May 08, 2006

Offshore Outsourcing - Recent U.S. Legislative Developments

Offshore outsourcing continues to be in the political spotlight in the U.S. and has triggered a flurry of recent legislative activity both at the federal and state level. Although much of the proposed legislation has yet to be enacted, a few common regulatory approaches are emerging. The approaches being targeted at companies that utilize offshore outsourcing are generally broken down into three areas (1) disclosure to authorities and/or customers that a company is using offshoring services, (2) restrictions on sending personal information overseas, and (3) disqualification from or prejudice against being awarded government contracts or grants. Given these actual and potential regulatory developments, preserving flexibility in offshore outsourcing relationships is now more important than ever.

I. Federal Legislation

As of February 2006, no federal laws had been enacted directly regulating offshore outsourcing. Although there are federal laws that come into play in certain offshoring transactions (e.g., SOX for public companies; HIPAA and Gramm-Leach-Bliley ("GLB") for certain types of data transfer; export laws in cases where offshore personnel are accessing technologies in customers' systems requiring export licenses), the primary driving force behind these laws was not to address offshore outsourcing. However, during the past two sessions of Congress, over twenty bills have been introduced in Congress directly addressing offshore outsourcing or cross-border data transfers of personal information which is present in many offshore outsourcing transactions.

The majority of the proposed federal legislation impacts or restricts the offshoring of services in government contracts, military contracts, or the receipt of federal funding. Some proposed federal legislation imposes obligations on a party who is outsourcing jobs overseas to provide notice to its employees or government agencies prior to laying off any employees affected by its outsourcing activities. Possibly the most important of the proposed federal laws are S. 810 and H.R. 1653, which prohibit the transmission of personally identifiable information to foreign affiliates or subcontractors unless certain safeguards are implemented. Such legislation, if enacted, could prohibit the transfer to offshore locations or even the viewing of personally identifiable information housed in the United States by offshore personnel unless the company first undertakes the required steps set forth in the bill. Observers of these developments anticipate federal legislators may use recent high profile identity theft cases to further support data privacy legislation in attempts to stem the tide of offshore outsourcing.

A summary of a number of proposed federal bills is provided in the attached Appendix to give the reader a flavor of what these bills contain.

II. State Legislation

In 2004 and 2005, there were over 100 state bills introduced each year addressing offshore outsourcing. In each of these two years, bills were introduced in nearly all 50 states. By comparison, in 2003, the total was four bills in four states. The majority of these proposed laws are directed at government contracts or call centers utilizing offshore outsourcing services. There are also a number of proposed laws requiring prior consent to transfer personal information to offshore locations. During this two year period, nine states passed into law eleven bills.

A summary of the enacted state laws and a sampling of proposed 2005 state laws are provided in the attached Appendix.

III. Recommendations

If your company utilizes or plans to utilize offshore outsourcing, it is advisable to put in place a system to monitor these legislative developments. Some organizations such as the National Foundation for American Policy are tracking this legislative activity and posting it on their websites. (See Note in the Appendix.) Some customers of offshore outsourcing are requiring the U.S. vendor utilizing offshore locations to monitor these developments and timely inform them of enacted legislation impacting the transaction. That is to say, customers require that a vendor actively monitor legislative developments affecting the vendor's own industry as well as the impact of those developments on its customers.

Given the uncertain landscape, preserving flexibility in the company's offshore contracts is key. Contracts should specifically address the company's right to change processes (e.g. handling of data) or service locations as a result of changes in law. Contracts should also address who bears the cost of such changes. If work has to be brought back to the U.S. or moved from one offshore location to another offshore location, who pays for this transition? For example, the SAFE-ID Act pending in Congress seeks to put in place a system where the Federal Trade Commission would certify countries "with adequate privacy protection." For certified countries, a company would only have to give a U.S. citizen notice and an opt-out right before sending personal information offshore. For countries not certified, a company would not be able to send the personal information offshore without first providing notice and obtaining consent (i.e. opt-in) from the U.S. citizen. It is likely some of the countries (e.g. China) used by offshore vendors in providing "global services" would not meet the standards for certification.

Preserving flexibility also requires revisiting termination clauses in offshore contracts. If the vendor does not have U.S. facilities or other acceptable offshore locations to which it can move the work, termination may be the only viable option. At a minimum, a company should craft termination for convenience clauses so that they can be exercised easily in the event of a change in law. Also, companies should consider making the termination fee be a lesser amount in the case of a termination necessitated by a change in law than it is in other cases.

If government contract work is an important part of your company's business, carefully consider the scope of the offshore deal and the corporate structure of the business unit doing government contracts. Should the business unit doing government contract work be a separate company? Should the separate company participate in receiving offshore services (e.g. IT services outsourced by the procurement subsidiary of the family of companies)? Is this segregation even feasible? If not, should the offshore plans be pursued?

The general sense of those observing these legislative developments is that legislators may well prevail in using offshore data transfer restrictions and privacy concerns to target offshore outsourcing. Therefore, keeping track of a company's data (particularly personally identifiable information) and its access and flow to offshore locations is crucial. A company should inventory data that is being transferred to offshore locations or accessed by offshore personnel. This can be tricky in the era of "global services" by U.S. outsourcing vendors and U.S. companies with offshore employees. Companies which think they have engaged only U.S. companies to provide services may find out they have unwittingly been receiving offshore services. It is advisable to add specific provisions into all service contracts specifically addressing the requirements for handling and transferring data outside the U.S. These provisions should require adequate safeguards to protect the confidentiality and misuse of personal information. A typical general confidentiality clause is no longer enough. A company should require the vendor to get its consent before data is transferred to or accessed by offshore personnel (whether it's the vendor's subcontractors or employees). Consent should also be required before the vendor transfers data or allows access from one foreign country to another.

When a company is outsourcing services, it cannot outsource compliance with laws. At the end of the day, a company is still responsible for complying with existing and new laws applicable to its business. Given the uncertain legal landscape in the offshore outsourcing arena, staying informed and preserving flexibility is a sound and necessary strategy.

APPENDIX

I. Sampling of Proposed Federal Legislation Affecting Offshoring
Requires disclosure that a company is using offshoring services

  • 108th Congress H.R. 3816/S. 1873: requires employees at call centers who either initiate or receive telephone calls to disclose the physical location of such employees
  • 108th Congress S. 2090: requires companies that offshore 15 or more jobs to provide at least 3 months notice of their intentions to offshore as well as notification to the Department of Labor
  • 109th Congress H.R. 828: creates a new administrative commission to collect information and data on outsourcing

Restrictions on sending personal information overseas

  • 109th Congress S. 810: regulates the transmission of personally identifiable information to foreign affiliates and subcontractors
  • 109th Congress H.R. 1653: prohibits the transfer of personal information to any person outside the United States without notice and consent unless the company: (i) provides a notice of privacy protections provided in GLB Section 502, (ii) complies with safeguards of GLB Section 501(b), (iii) gives the consumer the opportunity to object to the disclosure of the personal information, and (iv) gives the consumer an explanation of how the consumer can object

Disqualification/prejudice for government contracts or grants

  • Amendment 2660 to S. 1637: prohibits outsourcing in government contracting concerning the privatization of federal work, federal procurement of goods and services and state government procurement for contracts using federal funds
  • 108th Congress H.R. 3911: makes certain companies that have outsourced jobs during the previous five years ineligible for the receipt of federal grants, federal contracts, federal loan guarantees, and other federal funding
  • 108th Congress H.R. 3888: prohibits business enterprises that lay-off a greater percentage of their U.S. workers than workers in other countries from receiving any federal assistance
  • 108th Congress S. 2148: funds appropriated for financial assistance for a state may not be disbursed to or for such state during a fiscal year unless the chief executive of that state has transmitted to the federal government a written certification that none of such funds will be expended for the performance of a state contract outside the U.S. unless the chief executive of such state certifies in advance that the contract at issue cannot be performed within the U.S.
  • 108th Congress S. 2094: funds appropriated for federal financial assistance for procurement contracts may not be distributed to a state unless the chief executive of the state has provided written certification to the Administrator for Federal Procurement Policy a written certification that none of the funds will be expended for goods or services performed outside the U.S.
  • 108th Congress H.R. 3134: for any contract for the procurement of goods and services to be entered into by a military department of an executive agency, the head of the appropriate department or agency may not consider a covered prospective contractor to be a responsible source unless the covered prospective contractor employs at least 50% of its employees in the U.S.
  • 108th Congress H.R. 2989: an activity or function of an executive agency that is converted to contractor performance under Office of Management and Budget Circular A-76 may not be performed by the contractor at a location outside the U.S. except to the extent that such activity or function was previously performed by federal government employees outside the U.S.
  • 109th Congress H.R. 829: restricts federal agencies from contracting with entities that have outsourced jobs in past five years offshore.

II. State Legislation Affecting Offshoring

A. State Laws Enacted in 2004 and 2005

Requires disclosure that a company is using offshoring services

  • North Carolina: HB 800 – requires bidders on state contracts to disclose where the services under the contract will be performed

Restrictions on sending personal information overseas

  • California: AB 1741 – prohibits voter information from being transferred outside the U.S.

Disqualification/prejudice for government contracts or grants

  • Alabama: S 63 – preference for Alabama-based professional services
  • Colorado: H 1373 – state agencies can contract for personal services performed outside the United States if it is clearly demonstrated that there will be no reduction in the quality of services offered and contracts contain confidentiality and right to privacy safeguards; H 1307 – provides an in-state preference for agricultural products
  • Illinois: S 1723 – allows for a preference for U.S. manufactured goods in state procurement process
  • Indiana: H 1080 – price preferences of 1% to 5% for Indiana companies in state contracts
  • New Jersey: S 494 – prohibits work or services performed under state contract from being performed outside of the U.S.
  • North Dakota: H 1091 – provides an in-state preference on equal bids on state contracts
  • North Carolina: H 1414 – preference for North Carolina or U.S. products
  • Tennessee: S 2344 – preference to data entry and/or call center vendors who use U.S. citizens at U.S. locations

B. Sampling of State Laws Proposed in 2005

Requires disclosure that a company is using offshoring services

  • California: AB 1172 – requires vendors of state contracts valued at over $100,000 to disclose if work will be performed outside of the U.S.
  • Kansas: HB 2462 – requires operators of call center to identify location
  • Minnesota: SF 776 – call center operators must disclose location and switch calls back to the U.S. upon request as well as obtain written consent to send personal information outside of the U.S.
  • Minnesota: HB 2440 – obligates employer to provide employee with 90 days advance written notice if employer intends to terminate such employee's job in Minnesota to shift his/her work offshore
  • Oregon: HB 3320 – requires call center operators to disclose the location of the call center and to switch the caller back to a U.S. based operator upon request
  • Texas: HB 953 – call center operators must identify locations

Restrictions on sending personal information overseas

  • Arizona: SB 1260 – prohibits the transfer of data outside of U.S. without written consent
  • Connecticut: HB 6641 – must obtain consumer's written consent before sending consumer data overseas
  • Texas: HB 411 – requires patient's written consent before transmitting health information outside of the U.S.

Disqualification/prejudice for government contracts or grants

  • California: AB 1651 – encourages state agencies to use contractors that employ California residents
  • Massachusetts: SB 1742 – prohibits state contract work from being performed outside of the U.S.
  • Michigan: HB 4102 – requires annual report on state contracts performed by non-citizens or legal residents and companies in tax havens
  • Minnesota: HF 418 – requires state agencies to attempt to arrange contract work to be done in the state
  • New Mexico: HB 677 – no state contracts with entities that transmit personal information outside the U.S.
  • New York: SB 5427 – prohibits state contract work outside of the U.S.; AB 1213 – limits state development aid if company outsourced jobs out of state in past 5 years
  • North Dakota: HB 1377 and HB 1091 – preference on state contracts if work performed in the U.S.
  • Oklahoma: SB 42 – state contractor must show that only U.S. citizens or lawful permanent residents will work on state contracts; state contract ban; SB 5 – state contracts involving call centers must be based in U.S.
  • South Dakota: HB 1156 – prohibits businesses from receiving financial assistance or any tax exemption, credit or incentive if work is performed at a site outside the U.S.
  • Texas: SB 823 – prohibits state contract work from being performed outside the U.S.; HB 817 – no state investments or purchases in company that created employment in foreign countries that could have been created in U.S.
  • Wisconsin: AB 186 and SB 98 – prohibit state contract work from being performed offshore

Note: For a complete list of offshore legislation see the National Foundation for American Policy website which is tracking the legislative activity on "Global Sourcing." www.nfap.net/researchactivities/globalsourcing

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