The Brookings Institution recently published a study on drones — the flying computers used to conduct surveillance and arm-chair warfare, so that pilots are never put at risk. Of increasing concern, according to the study, is the possibility of drones “going rogue,” either through mishandled technology or retasking by enemies. The prospect of “drones gone wild” and potentially wreaking havoc on U.S. soil suggests that “low-cost,” remotely piloted alternatives may be risky.

Employers are experiencing a low-tech version of such unintended consequences. Much like the U.S. military delegates certain tasks to machines, employers have outsourced certain human resource operations with an eye toward efficiency and cost savings. But like the military, many are finding that ceding control may come at a greater cost than expected.

Take, for example, a company operating in a high-security environment that hired a third party to perform pre-employment background screenings. All went well, until they found out one previously “screened” applicant — whom they hired — had spent time at San Quentin on a felony conviction, a fact apparently missed by the vendor and which put the company in breach of its commitment to its customers. More to the point, in this industry, where the employer’s business includes protecting massive amounts of proprietary and confidential data, some of it belonging to the U.S. government, such a breach can have devastating consequences.

Or consider the company that outsourced its leave-of-absence administration. The vendor never warranted that it would comply with federal and state law in administering the leaves, and in fact did not comply. When an error by the vendor resulted in a violation of an employee’s rights under the Family and Medical Leave Act, he sued. The employer, who acted without counsel when entering the agreement, learned then that the vendor was insulated from liability through an indemnity provision. Now the employer is engaged in litigation that could result in hundreds of thousands of dollars in damages, not to mention legal expenses, without any recourse against the third-party administrator.

Then there is the case of an outsourced harassment investigation, where a small company in California farmed out all employee complaints to a company in Oklahoma. A race harassment claim was botched when the investigator conducted only telephone interviews, failed to review all relevant documents, and had only modest awareness of California law. The company would have little response to a “failure to investigate” claim. And query whether a Faragher/Ellerth defense is even available to a business that, despite compliant policies, outsources completely its human resources obligations to a vendor that falls short. No doubt the contract’s indemnity provision provides no recourse to the employer.

Employers also use paycheck administrators. They generally assume that the vendor properly calculates employee wages and issues legally compliant paychecks. Many are surprised to learn, however, that their workers’ paychecks are sometimes inaccurate, and often on a companywide basis. If the vendor omits certain information, or simply displays it in such a way that does not comply with the California Labor Code, the company may be exposed to a class action. And vendors typically cannot be held accountable for the noncompliant pay stubs under the terms of their service agreements.

Not all vendor relationships or contracts are bad. There are certainly circumstances where it makes sense to outsource a project or a function. Indeed, many third-party businesses are specialists that can more easily, accurately and efficiently perform certain tasks. Services like benefits administration, for example, are often too laborious and specialized for employers — especially smaller ones — to perform in-house. When teed up correctly in the service agreement, and where execution is sound, use of a vendor-expert makes good sense.

So how best to approach the outsourcing of an HR function? As a threshold matter, the company should keep in-house any processes that it could more efficiently and accurately perform for itself. But if use of a third-party vendor makes good business sense, the company and its counsel should first look critically at the proposed contract. Understanding this document and requiring certain key terms will ensure the company is getting real value in connection with its delegation of human resources functions.

The agreement should clearly and expressly set forth each party’s responsibilities and obligations. Importantly, the vendor should warrant that the service it provides is legally compliant. If the vendor is not willing to do this, the employer should either find another vendor or commit to expending additional resources to ensure compliance itself. Each party should then assume liability for its own mistakes and omissions under the contract. And counsel should vet and/or revise the indemnification provision to make certain that there is recourse available in the event of misperformance by the vendor. Once the parties enter the agreement, the employer cannot go on autopilot. Neither the employer nor its counsel should assume that once the ink is dry there is no ongoing duty with respect to the outsourced tasks.

Take paycheck administration, for example. If the function has been outsourced, the employer should nonetheless periodically review payroll procedures to ensure that the data sent to the vendor is accurate and complete. Certain processes, like regular rate coding, can be extremely complicated and will require review by an experienced payroll practitioner or analyst. The person charged with analysis must be savvy regarding issues such as time rounding, draws and advances, pager pay, fringe benefits, premium pay, treatment of bonuses and prizes, etc. If you have no such person on staff, have the vendor sit with your employment counsel to explain its methodology in deriving wage payments. The employer should also regularly spot-check issued paychecks to ensure Labor Code compliance.

Similar diligence is necessary with other human resources functions. Counsel should, for example, periodically review the employer’s handbook and other relevant policies to make sure the vendor is managing HR functions in a manner consistent with company policies. Too often, vendors set up protocols that are at odds with the published policies of the employer. Consistency here is crucial. And if an employee seeks assistance on an outsourced issue, management (and/or its counsel) should stay involved — at least on an informational level — even if the nuts and bolts are handled by a third party. The employer is wise to double-check the vendor’s work — e.g., Was the harassment investigation thorough? Was the medical leave appropriately administered? The employer cannot be too careful.

In all third-party situations, counsel should confirm the vendor’s awareness of any changes in the law or regulations by requiring legal updates. In the event of a change in the law, affected services should be re-evaluated and not allowed to remain on autopilot. And the employer should always designate a point-person conversant in the outsourced function to appropriately resolve any issues.

No matter the circumstance, a company cannot turn a blind eye to the outsourced subject matter and cede all control. The company must remain diligent in protecting itself and its employees, even after the service agreement is in place. It should also involve counsel whenever a new contract for service is under consideration. Otherwise, your company may be left on the hook and without a remedy from a third party that has gone rogue.

This article first appeared in The Recorder, a Legal affiliate based in San Francisco. 

Mary Dollarhide is chair of the employment law department in the San Diego office of Paul Hastings, where she concentrates on employment law class actions. She is admitted in California, Connecticut and Washington, D.C., and has been specially admitted in numerous other states.
 
Haley Morrison is an employment law associate at the firm and has a particular expertise in the area of worker misclassification.