organizations, or PEOs. PEOs did HRO before anyone knew what HRO was. And they did it pretty well, Bierce says. Large-scale HRO really started in earnest with Exult's deals with BP/Amoco and Unisys. Those two contracts were the starting flock. Now Proctor & Gamble is trying to take the risk-sharing and cost-sharing to another level. P&G is asking the supplier to buy its HR IT installation. So it's really an M&A deal in combo with an outsourcing deal. The provider will not see any real revenues for some time, and there is no guarantee that the provider will see much return from the assets. But if the P&G deal ever gets done (EDS, ACS, and several other HRO providers have walked away from the deal several times), it will violate one of Bierce's firm's tenets: that the provider always has the reasonable right to expect a return.

Bierce says that HR service buyers fall into a number of traps. They forget basic principles that he calls Truth In Outsourcing. First, buyers should not just let the service provider take over the business process. Consequently, a Bierce-written contract provides for customer's retained rights on management, strategy, supervision, and control. Second, buyers need to bake-in flexibility, which includes a walk-away right to exit the relationship with minimal adverse impact. Third, Bierce's contracts ensure that ill-conceived governance provisions neither cancel out the benefits of outsourcing nor lose the client's intellectual property.

Bierce thinks that the biggest legal development impacting HRO is the formal recognition of the HR outsourcing service provider as a partner with governments globally, with legal liability for regulatory compliance and tax collection. The challenge for the HR outsourcing provider industry is to keep such regulation moderate and not increase costs or reduce the advantages of economies of scale. Bierce sees more global HR outsourcing deals that will allow enterprises to expand globally and breathe locally. But there are many conflicts of law that pose challenges for such things as shared liability for employment taxes.

In the U.S., PEOs are on a lobbying campaign to obtain federal and state legislative recognition and to overcome existing laws that create barriers or additional costs for third-party administration of HR operations. State legislators have responded by appointing them as the front-line tax collector and pension-administrator with legal liability for noncompliance. In Europe, the E.U. Acquired Rights Directive and other local legislation (such as Section 122 of the French Labor Code) effectively make HR outsourcing a costly pill, or in French, "un médicament cher," the French-speaking Bierce says. These laws leave the enterprise buyer with the ultimate burden of managing its workforce and taking financial responsibility for downsizing and employee restructuring. Bierce predicts that in ten years, what was once merely a payroll-processing bureau or medical-claims bureau will become a regulated industry. Go-to-market strategies and resulting HR outsourcing contracts will reflect this tension between "supporting" HR functions and "providing" HR functions.

As far as what drives customers to outsource HR, Bierce has some very strong feelings, based on long experience. He says cost savings need to translate to net-profit improvements, that smart HRO providers will almost never decrease a client's risk profile, that best practices are just wishful thinking unless managed each day, and that focus on core competency is the most important justification to outsource. After all, he says, no one makes money from complying with laws and regulations, unless that is their core competency and they don't do anything else.

BRIAN COPPLE

Southern California-based Exult General Counsel Brian Copple went to college at UCLA. But he grew up in the Arizona desert. Which explains why, despite the good looks of a Malibu lifeguard, Brian was never a surfer. Brian toiled away at Los Angeles mega-law firm Gibson, Dunn & Crutcher for eleven years. By his own admission, he actually liked working at Gibson. But, despite the company-paid cappuccino machine, in-office dry-cleaning pickup and thoroughly sufficient paycheck, there were a couple things that were missing.

In law-firm life, professionally, he says, there is a line between business issues and legal issues. At Exult, he relishes stepping over to the business side. In the law firm, Brian's day was dictated by his clients' requirements. At Exult, he can be more pro-active in actually helping Exult and its clients achieve things that for his clients were previously unachievable with the limited resources of an in-house HR department. Also, as in-house General Counsel, he sees a lot more that he likes to see. That includes, more often than not, catching dinner at home with his wife. At the law firm, he often worked 80-hour weeks and ate dinner at his desk.

Brian says that the clients with whom he has worked don't really make any legal mistakes, because they are represented by high-priced counsel. Instead, he mentions what he has seen clients do with the legal part of the process to add value and facilitate outsourcing transactions. Since outsourcing to Exult represents a commitment to a complex, seven-to-ten-year contract, it requires that clients understand what they want to achieve through outsourcing. The best companies, Copple says, have legal and business minds with deep outsourcing experience and a solutions orientation. Competent counsel on their side of the table gives clients the confidence to proceed with complex relationships.

Brian is an enemy of seeing HRO as a commodity. It's a relationship in which BPO issues, rather than legal issues, rule. The best lawyers, he says, understand that they are being hired to help the client make the deal work, not to pick it apart. A contract that favors either party too strongly is not a stable foundation for the kind of trust that will sustain the relationship through many years and inevitable changes in circumstances.

On the legislative side, Brian points out that privacy and data security are the hottest topics. HR outsourcing involves accessing and manipulating vast amounts of data that is personal to individuals and critical to client organizations. The E.U. and most European countries have addressed privacy concerns vigorously through legislation, and Brian points out that we are beginning to see significant legislative and regulatory activity in these areas in the United States, both at the federal and state level. The Department of Commerce Safe Harbor regime and recent California legislation regarding Social Security numbers are just a couple of examples.

On what drives clients to outsource, Brian sees that many Exult clients focus first on cost savings, probably because Exult guarantees that it will reduce our clients' costs through outsourcing, and because it can deliver cost savings to quicker than clients can achieve savings on their own. The cost-savings theme also comes in to play in something Brian calls "capital investment avoidance." This is especially true in the area of employee and manager self-service tools, where fixed costs are converted to variable costs. When client employees become Exult employees in, for example, an HR call center, there are also cost savings in terms of reduced cost of replacing valuable employees who stay on because they are now part of Exult, a growing company with attractive career opportunities.

When asked to write a newspaper headline that he would like to see in the year 2003, Brian Copple doesn't hedge his language. He has truly moved over to the client side. His headline would read: "Exult Inks 20th Global 500 Client; Market-Leading HR BPO Provider on a Roll."

J. ROSS DOCKSEY

You can call him J. Ross. You can call him Ross. But he just wants to make sure that you call him. He is J. Ross Docksey of the law firm Sonnenschein. Unlike some of the other attorneys portrayed here, Docksey only represents outsourcing service providers. Yes, his advice is only for providers. But for buyers, it's probably interesting to know how the other side's lawyer thinks.

Buyers and service providers, says Docksey, often make the mistake of believing that legal issues are separable from business issues. They are not. The issues typically referred to as legal issues are, in fact, business issues obscured and burdened with legal verbiage. Legal language is just a way of technically describing a business issue. So don't over-delegate to your lawyers, he says, because by working technical terms, lawyers can actually change the business terms of your deal. At the same time, don't under-use your lawyers in the early stages, because legally exact phrasing actually makes sure that the deal works the way you want it to.

Ross sees many clients using inexperienced outsourcing counsel, which results in useless contracts. HRO contracts are not like public-procurement lowest-bidder-type contracts, which would put demands on an HRO provider that are unreasonable and detrimental to the welfare of companies and employees.

In the legislative area, Docksey says, the single biggest legal development for multinational companies is adoption of conflicting data-privacy regulations. Data privacy is, in the United States, loosely regulated by a hodgepodge of federal and state laws including HIPAA, GLB, and the FCRA. In Western Europe and in parts of Asia, data privacy is regulated far more heavily. As countries around the world step up enforcement of data privacy laws, HR outsourcing will be seen as one alternative for effecting compliance and reducing the risk of noncompliance with those laws. Statements of work will be designed to ensure compliance with data privacy laws.

Finally, Docksey tells the story of participating in a panel at Georgetown's Advanced Computer Law Institute, when a fellow panelist who generally represents customers described outsourcing as nothing more than another form of finance. While he at the time thought the panelist was mistaken, Docksey now thinks he was at least partially right. While buyers will cite a variety of reasons for purchasing HR outsourcing services, at their core most of these reasons are financial.

After all, Docksey concludes, no corporate executive becomes a corporate hero by boasting that she increased corporate overhead by paying more for bigger and better noncore, nondifferentiating support services.

ROBERT ZAHLER

If you ask other attorneys in the outsourcing field whom they would call with an extra-thorny outsourcing conundrum, nine of ten would name Robert Zahler of the Washington D.C. law firm Shaw Pittman. He is the outsourcing lawyer's lawyer. Being a lawyer's lawyer can be a good thing. And it can be confounding. Please allow us to illustrate.

Zahler's first piece of advice to anyone drafting an HRO agreement is to exactly describe which functions are in-scope and which are out-of-scope, for now and for the future. But Zahler warns that terms that are too exact can handcuff you. Actually, Zahler would use lawyer language to say the same thing. He would say that words of specificity can be words of limitation. Is that clear? Let's review: Be exact. Just not too exact. Exact enough for now. With wiggle room later. That is, except when you want no wiggle room. Got it?

Now if you feel like you want to call your lawyer for a translation of the above, you are not alone. But hang in there. Zahler knows his stuff. Keep reading.

Zahler says that the most oft-overlooked step in the HRO contract process is counting costs before the work begins. Count the costs of your scope of work, he says. This includes the costs of transferring HR work, tax expenses, and, for international work, currency exchange. Customers and providers need to be especially careful about two types of counting: off-balance-sheet financings and percentage-of-completion accounting. For customers, one of the potential benefits of HRO is removing balance-sheet assets by receiving current cash for such assets, converting the cost of such assets to ongoing operational expenses, and financing the transaction over an extended term. For providers, achieving the economic benefits clients seek from an HRO transaction means spreading the early year costs over the life of the contract either through percentage completion accounting or long-term capitalization. Zahler's advice: hire an accountant.

Zahler says that while counting costs is important, cost alone is usually not a sufficient reason to go through the effort to outsource HR. He challenges anyone who says that one factor is more important than another. Zahler's clients want all the benefits of HRO, economic, operational, and risk management. In other words, they want what everyone wants from HRO: The Full Monty.

JOHN HALVEY

John Halvey, of the giant Manhattan law firm Milbank Tweed, is in many ways the ultimate cheerleader for the outsourcing industry. As a venture capitalist, he invested in technologies to Web-enable outsourcing. As an author, he wrote the book on Business Process Outsourcing (BPO) (from which you can read an excerpt elsewhere in this issue of HRO Today). As an outsourcing-industry expert, he is the most-sought-after conference panelist in the business. As a media personality, John earned the handle "Mr. Outsource." And as a member of the Bar, he has coached dozens of clients into and out of outsourcing relationships. Clients admit that while John's price is high, his advice is worth the price. And his faith in BPO and HRO as business strategies has never been stronger than now.

With his attorney's hat on, Halvey says he takes the approach that there is a right outsourcing horse for each course. HRO deals have a huge number of variables. Hire advisors, Halvey says, who have seen all the horses and all the races before. The thorniest part of any HRO deal, he says, is to make sure everyone knows who owns what intellectual property, which means all the specific knowledge and technologies necessary to service the client's workforce according to the needs reflected in the scope of work. It is amazing, says Halvey, how often the soft stuff of intellectual property is forgotten while everyone is fussing over cost savings.

Halvey thinks that one thing the U.S. HRO product can also do is be the spearhead for effecting advancement in the European outsourcing market. As HRO becomes more accepted in the U.S., and the outsourcing platform widens, cultural and legal limits that have tempered the European outsourcing movement, such as France's Rule 122, will be reassessed in order to keep E.C. companies competitive.

The HRO market, Halvey says, is where IT outsourcing was in 1993 or 1994. It's a market waiting for a series of emblematic deals that increase the public awareness of the product. The State of Florida and Federal government outsourcing transactions could be among those that help the movement become part of the national psyche. But it is the big private-sector relationships that will make real news. In fact, the headline John the energetic HRO cheerleader hopes to see in the Wall Street Journal in 2003 is: Vanguard of the New Organization: HRO Takes Hold.

EXCERPT: Business Process Outsourcing Transactions, by John Halvey

Considering Outsourcing as an Option

The reasons for issuing the directive to consider outsourcing varies from customer to customer and may vary depending upon whether it comes from senior management or management responsible for the business process. Senior management typically decides to evaluate outsourcing as part of:

• an organization-wide directive to outsource "noncore" business processes;
• an effort to globalize/standardize business processes throughout the organization;
• an organization-wide directive to downsize or cut costs;
• the reorganization of a business department, often in response to a re-engineering study;
• the redirection of certain methodologies/technologies in an effort to remain competitive; and
• an effort to enhance public perception.

Management responsible for the specific HR processes to be outsourced typically targets outsourcing as an option:

• as part of the reorganization of all or part of the HR department;
• as a means to cut business process costs;
• as a means to focus more resources on HR strategy rather than process;
• in an effort to enhance performance;
• as part of the rollout of new methodologies/technology; and
• in order to provide lacking expertise/experience.

The reasons underlying a company's decision to evaluate HR outsourcing as an option will affect the process, timetable and substance of the transaction. If, for example, senior management has decided to outsource noncore capabilities as part of an organization-wide downsizing initiative or the customer wishes to sign the contract by the end of the customer's fiscal year, the customer may spend limited resources on assessing the benefits/risks of outsourcing and move quickly to the request for proposal or vendor selection stage. In other instances, for example, where the "go ahead" to consider an HR outsourcing comes from HR management and the primary objective is to improve performance, there may be a more lengthy evaluation and negotiation process.

Defining the Scope of the Transaction

For some customers, it is an easy step to define the HR functions to be outsourced. Part of the outsourcing directive, for example, may be to outsource all of the functions except for strategic planning. Other customers are not sure which functions to outsource, mostly because they are not sure what the vendor can deliver and how much it will cost. If a customer is not sure what to outsource, it is often beneficial to be over-inclusive of what is to be outsourced and include a requirement that the vendor "unbundle," or provide separate pricing, for certain functions.

In addition to defining which HR functions are "in scope," many customers have a difficult time determining which sites will be "in scope." Is just one site being outsourced or are all sites to be outsourced? Will the deal be just the United States or will it be "global"? Will particular countries be out of scope? Many customers-particularly larger customers, with geographically dispersed locations-spend a great deal of time assessing which sites should be outsourced and which should either stay in-house or be part of a separate transaction. The decision as to whether certain sites should be included in scope is in some instances guided by local law requirements. For example, if a state or country has prohibitively high services taxes or restrictive laws relating to employee transfers, the customer may decide not to outsource services provided to or from that site/country. Another factor affecting what sites/countries are in scope is the customer's management structure. If a customer has a decentralized structure, it is often difficult to get a consensus as to what sites should be outsourced. The managers often have conflicting ideas about whether outsourcing is the right solutions for all sites. An option for customers that are hesitant about outsourcing is to first enter into a "proof of concept" phase where a few sites are outsourced with the understanding that if the trial period is successful that other sites will follow.

Determining where the services will be provided will aid in assessing the complexity of the transaction-and often the cost (and consequences). Even if the transaction is in the United States only, questions are raised regarding state and employment law issues. If foreign locations are to be included, more lead time will be necessary to assess the requirements for local approvals, authorizations and notices. It is often a time-consuming (and costly) task to coordinate with these foreign locations. One thing to keep in mind is that international transactions will often require local counsel and in some instances local consultants. The outsourcing team will need to be expanded to include representatives from the various local sites.

Other issues to consider when starting to define the scope of the transaction include:

• Are there any other entities that are currently being provided services? Will they be in scope?
• Who are the users? Employees? Customers? Suppliers? Independent consultants?
• Are there any existing outsourcing/subcontracting arrangements in effect that cover "in scope" services? Are there costs associated with terminating, transferring these relationships?
• Will assets be transferred to the vendor?
• Will employees be transferred to the vendor?
• Consider alternative structures-forming a joint venture, spinning the business process off into a separate entity.

Just as important as defining what services are to be outsourced is defining what services the customer wishes to keep in-house. The scope of "retained" responsibilities may vary from function to function with respect to financial, administrative and operational responsibilities. Areas that are often "retained" in whole or in part by the customer are set forth below. Obviously, these areas will vary depending upon the business process being considered:

• Process control
• Strategical planning
• Asset acquisition
• Technology upgrades, replacements
• Provision of office space
• Business recovery
• Office-related services
• Payment of third party invoices
• Report distribution
• Data entry
• Telephone charges

Understanding Your Existing Resources

It is important for any customer wishing to outsource it HR processes to have a strong understanding of the tasks its HR staff performs today. This is an important step early in the transaction for a number of reasons: (1) it is difficult to define what services the customer wants the vendor to provide if it does not know what it is doing today, (2) it makes writing the request for proposal and service exhibits to the outsourcing agreement less overwhelming and (3) if the customer does not have a clear and comprehensive understanding of its current tasks, it loses much at the negotiating table-particularly if the vendor has done its due diligence. We have been involved in many situations where the vendor knows more about the customer's business process environment than the customer. The greater understanding a party has of the business environment to be outsourced, the better such party's negotiating position will be.

In addition to understanding the current scope of HR services being provided by the customer, it is useful to understand the customer's strengths and weaknesses with respect to the performance of these services. Often, in fact, it is the knowledge of the customer's weaknesses that serves as a strong negotiating tool in ensuring that the vendor fills these weaknesses. If the vendor understands the customer's weaknesses better than the customer, the customer is at a disadvantage at the negotiating table.

Set forth below is an overview of areas that are useful to understand prior to issuing the request for proposal:

The Relevant Budget

A useful starting point in determining what the HR department's existing responsibilities is a review of its budget. The budget is often what the vendor will use to show how it can perform the same services more efficiently and at a lower cost. It is important then to understand the budget and to be able to clearly define what is and what is not included.

Shadow Support

One thing the budget does not often reveal is the "shadow support" the HR department provides to users and, in the same vein, the shadow support the HR department receives from other departments. If there are shadow organizations that provide business services that are not within the HR department, the outsourcing team should be aware of these people and consider whether these are services that the outsourcing vendor should be responsible for and, if so, whether such people should be transferred to the vendor. It is helpful to understand all of the seemingly minor things for which the HR department is responsible.

Organizational Structure

If the customer has not already prepared a list of "in scope" personnel, it is useful to do this early in the process. This can be done by preparing an organization chart, specifying the names, duties and location of each of the employees and subcontractors performing business process functions.

Management Structure

An area to pay particular attention to is the internal management structure. Outsourcing is a good time to get the management structure in line with the changing role of operational management to contract management.

Inventories

One area which is inevitably lacking (particularly with customers with numerous field sites) is an inventory of assets that the customer owns leases/licenses which are used in connection with the provision of the HR services. If the customer understands what is out there, it will be easier to evaluate whether to transfer its assets or simply allow the outsourcing vendor to use the assets to provide the services. In addition, it is difficult to understand what the upgrade, replacement and refresh responsibilities will be without an inventory of existing assets.

Service Levels

Another topic to consider early on is service levels. Service levels are one of the most important aspects of the outsourcing agreement, yet often attention is not paid to these levels until late in the transaction. Vendors typically will commit to what the customer is doing today or better. But what is it that the customer is doing today? If the customer does not know prior to entering into the outsourcing transaction, or does not have historical data to look to, the vendor will often take the position that it will measure the service levels over a period of time ranging from 30 to 180 days after the effective date of the agreement. The more the customer can get a foot up on service levels the better service levels it will likely be able to negotiate.

Developing A Long Range Plan. Many customers find it useful to develop a long range plan prior to issuing a RFP. Where would the customers like to see its HR operations in the next three, five and seven years? For example, does the customer wish to upgrade or standardize its methodologies/technology? Included in the long range plan should be a list of all of the projects that the customer foresees implementing in the next three, five and seven years. What are the anticipated costs of these projects? Does the customer want such projects to be "in-scope"? Does the customer wish to obtain from the vendor a pool of resources to perform such projects or will each project be priced separately? Other aspects of the long range plan should include upgrades and replacements, as well as any significant capital expenditures. The customer will need to consider which upgrades, replacements and other capital expenditures are part of the business deal.

The customer will need to build into its analysis what the customer's business needs are currently and in the future -- this includes new/divested sites and any anticipated expansion or down-sizing. More often than not the outsourcing team works in a vacuum and part way into negotiations a business person will tell the team that there is some significant restructuring or organization-wide initiative that will affect the transaction. If possible, the outsourcing team should be tapped into management -- its own and often its parent's -- to understand the direction the overall customer organization is going in. Finally, the customer will need to evaluate the extent to which corporate initiatives in respect of other business processes may impact the outsourcing of the HR processes.

Reprinted with permission from the book 'Business Process Outsourcing Transactions: Process, Strategies and Contracts,' by John Halvey (John Wiley & Sons, 2000).