Outsourcing Spotlight - Spring/Summer 2024

The next UK general election is scheduled for 4 July.  A lot could happen between now and polling day – but assuming the polls are right, what impact would a Labour Government have on outsourcing in the UK?

Labour plans to reform unfair dismissal laws by removing the qualifying period for claims, removing the limit on compensation and making the right available to all workers (not just employees).  On the face of it,this last change would, for example, potentially extend unfair dismissal rights to casual workers on zero hours contracts.  The proposals would have a significant impact on the number of people who could claim unfair dismissal and the potential cost to employers.  Currently, only employees can bring unfair dismissal claims (not all workers) and only after they have clocked up at least two years' service with their employer (in most cases).  Compensation is currently also capped (in most cases) at the lower of a year's pay and £115,115.

A key question is whether there will be any probation period during which it would be easier to dismiss on the basis of e.g. unsatisfactory performance - and if so, how long it will be.  Recent press reports based on leaked documents suggested that Labour plans to allow "probationary periods with fair and transparent processes", but we have not yet seen any further detail on this.

Labour plans to ban zero hours contracts, although the leaked document talks in terms of banning "exploitative" zero hours contracts (rather than all such arrangements) and "ensuring everyone has the right to switch to a contract that reflects the number of hours they actually work, based on a twelve-week reference period".  This suggests that there may be more flexibility than the headline announcement of a "ban" would imply - and that staff who wish to remain on zero hours arrangements could choose to do so.  However, union leaders are reported to have pushed back against any watering down of the original commitment to ban zero hours contracts.  As a result, until we get more detail on the specifics, businesses should not assume that they will be able to keep staff on zero hours contracts in the event of a Labour victory.

More generally, the new regime will also allow the next Government to take a harder line on excluding bidders from future contracts:

Whether you're typically a customer or a supplier in an outsourcing context, pricing looms large in negotiations. It can be particularly challenging where the arrangements are longer term, because both parties are likely to be concerned about being locked into a pricing arrangement that seemed like a good deal at the time – but quickly gets overtaken by developments such as inflation or new offerings from competing providers of equivalent services.

In the last edition of Outsourcing Spotlight, we looked at different approaches to dealing with high inflation, including indexation clauses and the pros and cons of open book vs closed book pricing.  This time, we focus on mechanisms that parties can use to provide assurance that they are still "getting a fair deal" (both in terms of the customer achieving value for money and the supplier being able to achieve an acceptable profit margin).

Benchmarking is inherently more involved than "most favoured customer" obligations, which has contributed to its reputation for being costly and complex, particularly compared with other pricing mechanisms. On the other hand, it also allows for rather more refinement and nuance than a "best prices" approach, recognising that pricing does not exist in isolation. That should also make it a less adversarial and more collaborative exercise.  In our experience, it is worth considering in the context of long term, higher value outsourcings where there is a recognition that prices will need to change but also a desire to minimise the risk of damage to the parties' commercial relationship from that process.  For more discussion, including a checklist of key commercial and drafting issues to address, see our briefing: Benchmarking clauses: getting the balance right.

Finally, returning to the topic of external developments such as inflation which can cause problems with pricing, it's worth considering the impact of currency fluctuations – particularly where offshoring is involved.  As we explain in our briefing Pricing and payment clauses: who bears the risk of currency fluctuation?, the usual rule is that the risk of currency fluctuation is typically borne by the payor – so if pricing is not in sterling, but the currency used by the offshore outsourcing provider, the customer will bear the risk. 

With an election coming up in July, regulation of artificial intelligence in the UK is currently in a state of flux.  The approach to date – as recently confirmed by the current UK administration in the response to its March 2023 White Paper - has been as follows:

• Flexible approach based on existing law:  Overall, the current UK administration Government has taken the view that a non-statutory, context-based approach to regulating AI is the best way forward because it offers "critical adaptability".  Instead of legislation, regulators in areas such as data protection, financial services or competition law are being asked to produce guidance on their strategic approach to AI.
  
  
• Regulators to watch:  From an outsourcing perspective, the regulators to watch are likely to be the Information Commissioner's Office (personal data), the Equality and Human Rights Commission (bias and discrimination) and – depending on your industry focus – sectoral regulators such as the Financial Conduct Authority, Ofgem or Ofcom.
  
  
• Extra funding:  Following concerns that many regulators had no dedicated AI governance specialists, the current UK administration has committed to providing an additional £10 million in funding to support the development of AI-related regulatory capacity. This is welcome but to avoid leaving gaps in the UK's regulatory framework, regulators will also need to work hard to coordinate their various responses to the challenges posed by AI.

However, if the Labour Party were to form the next UK Government, we could well see changes to this approach.  Labour appears to be more open to legislating on AI and may want to consider additional statutory protections around issues such as employee rights (see, for example, the draft AI (Regulation and Employment Rights) Bill being promoted by the Trades Union Congress), bias and discrimination.  That said, economic growth is likely to be a key priority, which may make it cautious about over-regulating what is still in many respects an emerging technology.

The EU continues to take a different approach from the UK, based around legislation.  Its AI Act has now been approved by the EU Council of Ministers and is expected to be brought into effect in stages over the next 2-3 years. However, given the longer term nature of many outsourcing transactions, parties looking to include an AI-based solution will want to ensure that whatever system they deploy is likely to pass muster under the legislation.  Obviously the Act will not be part of UK law, but it is likely to affect outsourcings implemented in the UK where, for example, the output of the AI system is going to be used by e.g. customers in the EU.

For more discussion of AI and its implications for outsourcing, see:

• A 3 minute primer on AI and outsourcing – partner James Longster provides a bite-sized checklist of the key points to watch out for
  
  
• Outsourcing Spotlight Autumn 2023 – includes discussion of the key risks to consider when deploying AI systems as part of an outsourcing
  
  
• Smarter AI Regulation, our series of briefings on the legal aspects of AI, including the general regulatory framework, data protection and IP

Many outsourcing  contracts contain blanket exclusions of certain types of loss, such as loss of profits – and sometimes the parties also agree that such clauses will be mutual (so both service provider and customer benefit from the same exclusion). But a recent dispute between EE and Virgin Mobile highlights the significant impact such provisions can have on a party's remedies for breach – especially where the clause is reciprocal.  

The key lesson of the case for outsourcing service providers is that although a blanket exclusion of certain types of loss will normally be to your benefit, you need to be alive to the implications if you agree that the clause will be mutual. In this particular case, it resulted in EE (the supplier) being unable to obtain damages for breach of an exclusivity obligation in its favour – which is probably not what EE intended (but the court ruled that this was what the contract said).  From a customer perspective, the case is simply a further reminder of how blanket exclusions can severely constrain your ability to recover damages for breach.  For more detail, see our briefing: EE v Virgin Mobile: reciprocal liability clause prevents damages claim for breach of exclusivity.

In January 2024, the UK Government signed the 2019 Hague Convention on the Recognition and Enforcement of Foreign Judgments in Civil and Commercial Matters (Hague 2019), a framework of rules facilitating the recognition and enforcement of civil and commercial judgments between contracting states.  The contracting states to Hague 2019 are currently all EU member states except Denmark, plus Ukraine and Uruguay.

The most important benefit of Hague 2019 is that it will, subject to certain carve outs, apply to English civil court judgments arising from disputes governed by non-exclusive or asymmetric English jurisdiction clauses (or indeed not governed by a jurisdiction clause at all).  This will allow UK parties to agree non-exclusive or asymmetric English jurisdiction clauses in contracts with parties from other contracting states, in the knowledge that qualifying English court judgments arising from those clauses should as a matter of Hague 2019 be enforceable in those states – including, importantly, in all EU member states (except Denmark).  As such, it improves on the position under the 2005 Hague Convention, which only assists as regards recognition and  enforcement of judgments arising from disputes governed by exclusive jurisdiction clauses. This development is therefore of particular importance to cross-border outsourcings where one party is based in the EU (except Denmark).

On 6 September 2023, the Law Commission issued its Final Report and Bill on the proposed amendments to the Arbitration Act 1996 (the "Act"). The UK Government had tabled an Arbitration Bill, which had been expected to enter the statute books later this year. With a UK election taking place on 4 July, however, this now looks unlikely. Much depends on whether the next Government brings it back before Parliament (where it will have to start the legislative process all over again). If it does, the Bill will be the biggest reform of the UK arbitration landscape for almost 30 years – so if arbitration is your preferred dispute mechanism for outsourcing transactions, we strongly recommend taking a look at our briefing: Law Commission Review of the Arbitration Act 1996: Key Areas of Review and Recommended Change.

So-called "umbrella companies" are used to facilitate provision of staff without the "end user" business having to take them on as employees.  Such arrangements can be highly beneficial to outsourcing service providers with a fluctuating demand for staff, as they allow for increased flexibility compared with engaging staff as employees. As the individual's employer, the umbrella company is required to deduct income tax and NICS from salary payments it makes to them.  In some cases, individuals may also be required to provide their services through an umbrella company operated by the employment agency which they have signed up with.

The UK already has mandatory gender pay gap reporting for large employers (250+ employees). A new EU Pay Transparency Directive will introduce an EU-wide gender pay gap reporting regime from 2026, with stronger enforcement mechanisms. If there is a gender pay gap of 5 percent or more, employers will be required to conduct a joint pay assessment with their workers' representatives and EU member states will be required to introduce penalties for employers that break the rules. While the Directive will not apply in the UK, UK businesses with operations in Europe may be caught. The Directive will initially require annual reporting for businesses with 250+ employees and reporting every three years for businesses with 150+ employees.  In the UK, the Government is encouraging voluntary ethnicity pay gap reporting and a Labour Government would introduce mandatory ethnicity and disability pay gap reporting for large businesses.

On 6 April 2024, a number of changes to flexible working and family friendly rights came into effect, including the right to request flexible working becoming a "day one" right.  Employers should ensure their flexible working and family friendly policies are updated to reflect the changes. For more details of the changes see our January 2024 Employment Update.

Finally, a reminder that from 6 April 2024, the main rate of Class 1 employee NICs, charged on annual earnings between £12,570 and £50,270, was cut from 10% to 8%. When combined with the 2% cut that took place at the start of the year, this represents a one-third reduction in the 12% rate that previously applied. However, the rate of Class 1 employer NICs on earnings above £9,100 per year will remain unchanged at 13.8%.

The main rate of self-employed Class 4 NICs, charged on annual profits between £12,750 and £50,270, had already been reduced to 8% for the 2024/25 tax year but was cut even further in the Budget to 6% from 6 April 2024. The requirement for self-employed individuals to pay Class 2 NICs, charged at £3.45 per week, ended from 6 April 2024.  In the Budget, the Government announced that it would launch a consultation later in the year to fully abolish Class 2 NICs, but it remains to be seen whether this will be pursued if there is a change of Government following the election in July.

UK pensions schemes and personal pension providers are facing upcoming deadlines to connect their systems to a centralised "pensions dashboards" ecosystem, allowing people to see all of their future pension entitlements online, in one place, via one of a likely range of dashboards providers. 

The ultimate deadline for connecting is 31 October 2026 but schemes are required by law to have regard to government guidance and that guidance sets out (among other things) a range of earlier expected connection dates. The applicable date varies by reference to scheme type and size. The earliest is 30 April 2025. Whilst some schemes' deadlines are some way off, schemes and their administrators have a sizeable "to do" list, as explained in our briefing on pensions dashboards more generally: 10 actions for getting to grips with pensions dashboards.

Impact on outsourcing in the pensions sector

Most schemes will require input from third party administrators and/or software providers to ensure they can meet the new dashboard requirements. In particular, schemes may need assistance in establishing access to scheme data via the dashboards, developing search functionality and ensuring that new systems and processes are appropriate and robust.

In the first instance this is likely to involve conversations between schemes and with their administrators and software providers to explore project plans and identify any additional resource or support requirements and any need for further expertise to be brought in. A key part of this assessment will be a review of the terms of existing outsourcing contracts to ensure they remain fit for purpose once the dashboards regime is in place.

By their nature, any changes to the outsourcing arrangements will need to be made in collaboration with the service providers. Trustees should engage with administrators and IT suppliers at an early stage to understand their technical proposals for connecting to the dashboard ecosystem.  The Pensions Regulator has warned trustees that "[w]hile you can use third parties to help you meet your duties, you will ultimately remain accountable for ensuring that your scheme is connected to dashboards on time and that you are (and remain) compliant with the requirements."

As we reported in the last issue of Outsourcing Spotlight, the UK has been looking at expanding the scope of financial services regulation to encompass "critical third parties" – which would include some businesses providing outsourced services to customers in the financial services sector.  More detail on those proposals has now been published and whilst the number of service providers expected to be designated as third parties is small (the Government estimates in the region of 20-30 providers), the compliance obligations involved are potentially onerous and costly (the Government estimates the cost as being £600k-£900K for implementation and ongoing costs of £500K – but these could prove to be conservative).  As noted previously, this may prompt certain providers of outsourced services to raise their prices in response to the increased regulatory burden.  For more detail, see our briefing Situation critical: Proposed new rules to regulate Critical Third Parties.

Meanwhile the EU has also been active in this area; the Regulation on Digital Operational Resilience (DORA), which will apply from 17 January 2025, imposes new obligations on EU-regulated financial entities to better manage the risks from their use of outsourced IT service providers. In addition, like the UK critical third parties regime, it also imposes obligations directly on some providers of outsourced services; in very broad terms, this will involve a similar designation regime to the proposed UK regulations outlined above. That said, there will be some differences. Aside from DORA being extremely prescriptive in the way firms must comply, the major difference for third parties is that the bar for designation in DORA is expected to be lower, and the UK test is certainly tied more clearly to major systemic risk.  For more detail, see our briefing: DORA: time to review your ICT contracts.

We regularly advise both customers and suppliers on outsourcing transactions in a broad range of sectors.  Recent examples include: