With all of the political debate and media attention over employees losing their jobs due to outsourcing*, it is important to remember the possible exposure to liability that can occur as employers consider the option of outsourcing in its many forms. While time will not permit going into all of the legal exposure that can arise, two such areas of vulnerability that come to mind are as follows:
1. Liability under ERISA. ERISA section 510 prohibits an employer from discharging an employee for the purpose of interfering with the attainment of any right to which the employee may become entitled under an ERISA plan. Courts have held that such practices as terminating employees based on benefits cost to the employer or changing the status of an individual from “employee” to “independent contractor” for such purposes have violated ERISA. What this means is that employers who terminate employees for the wrong reasons can be exposed to section 510 claims from disgruntled employees under ERISA. The issue is particularly relevant in today’s work environment as employers are faced each year with the daunting and reoccurring task of containing benefits costs.
How does the issue apply to employers who outsource work to outside contractors? According to the U.S. Supreme Court in the case of Inter Modal Rail Employees Ass’n v. Atchison, Topeka & Santa Fe Railway Co. , an employer cannot outsource work to a sub-contractor where the purpose of the outsourcing is to interfere with the benefit plan rights of plan participants. The employer in that case outsourced its employees to another company that did not provide equal health and pension benefits, and allegedly did so for the purpose of cutting its own health and pension benefits cost. The court held that the employer could be held liable for violation of section 510 of ERISA.
While it is true that oftentimes it is difficult for employees to prove that an employer terminated an employee for the purpose of interfering with benefits, employees have prevailed in many instances. A well-known example of the type of evidence that can prevail in a section 510 case appears in McLendon v. Continental Can Company, 749 F. Supp. 582 (D.N.J. 1989), aff’d sub nom., McLendon v. Continental Can Co., 908 F.2d 1171 (3d Cir. 1990) in which a sophisticated benefits liability avoidance system was utilized by the employer. Employees were able to show that the employer had devised a computer program which identified employees who were close to meeting the age and service requirements for certain pension benefits so that such employees could then be targeted for termination. The court in McLendon had no trouble in finding that the employer had violated section 510 of ERISA.
Others may recall the recent case of Millsap et al. v. McDonnell Douglas Corporation (read about it here and here) in which plaintiffs achieved a $36 million settlement for claims brought against their employer, alleging that the employer closed one of its plants for purposes of preventing employees from attaining eligibility for benefits under their pension and health care plans. The damaging evidence in that case were memos from the actuaries analyzing the reduction in benefits which would occur if the plant were closed. One such memo prepared by the actuaries (which was apparently not protected by attorney-client privilege) considered “various what if scenarios, analyzing the effect on costs and savings if the company decided to reduce heads.” The kinds of costs analyzed included “pension cost, savings cost, savings plan cost, health care cost, and just direct overhead cost.” According to the court in that case, the employees were only required to show that the employer’s alleged desire to block the attainment of benefits rights was a “determinative factor” in the challenged decision, i.e. the claimant was not required to show that it was the sole reason for closing the plant.
2. Liability under FLSA. A troubling decision for employers that was issued late last year in the Second Circuit (covering New York, Connecticut, Vermont)–Zheng v. Liberty Apparel Co –held that an employer who outsourced certain tasks to a subcontractor in the garment industry was a “joint employer” for Fair Labor Standards Act (“FLSA”) purposes. The case is troubling because most courts in the past had looked to a “control” test to determine whether the contracting company was an employer for purposes of FLSA. However, the court in Zheng held that an employer could be deemed to be a “joint employer” if the employer had “functional control,” but not “formal control,” over the workers. In holding for the plaintiffs in the case and utilizing a factors test , the court stated that “although an entity’s exercise of an employer’s formal prerogatives-hiring and firing, supervising schedules, determining rate and method of payment, and maintaining records-may be sufficient to establish joint employment under the FLSA, it is not necessary to establish joint employment.” (The Zheng factors used by the court were: (1) whether the contracting employer’s premises and equipment were used for the work being done by the employees; (2) whether the subcontractor had a business that could or did shift as a unit from one putative joint employer to another; (3) the extent to which the employees performed a discrete line-job that was integral to the contracting employer’s process of production; (4) whether responsibility under the contracts could pass from one subcontractor to another without material changes; (5) the degree to which the contracting employer or its agents supervised the work being done; and (6) whether the employees worked exclusively or predominantly for the contracting employer.)
In light of the Zheng case and the ripple effect it might have in other districts, all employers, not just those with facilities in New York, Connecticut and Vermont, are being urged to review all of their subcontracting and outsourcing arrangements with counsel and to re-evaluate these arrangements. Given the FLSA’s harsh remedial scheme, the case could have a chilling effect on legitimate outsourcing arrangements which, according to the Zheng court, occupy a “substantial and valuable place” in the way American companies of all sizes do business.
Conclusion: While there are many business reasons for embarking upon a path of outsourcing, the case law demonstrates how, under ERISA, making the decision to outsource for the wrong reasons could come back to haunt the employer. In addition, outsourcing could lead to problems under the FLSA if employers who outsource are deemed to be “joint employers” under the factors cited in Zheng. When considering this option, employers need to be wary that, while outsourcing may save costs, it could also lead to unexpected lawsuits and result in exposure to liability in some circumstances.
(*Outsourcing is the delegation of a business process to an external service provider. The service provider is then responsible for the hiring of employees to accomplish the delegated business process.)