Labor law and outsourcing: increased restrictions on this means of hiring personnel
Regulations governing outsourcing in several countries in Latin America are hindering the use of this strategic option for companies in certain areas of business.
As an essential part of the measures implemented by businesses to ensure their efficiency and specialization, a number of hiring strategies are used, such as outsourcing of services or processes, labor intermediation, independent contractors and contracts for services, among others. All of these measures ensure a simple objective: to maximize profitability with a view to being more competitive in the market.
Outsourcing is a process whereby an organization seeks to improve its production efficiency and results by delegating processes to a specialist third party. It is a business practice consisting of hiring an external party to provide services or produce goods that were traditionally provided or produced internally.
Outsourcing processes offer benefits to companies, such as (i) increased profitability, by freeing up resources for reassignment to core tasks, (ii) freedom to be able to seek external assistance on a temporary basis, with no long-term commitments, (iii) savings in recruitment processes, (iv) flexibility to respond to changes and crises, (v) fewer legal and labor contingencies for the principal, among others.
From a global perspective, outsourcing now allows companies that operated at local level to offer their services on foreign markets, thereby expanding their customer base and increasing their profitability. In turn, end customers or recipients of the services can optimize processes and, more importantly, delegate tasks that are not related to the core business to specialized third parties, leading to a substantial cost savings and, above all, better quality services.
In this article we will take a look at the main restrictions on outsourcing in Peru, Colombia, Chile and Mexico, countries in a region that, from a labor standpoint, proposes a series of restrictions on implementing this mechanism.
Outsourcing in Peru: chronicle of a reform foretold
As a starting point in Peru, outsourcing processes are regulated by Law 29245 and by Supreme Decree 006-2008-TR, a legal framework which was recently reformed by Supreme Decree 001-2022-TR, of February 23, 2022.
Peruvian labor law defines outsourcing as a form of business organization whereby a principal company entrusts or delegates the pursuit of one or more parts of its main activity to one or more outsourcing companies that provide it with goods or services linked to or forming part of such activity. As requirements in order to determine the validity of outsourcing structures, outsourcing companies must assume the services provided at their own risk and expense; must have their own financial, technical and material resources; are responsible for the results of their activities, and their workers must report exclusively to them. If these requirements are not met, the outsourcing arrangement could be declared unjustified, and the principal company could be ordered to take on the outsourced workers as part of its workforce. This is notwithstanding the corresponding fine, which could amount to up to USD 60,000.
Following the February 2022 reform, Peruvian lawmakers – similar to the case in Mexico – have decided to severely restrict outsourcing processes, limiting them to activities that do not form part of the core business of the principal company. The penalty for companies that outsource core-related activities is quite serious: the “insourcing” of such services.
But what impact does excessively strict legislation, such as that proposed in Peru, have?
Mining is Peru’s largest export subsector, representing 51% of the country’s total exports in April 2022, according to a report by CooperAcción. In terms of employability, according to a report by the Ministry of Energy and Mining (MINEM), in May 2022 mining directly employed 237,043 workers nationwide. The report also highlighted the importance of the “multiplier effect of the jobs created by mining, since for every direct job created, 8 indirect jobs are created, thereby helping stimulate the economy.”
Bearing all this in mind, let us imagine a case where a mining company has its own mining unit and is also a key source of employment, both directly (on payroll) and through third parties (contractors and subcontractors). This mining company – in addition to having its own employees – has contracts with several specialist contractors, who mainly work in the core business: extraction of minerals.
Following the outsourcing reform, all activities provided by contractors that are linked to the core business must be assumed directly by the mining company itself, with no possibility of outsourcing any process to third parties. In the case of the mining sector, it is expected that the reform could increase production costs by around 70% (El Comercio), a significant impact in terms of the survival of this activity.
However, the outsourcing reform also affects contractors – particularly micro and small enterprises – which tend to be service providers and which, following the proposed restrictions, will see their contracts terminated and operations cease, being condemned to liquidation and business closure processes.
From a labor standpoint, the outsourcing reform could have an adverse impact on formal employment, since restrictions on the ability to outsource certain services and/or processes will mean that they will have to be assumed directly by companies, along with the greater payroll cost. The consequences of this could lead to (i) excessive wage bills, (ii) lower productivity, linked to increased material, human and financial resources, (iii) the need to provide internal training on specialist knowledge (technical skills, work teams) in order to perform certain activities, with the cost this entails, and (v) an increase in potential contingencies with small staffing companies. All of this could slow formalization in a labor market in which 7 of every 10 workers are informal workers.
Thus the restrictions created by the outsourcing reform will directly affect the production efficiency and results of organizations. And, equally importantly, a large number of workers could lose their jobs due to the reduction in services that outsourcing companies will be able to provide.
Outsourcing in Colombia
Pursuant to Colombian labor legislation, companies can outsource activities and/or services, whether core or ancillary to their ordinary business, by signing a contract for services with a specialist third party. Under this contract, in exchange for payment of the agreed rates, the third party undertakes to perform the contracted activities or services using their own personnel, provided that this is not done with the intention of disregarding pay scales and/or the labor and/or constitutional rights of workers.
In this regard, the law provides that the contractor must provide the contracted services with full technical and administrative autonomy. This means that the principal company has no authority to issue orders regarding the timetable, mode of working, place of work and workload of the contractor’s employees.
Thus the principal company may only issue guidance or guidelines to the contractor and not to the contractor’s employees, and the formal and practical aspects of the service provided must be set out in the contract or attached service agreement.
This concept is regulated under article 34 of the Substantive Labor Code (CST) and, in some cases, its use may give rise to joint and several liability between the beneficiary of the activity and/or service and the independent contractor.
This joint and several liability arises when the contracted work is work habitually performed by the principal company, since it forms part of the normal or ordinary course of its business.
It should be noted that, while outsourcing is currently permitted in Colombia, it is an area of particular interest to the Ministry of Labor, which is increasingly looking to limit its use.
In practice, the main risks center on the fact that unjustified use of outsourcing can lead to administrative investigations by the Ministry of Labor and the consequent imposition of fines. Other potential risks include individual claims brought by the contractor’s employees, alleging the existence in reality of an employment contract with the principal company.
It is also important to mention that, in addition to outsourcing in Colombia, there is also the concept of manpower supply, as an alternative and indirect employee relationship under certain circumstances and subject to specific rules.
Law 50 of 1990 allowed for the supply of temporary personnel through temporary employment agencies (ESTs), which are agencies that can be hired by third parties to supply them with temporary personnel, thereby collaborating in the performance of certain activities.
Under this mechanism, the personnel are hired directly by the EST, which is responsible for complying with its obligations as employer of the workers. However, the authority to control the workers is delegated to the principal company.
This type of relationship is designed to meet temporary contingencies that may arise in the ordinary course of business. The EST provides the service by sending workers hired by the EST to the premises of the principal company in order to perform the task or service contracted by it.
The fundamental principle governing the sourcing of personnel through an EST is that this hiring mechanism cannot be used as a strategy to replace employees that should be hired directly. The restrictions seek to leave hiring through ESTs only for truly temporary activities and to ensure permanent activities are performed by direct employees.
Failure to comply with the parameters established for manpower supply arrangements could lead to: (i) a classification of illegal labor intermediation, punishable by fines by the Ministry of Labor; (ii) claims by agency workers alleging that their contract is in fact an employment contract (“contrato realidad”); and (iii) joint and several labor liability for the worker’s labor-related claims.
Outsourcing in Chile
Law 20123, from 2007, which modified the Chilean Labor Code, established a regulatory framework for work performed under an outsourcing arrangement and also for the supply of temporary labor in Chile.
First, work performed under an outsourcing arrangement is defined as work carried out under an employment contract by a worker for an employer, called a contractor or subcontractor, where the latter, under a contract, is in charge of performing works or services, at its own risk and expense and with workers that report to it, for a third individual or legal entity that owns the work, company or task, known as the principal company, which performs the services or works engaged. Works or services that are provided on a discontinuous or sporadic basis are not subject to the provisions of work performed under an outsourcing arrangement.
In work performed under an outsourcing arrangement, the principal company is jointly and severally liable for the labor and social security obligations affecting contractors in favor of their workers, including the potential statutory severance due to the end of the employment relationship. Such liability is limited to the period during which the workers provided outsourcing services for the principal company.
In this same vein, contractors are jointly and severally liable for the obligations affecting their subcontractors, vis-à-vis the workers of the subcontractors.
This liability regime may be secondary, to the extent that the principal company exercises the right to be informed of the extent to which the contractor complies with the labor and social security obligations for which it is responsible, and the possessory lien in the event of breach. The contractor assumes this same liability with respect to the obligations affecting its subcontractors, vis-à-vis the workers of the subcontractors.
The principal company is directly liable for the life and health of the workers performing its works, irrespective of who they report to, notwithstanding the obligations of the principal company, contractor and subcontractor with respect to their own workers, and must take the necessary steps to effectively protect the life and health of all the workers that provide services in its works, company or job.
Second, supplying or making workers available to provide temporary services is a method through which a duly formed company, with this sole corporate purpose, called a Temporary Services Company, makes workers available on a temporary basis to another company called a User Company, only for those cases and the maximum time periods established by labor legislation. Accordingly, the supply of temporary workers in Chile is not a mechanism that is used indiscriminately; quite the contrary, it must be based on the cases established by law in this regard and must adhere to the maximum time periods established.
Chilean legislation does not limit the services that can be outsourced and it is perfectly possible under Chilean law for the principal company to decide to outsource the services inherent in its corporate purpose, without this blocking or impeding the exercise of the rights associated with outsourced work explained above.
It is precisely this aspect that has led the government authorities to discuss the need to restrict the activities that the principal company can outsource. In this regard, the Government Program of the President Gabriel Boric points out that one of the core aspects of his mandate will be the progressive restriction of outsourcing, since it is considered be one of the forms of labor insecurity in Chile. In view of the above, during his period as president he is likely to propose a bill to restrict the activities that a company may outsource to third parties.
The above may have a big impact on the structures that many companies currently have in place, with a significant presence of personnel, both inhouse and outsourced. For this reason, the potential legislative change that may arise in this context will be of great interest to companies.
Mexico: one year on from a major reform
Outsourcing in Mexico was regulated for the first time in 2012, when legal parameters were established to ensure respect for and the correct exercise of the employment rights of workers in Mexico.
However, this initial regulation was insufficient, since there was a growth in the use of schemes aimed at concealing labor relations with a view to companies avoiding labor obligations (mainly payment of the workers’ share in company profits), as well as social security and tax obligations.
This was so widespread that the Ministry of Labor issued Press Release 0001/2021, reporting that in September 2019, it had detected that 83% of the companies inspected had outsourced their entire workforce and the other 17% had outsourced 95.5% of their workforce. It was also found that 75% of the employees of the companies inspected were registered at the Mexican Social Security Institute with lower salaries than those they actually received and that they were also registered for different activities to those that they actually performed. It also confirmed that 29% of the companies inspected imposed on workers, the monthly renewal of their contracts. It also identified that 95% of the companies inspected obtained their workers via three to six contractors who did not have their own assets and always acted as mere intermediaries.
As a result, the Mexican labor unions demanded stricter comprehensive regulations, as well as penalties and fines. Consequently, on April 23, 2021, the Official Federal Gazette published several reforms that limited the outsourcing of labor, which came into force between April 24 and September 1 this year.
Thus, following intense negotiations between the government, employers and the labor unions, the following guiding principles for the outsourcing of personnel were established:
- The outsourcing of personnel was prohibited in general, understood as when an individual or legal entity provides or makes available its own workers for the benefit of others.
- As an exception to that rule, the outsourcing is permitted of specialized services or of the performance of specialized projects (specialized outsourcing) that do not form part of the corporate purpose nor the primary activity of the beneficiary of same.
Additional or shared services or projects provided by companies in the same business group will also qualify as specialized services or projects if they do not form part of the corporate purpose or of the primary activity of the company receiving them.
- Providers of specialized services or specialized projects were obliged to register on a new Register of Specialized Service Providers or Specialized Projects (REPSE). In order to secure registration, the providers must evidence that they are up-to-date in their tax and social security obligations, establish precisely the service to be provided or the type of work to be performed, evidence the specialized nature of same and describe the elements or factors that support the exceptional nature of the work or service.
- The specialized outsourcing must be set out in a written contract, indicating the purpose of the services to be provided or projects to be performed, as well as the approximate number of workers who will be participating in the contract.
- It was established that the company that engages the specialized services or projects will be jointly and severally liable with the contractor of those projects or services, in the event of the contractor’s breach of its obligations arising from the labor relations.
- Finally, to facilitate the ongoing supervision of the providers of specialized projects or services, they were obliged to provide the Mexican Social Security Institute and National Workers’ Housing Fund Institute every four months with information on the contracts concluded in the period concerned.
As a result of the reform in 2021, in addition to the joint and several liability, heavy fines and penalties were established (ranging from US$1,200 to US$240,000 depending on the case), together with a rule preventing the deduction for tax purposes of the expense or the VAT on the payments made to the contractor, and this was even classified as an aggravating factor of the offense of tax fraud in the event of breach. Consequently, although the reform was proposed as a labor reform, it ultimately became a revenue-collection reform.
Following the reform of outsourcing regulations, a three-month term was given to bring employment contracts into compliance, by migrating the workers to the company for whom they actually worked, with the legal consequences that this entailed. For example, in July 2021, the largest bank in Mexico integrated 37,000 employees into the parent company all at once. In June that year, the Mexican government estimated that the recognition of those individuals would involve an increase of at least 25% in the operating costs of the companies, because employees had to be registered at the Mexican Social Security Institute, with the consequent payment in employee and employer contributions, adjustments in salaries and benefits with respect to the company’s employees and new hires, together with vacations, vacation bonus, Christmas bonus, payment of profit-sharing and other benefits existing at companies, in addition to the increase in tax payments, not to mention the increase in daily operating activity.
After demonstrating the deficit that the new outsourcing rules would generate without a real increase in profits, the reform was accompanied by a modification in the payment of the workers’ share in the company profits, which was one of the central elements in the discussion and one of the demands of the Mexican business sector. As part of the negotiations, it was agreed to establish a cap on the amount to be distributed among employees, with two possibilities: a maximum limit of three months of the employees’ salary or the average of the share received in the last three years. This cap represents an incentive to companies’ financing, since it will help to reduce the impact of labor migration under the new Mexican labor outsourcing system.