Outsourcing: South Africa overview
A Q&A guide to outsourcing in South Africa.
This Q&A guide gives a high-level overview of legal and regulatory requirements on different types of outsourcing; commonly used legal structures; procurement processes; and formalities required for transferring or leasing assets. The article also contains a guide to transferring employees; structuring employee arrangements (including any notice, information and consultation obligations); and calculating redundancy pay. It also covers data protection issues; customer remedies and protections; and the tax issues arising on an outsourcing.
To compare answers across multiple jurisdictions, visit the Outsourcing Country Q&A tool. This article is part of the PLC multi-jurisdictional guide to outsourcing. For a full list of contents, please visit www.practicallaw.com/outsourcingmjg.
Regulation and requirements
Currently there is no national legislation dealing specifically with outsourcing agreements. However, certain provisions in the Consumer Protection Act 68 of 2008 (CPA), the Competition Act 89 of 1998 (Competition Act) and the Labour Relations Act 66 of 1995 (LRA) may have an impact on a variety of aspects of outsourcing agreements.
The CPA applies to the provision of both goods and services for consideration to consumers in South Africa where the supplier is acting in the ordinary course of business. This applies irrespective of whether the supplier resides or has its principal office within or outside South Africa. The definitions of goods and services in the CPA extend to the products and services typically provided in outsourcing agreements.
Where the CPA applies, it has a far-reaching impact on outsourcing agreements and, amongst other issues, regulates:
Marketing activities and administration of the relationship.
The terms and conditions of the outsourcing agreement.
The delivery of the goods and services.
The quality of goods and services and service levels.
Liability (including product liability).
The provisions of the CPA relating to product recall and product liability will apply in all circumstances (see Question 34). However, in addition to other exceptions, most of the CPA does not apply to outsourcing agreements where the consumer is either:
A body corporate with either an asset value or annual turnover which equals or exceeds ZAR2 million (this amount is subject to variation by the Minister) (as at 1 February 2012, US$1 was about ZAR7.8).
Most outsourcing agreements therefore fall within these two exceptions. Any supplier should, however, always assess whether the customer is entitled to the protections of the CPA and whether the CPA applies to the transaction (particularly where the customer is a sole-proprietor or a new company).
The South African Reserve Bank (SARB) has published Guidance Note 3/2008 (Guidance Note) in terms of section 6(5) of the Banks Act 94 of 1991. The Guidance Note provides guidelines to banks on factors that they must consider before entering into an outsourcing agreement. SARB must be notified of any outsourcing agreements that could:
Have a bearing on a bank's risk profile.
Affect a bank's systems and controls.
Be classified by the bank's management as being of strategic importance.
Have implications on the discharge of the duties under the supervisory processes followed by SARB.
The outsourcing arrangement must be structured so that the bank, SARB and other parties will at all times, have access to the information they require to fulfil their statutory obligations. This is particularly important when the supplier is not a South African entity and jurisdictional barriers may hinder access to information. Any possible restrictions should be reported to SARB. In addition, it is advisable that the legal representatives thoroughly scrutinise the service level agreements (SLAs) for the outsourcing arrangements before implementation. Provisions for early termination options, subcontracting of services, and amendment of the SLAs based on the supplier's performance should be built into the SLA.
Management of a bank needs to exercise high levels of care and diligence when they outsource functions to external suppliers or suppliers that form part of a banking group and ensure that the integrity of the bank's systems and controls is not compromised. Before an agreement is entered into the managing board must assess whether the proposed supplier will be able to perform the outsourced function at the required level. Proof that this has been determined must be provided to SARB on request.
The bank should be able to address any weaknesses that come about as a result of weaknesses in the supplier's service. These weaknesses can be identified by providing external agencies or the bank's internal and external auditor's with access to the supplier. The bank's management must ensure that it has capacity to deal with any problems identified. The Guidance Note also addresses issues surrounding contingency plans in the context of outsourcing arrangements.
Outsourcing of internal audit and compliance functions is not recommended, but SARB will, in certain circumstances allow this.
There are no regulations that specifically regulate business process outsourcing.
There are no regulations that specifically regulate the outsourcing of IT. However, if cryptography services or products will be provided or utilised pursuant to the outsourcing agreement, then various provisions and requirements (including registration obligations) in the Electronic Communications and Transactions Act 25 of 2002 (ECTA) and certain armaments legislation will apply.
While there are no regulations specifically regulating telecommunications outsourcing, the Electronic Communications Act 36 of 2005 (ECA) is likely to apply to outsourced services.
No person can provide an electronic communications service, which include telecommunications services, without a licence (section 7, ECA). The Independent Communications Authority of South Africa (ICASA) can grant, among others, the following licences (sections 5(2) and 5(4), ECA):
Electronic communications network services.
Electronic communications services.
Under the ECA, all potential transferees who will be providing electronic communications services or electronic communications network services under an outsourcing agreement must obtain the relevant licences and/or approvals from ICASA. Licences generally provide for the licensee to subcontract the service for which it obtained the licence. Accordingly, in instances where the customer holds a licence, the service provider using the customer's facilities or providing the service on behalf of the customer under a sub-contract will not require a licence.
Public sector outsourcing is extensively regulated through various legislation regulating public procurement (see Question 6).
The mining industry is governed by specific legislation including the:
Mineral and Petroleum Resources Development Act 28 of 2002 (MRDP). A company holding a mining licence must develop policies in line with the MRDP.
Mine Health and Safety Act 29 of 1996 (MHSA). Mining companies must create appropriate codes of practice to train and identify potential hazardous factors in the mine. A company with a mining licence must ensure the health and safety of its employees at all times. The mining company's contractors must comply with the MHSA. It is the licence holder's duty to ensure that the contractors adhere to all mine policies.
A mining company considering outsourcing certain of its business activities to another company must ensure that it does not violate the terms and conditions of its mining licence when doing so.
Mining companies must also consider black economic empowerment and transformation under the Broad Based Black Economic Empowerment Act 53 of 2003 and its Codes of Good Practice (BBBEE Act and Codes). Customers must assess the affect outsourcing will have on its black economic empowerment status and compliance with the BBBEE Act and Codes and the Mining Charter.
In applying for a mining licence, the prospective licensee must submit a work programme as part of the application. The customer (the outsourcing mining company) must ensure that the supplier adheres to the work programme in compliance with licence requirements.
South Africa is a member of the International Association of Insurance Supervisors (IAIS), which represents insurance regulators and supervisors in about 190 jurisdictions and sets global insurance standards. The IAIS published the Insurance Core Principles Standards, Guidance, and Assessment Methodology in October 2011. To ensure that South Africa complies with international standards, the Financial Services Board (FSB) issued Draft Directive 159.A.i (Directive) for comment. The Directive is intended to be in line with the IAIS Methodology. The Directive states that outsourcing may materially increase risk to insurers or adversely affect their ability to manage risks and meet regulatory obligations. Therefore, a regulatory framework is required to manage risks and meet regulator obligations.
The Directive applies to all aspects of the insurance business of insurers that are or may be outsourced to a third party. The Directive states that the outsourcing of any aspect of the insurance business of an insurer must not:
Materially impair the quality of the governance framework of the insurer.
Materially increase risk to the insurer or materially adversely affect the insurer's ability to manage its risk and meet its legal and regulatory obligations.
Impair the ability of the Registrar of Long-Term Insurance or the Registrar of Short-term Insurance (Registrar) to monitor the insurer's compliance with its regulatory obligations.
Undermine continuous, fair and satisfactory service to policyholders.
Create potential conflicts in respect of the insurance business of an insurer, the interest of policyholders or the business of the third party that performs the outsourcing.
The Directive states that an outsourcing policy must be reviewed at least once annually and be adapted in view of significant changes and that all outsourcing contracts must be in writing and must include, among other things, provisions relating to the following:
Frequency of the process service or activity to be performed.
Indemnity and liability provisions.
Allowances for period.
A requirement that the third party comply with applicable laws.
The Directive places a duty on an insurer to notify the Registrar before entering into an outsourcing contract and must immediately notify the Registrar of any material developments with respect to the outsourcing during the term of the agreement.
The Competition Act applies to an outsourcing agreement if the agreement involves:
Restrictive horizontal practices (section 4, Competition Act).
Restrictive vertical practices (section 5, Competition Act). Outsourcing agreements are more likely to contravene section 5 of the Competition Act. The Competition Act only prohibits such an agreement if it results in a substantial lessening or prevention of competition in the relevant market, or if it contains a compulsory minimum resale price maintenance provision.
A merger as defined in section 12 of the Competition Act. Two factors determine whether an outsourcing agreement will constitute a merger:
whether a business or part of a business has been transferred;
whether the transferee has gained control over the whole or part of that business.
In Competition Tribunal v Edgars Consolidated Stores Limited and Retail Apparel (Pty), the Competition Tribunal confirmed that the transfer (acquisition) of an asset could constitute the transfer (acquisition) of a business or part of a business. In addition, the Competition Tribunal stated that the transfer of an asset or the partial transfer of an asset will constitute the transfer of the whole or part of a business if it enlarges the market share or productive capacity of the acquiring firm (in this case, the transferee) or if it results in increased market concentration in the relevant market.
If the transferee has also gained control of the transferred business, then the outsourcing arrangement constitutes a merger. Outsourcing agreements that involve the transfer of assets and/or employees are particularly likely to be considered under the merger provisions.
Mergers are divided into three size categories (small, intermediate and large) in accordance with the values of the merger thresholds determined by the Competition Commission and firms must obtain pre-merger approval if the value of their contemplated merger falls within the merger thresholds (Chapter 4, Competition Act).
Exchange control issues and SARB authorisation
There are exchange control restrictions for South African residents and the present exchange control measures were introduced in the Exchange Control Regulations, Orders and Rules 1961 as amended, which were promulgated in Government Notices R1111 and R1112 of 1 December 1961, issued in terms of the Currency and Exchanges Act (Act No. 9 of 1933) (the Exchange Control Rules).
The Financial Surveillance Department of the SARB administers exchange control measures. The SARB has wide discretion, but it acts within policies set by National Treasury and the Minister of Finance in consultation with the SARB. There is a total prohibition on transactions in foreign currencies except with the approval of an authorised dealer (that is, a bank licensed to deal in foreign exchange). There are limits to the authority of authorised dealers and matters falling outside the scope of their authority are subject to approval by the SARB.
All outsourcing agreements entered into between South African residents and non-residents where residents pay non-resident parties for services are subject to approval being obtained by making an application to an authorised dealer or the SARB (as the case may be). Agreements between residents and non-residents where residents will receive payment from non-resident parties for services are generally not subject to prior approval, however, the resident has an obligation under the Exchange Control Rules to repatriate the foreign currency payment to South Africa.
In certain instances, a party to an outsourcing agreement may need to transfer intellectual property rights (IP rights) to the other party. The Supreme Court of Appeal in Oilwell (Pty) Ltd v Protec International Ltd & others 2011 JOL 27137 (SCA) held that South African owners of IP rights can transfer these to foreign persons or entities without the need for exchange control approval. In addition there is no longer a need to justify the purchase price for any intellectual property to SARB.
However, the payment of IP royalties from a resident to a non-resident party still requires exchange control approval. If IP rights are transferred abroad, the user of the IP rights in South Africa must obtain exchange control approval before royalties can be paid to the non resident owner of the IP rights.
Establishing a South African subsidiary
If a foreign entity intends to establish a South African subsidiary to conclude an outsourcing agreement with a South African entity, the share certificate issued to the holding entity for its South African subsidiary must be endorsed as "non-resident". This endorsement serves as evidence that the monetary amount paid for the shares in the subsidiary was a reasonable amount. No dividends will be payable if the holding entity failed to endorse the share certificate. In addition, if the purchase of shares in the subsidiary was financed through a loan, the loan agreement and conditions of repayment must be approved separately by the SARB.
The legal structures commonly used for outsourcing agreements are largely determined by the nature of the work to be outsourced and the requirements of the customer.
Description of structure. Under this structure, a supplier concludes a contract directly with the customer and is responsible for the entire service or function being outsourced (including any third party sub-contractors engaged by the service provider). This is the most typical structure for the outsourcing of a function.
Advantages and disadvantages. A key advantage of this structure is that the supplier is accountable to the customer and the customer is not required to manage multiple vendors, or deal with disputes between vendors.
Description of structure. Under this structure, the customer concludes agreements with various vendors for discrete portions of the service or functions being outsourced. This is also a common structure for customers to adopt.
Where a multi-vendor strategy is adopted, it is common for a customer to appoint a third party supplier, or one of the outsourced service providers, to take responsibility for ensuring the integration of the services and deliverables of the various vendors, and to manage the other vendors and their performance under the contracts concluded with the customer.
Advantages and disadvantages. An advantage of this approach is that the customer is able to contract the services of a vendor that best provide the particular service or function, where other service providers may not be as capable. The customer does not need to compromise or accept the risks of a single supplier not being able to properly provide all services or functions outsourced to it. This is an advantage where the services or functions being outsourced are discrete and relatively independent of each other. However, a key disadvantage is that the customer must manage multiple vendors and challenges can arise in managing the interaction between the vendors and the intersection of their activities (particularly in ensuring that all vendors are properly accountable and that there are no gaps in their responsibilities or between the different services or functions).
Public-private partnership (PPP)
Description of structure. Government procurement commonly occurs through a PPP. A PPP is a contractual arrangement whereby a private party performs part of a government department's service delivery or administrative functions and assumes the associated risks. In return, the private party receives a fee according to the predefined performance criteria.
Advantages and disadvantages. Government departments are increasingly using PPPs for efficiency and risk mitigation reasons. The National Treasury has developed the Treasury Manual on Public Private Partnerships (PPPs) to serve as a guideline to government departments that participate in PPPs. The government department that outsources the service remains accountable for the service rendered. PPPs follow public procurement processes (see Question 6).
Different procurement processes are followed by the government and private sector. Private sector companies develop their own procurement policies which are followed by the procurement division in the company. Government procurement must strictly adhere to statutes and regulations governing government procurement.
Private sector procurement
Request for proposal/request for information. While different companies apply their own procurement procedures, it is common for companies to have an established internal procurement procedure. In most cases, a company conducts a needs analysis and assessment of its requirements (which could be conducted itself or through the use of external consultants). On establishing the need and assessing whether there is a budget to procure the relevant services, a company typically issues a request for proposal (RFP).
In some circumstances, if it is anticipated that the services fall below certain financial thresholds, the company might not issue an RFP, but merely call for quotations. If the relevant procurement is expected to fall above certain thresholds, or where the customer is uncertain of the scope of its requirements or potential costs, a company may issue a request for information (RFI), before issuing an RFP.
Companies can choose to issue an RFI or RFP to a pre-selected group of potential vendors, or may publicly advertise invitations to respond to the RFI or RFP. The parties requested to respond to an RFP, may not necessarily be the same entities that responded to the RFI or who were invited to respond to the RFI.
Due diligence. Depending on the nature of the responses to an RFI or RFP (or other request for quotation or proposal), a company may "down-select" two or more bidders, before awarding a contract. The company may enter into negotiations with the down-selected bidders or issue a request for a best-and-final offer. Depending on the nature, complexity and scope of the proposed outsourcing, bidders are normally entitled to perform legal, technical and financial due diligence after they have been down-selected and before any contract is concluded with the customer.
Negotiations. It is common for the company to issue its proposed contract together with an RFP, for consideration and comment by bidders. The responses to the contract are then used as the basis for negotiations with the bidder. Additionally, a company will often enter into negotiations with a bidder regarding a contract (including pricing terms and so on) and will not formally award the contract to the vendor unless the outcome of negotiations is satisfactory.
Government departments also conduct a needs analysis and follow similar steps to those for the private sector (see above, Private sector procurement). In addition, certain government regulations must be adhered to strictly.
Under the Constitution of the Republic of South Africa (Constitution), all government procurement must be fair, transparent, equitable, competitive and cost-effective. The following statutes regulate the public sector outsourcing or procurement tender process at national level:
Preferential Procurement Policy Framework Act 5 of 2000 (PPPFA). The PPPFA is a critical component of black economic empowerment as it encourages procurement from historically disadvantaged individuals. It applies to all organs of the state and establishes a detailed regulatory framework for which procurement policies must be implemented.
Public Finance Management Act 1 of 1999 (PFMA). The PFMA aims to ensure transparency, accountability and sound management of government finances. The PFMA specifies the fiduciary duties and general responsibilities of governing bodies, heads of departments, accounting officers, managers and employees of boards or the accounting authorities, and provides for personal liability where legislative duties are breached.
BBBEE Act. Black economic empowerment must be taken account in any outsourcing transaction in the public sector. All public sector entities must comply with procurement processes that take into account the black economic empowerment status of the counterparty to the transaction.
Outsourcing by any national and provincial government departments, state-owned or state-controlled entities may require approval under the PFMA and any transaction concluded without the required approval is not enforceable against the particular state-owned entity or government department.
Where a government outsourcing transaction is a PPP, the transaction must adhere to the Treasury Manual on PPPs (see Question 5, Public-private partnership).
Transferring or leasing assets
Formalities for transfer
All transfers of immovable property must be made in writing through a deed of transfer that has been registered by the Registrar of Deeds (section 16, Deeds Registries Act 47 of 1937).
Alienation of immovable property only takes effect if it is contained in a deed of alienation, which is signed by the parties (section 2, Alienation of Land Act 68 of 1981). The transfer of immovable property also only takes effect the moment the transfer is registered against the title deed by the Registrar of Deeds.
Transfer of immovable property requires the following two certificates:
Rate clearance certificate, which sets out the future rates payable within the subsequent four to six months for the relevant immovable property (rates are payable in advance).
Transfer duty certificate issued by the South African Revenue Services (SARS).
Where the property is leased, consent from the lessor may be required to transfer the lease to the supplier. Lease agreements relating to immovable property do not need to be in writing or registered against the title deed of the property to take effect. Long term lease agreements of immovable property (that is, for ten years or longer), can (optionally) be registered against the title deed of the immovable property but this must be in writing. The non-registration of long term lease agreements of immovable property does not make them invalid. However, unregistered agreements cannot be enforced against third parties if these third parties were unaware of the lease agreement at the time they concluded their transaction with the landowner.
Ownership of movable property is transferred on delivery of the movable property to the transferee with the intention by the transferor to transfer ownership in the property to the transferee. Accordingly, parties are free to regulate the transfer of movable property by way of agreement. Agreements will be subject to the normal principles on the conclusion of agreements. It is recommended that a written agreement be concluded for evidential purposes.
IP rights and licences
Patents and designs. Once cession has been effected in writing and the prescribed fee has been paid to the registrar, the cession will be recorded in the register (section 60(1), Patents Act 57 of 1978 (Patents Act) and section 30(1), Designs Act No 195 of 1993).
A patent owner can apply to the registrar for a licence to be granted under his patent (section 53(1), Patents Act). If the registrar is certain that there is nothing prohibiting the granting of a licence under the patent, a licence will be granted and the register endorsed accordingly. A licence can be granted subject to conditions that the registrar deems necessary.
Copyright. Assignments and licences for copyrights are regulated under section 22 of the Copyright Act 98 of 1978, which states that copyright is transmissible by assignment, testamentary disposition or operation of law. Testamentary disposition or assignments of copyright can be limited to apply to a portion of the rights to which the owner of the copyright has exclusive control over, a part of the term of the copyright or a specified country or geographical area.
All assignments of copyright and exclusive licences must be in writing and signed by or on behalf of the assignor or licensor. A non-exclusive licence can be written, oral or inferred from conduct, and can be revoked at any time, unless there is an agreement between the licensor and licensee to the contrary.
Trade marks. The assignment of trade marks is governed by the Trade Marks Act 194 of 1993 (Trade Marks Act). Assignment must be in writing and signed by or on behalf of the assignor (section 39(7), Trade Marks Act). A registered trade mark is assignable and transmissible, either in connection with or without the goodwill of the business concerned for goods or services in respect of which it has been registered. An assignee must register his title with the registrar within 12 months of the date on which the assignment was made (section 40(1), Trade Marks Act).
For a person other than the proprietor of the trade mark to be registered as a user of that trade mark, the proprietor must make an application in writing to the registrar stating (section 38(6), Trade Marks Act):
The name and address of the proposed registered user.
The relationship, existing or proposed, between the proprietor and the proposed registered user.
The goods or services in respect of which the person is to be registered as a registered user of the trade mark.
The registrar can then register the proposed user as a registered user for the relevant goods and services.
The Competition Tribunal stated that certain asset acquisitions can increase concentration or give the acquiring firm a larger market share even though the asset itself does not increase productive capacity. Acquisition of a trade mark will fall in this category. In other words, the transfer of IP in an outsourcing agreement can cause that outsourcing agreement to constitute a merger under section 12 of the Competition Act, even though that transfer of IP by itself did not increase the productive capacity of the transferee but had the effect of increasing the transferee's market share or the level of concentration in the relevant market (see Question 4).
There is no legislation regulating the outsourcing of key contracts, therefore South African common law applies. Rights under contracts can be transferred through a cession, unless the contract contains an express prohibition. A party requires the consent of the counter-party if it wishes to delegate obligations, unless the contract expressly permits delegation without consent.
Formalities for leasing or licensing
See Question 7.
Transfer by operation of law
Section 197 of the LRA states that if the whole or part of a business is sold as a going concern, the transferor is automatically substituted by the transferee in respect of all contracts of employment in existence immediately before the date of transfer. All the rights and obligations between the transferor and an employee at the time of transfer continue as if they had been rights and obligations between the transferee and employee.
Change of supplier
Change of supplier is known as second generation outsourcing. In the case of Aviation Union of South Africa v South African Airways (Pty) Ltd, the Constitutional Court made clear that it does not matter what the "generation" of the outsourcing is, what must be determined is whether there has been a transfer of a business as a going concern by the transferor to the transferee. If so, section 197 of the LRA applies (see above, Initial outsourcing).
In the Aviation Union case, the Constitutional Court differentiated between simple contracting out where section 197 is not triggered and true outsourcing where section 197 does play a role. In the former, where the contract is cancelled all that follows is that the contractor forfeits the contractual right to provide the service and the employees' employment in relation to the outsourced service will cease.
If a business is transferred as a going concern under section 197 of the LRA, the transferee is automatically substituted in the place of the transferor (see Question 9, Initial outsourcing). All rights and obligations between the transferor and an employee at the time of transfer continue as if there had been rights and obligations between the transferee and employee. Anything done before the transfer or in relation to the transferor, including dismissal of an employee or commission of an unfair labour practice is considered to be done by the transferee. Employees must be transferred on terms and conditions that are no less favourable to the employees than under the transferor.
Employees are not prevented from being transferred to a pension fund, provident or similar fund different from the one they belonged to before the transfer, if the Registrar of Pensions is satisfied that the scheme is reasonable and equitable.
The transferor and transferee must allocate liability for the following payments as at the date of transfer:
Leave pay accrued by the employees while employed by the transferor.
Severance pay that would have been payable to the employee in the event of a dismissal for operational requirements.
Other payments accrued by employees but not yet paid to them by the transferor.
The transferor must disclose the terms of any agreement to each employee who is being transferred.
For 12 months after the date of transfer, the transferor remains jointly and severally liable with the transferee to any employee who becomes entitled to receive any of the payments set out above as a result of dismissal of any employee related to the employer's operational requirements. The transferor is only relieved of this obligation if it is able to demonstrate that it has complied fully with the provisions of section 197 of the LRA (that is, it has concluded the agreement relating to the payments referred to above).
The transferor and transferee are jointly and severally liable for any claim concerning any term or condition of employment that arose before the transfer.
Under the LRA, dismissal of an employee for a reason relating to the sale of the business as a going concern, is deemed to be automatically unfair. Therefore any retrenchment in contemplation of an outsourcing agreement could constitute an automatically unfair dismissal. Compensation awarded to an employee for unfair dismissal can be equivalent to 24 months' remuneration (section 194, LRA). An employer can, however, dismiss an employee for operational requirements, which may be economic, structural, technological or similar.
The public officer of a company (that is, the person responsible for ensuring that the company complies with the requirements of the South African Tax and Revenue Services) must reside in South Africa. Legal restrictions also apply to certain professionals. Employees performing certain functions can require accreditation by South African training associations.
A foreign national who wishes to work in South Africa must comply with the Immigration Act 13 of 2002 which regulates the entry of foreign nationals to South Africa. A foreign national who is not a holder of a permanent residence permit can enter and temporarily stay in South Africa only if he has a valid temporary residence permit (for an employee, this is a work permit).
The employee arrangement of an outsourcing agreement can be structured as a secondment from the customer to the supplier, but the provisions of section 197 of the LRA regarding transfers of a going concern must be kept in mind (see Question 9, Initial outsourcing). The question is whether a transfer of business as a going concern has taken place, irrespective of whether the contract has been structured as a secondment agreement. The courts will give effect to the substance of the agreement.
Information, notice and consultation obligations
If the outsourcing agreement results in the transfer of the business as a going concern under section 197 of the LRA, all employees are automatically transferred from the customer to the supplier. The documents that are generally required include the following:
A current list of employees.
Information on confidentiality or non-compete agreements to which employees are party.
All labour contracts, collective agreements, union agreements, recognition agreements and any consent, waivers or amendments to these.
All employee compensation, benefits, bonuses, pensions, deferred compensation, incentives, profit-sharing, employment equity, health and severance plans or programmes.
A schedule of current and pending employee grievances and recent industrial action.
Where an outsourcing agreement constitutes a merger under the Competition Act, (see Question 4, The Competition Act) the competition authorities will take into account the effect the outsourcing agreement will have on employment when deciding whether to approve the merger. A party to an intermediate or a large merger must notify any registered union that represents a substantial number of its employees or the employees concerned (if there is no registered trade union) of such a merger (section 13A, Competition Act).
The transferor is required, under the LRA, to inform employees regarding the liability of the transferor and transferee for certain payments (see Question 10, Employee benefits).
Data protection and data security
General requirements. Data protection refers to laws that regulate the protection of a person's personal information under the broader concept of the right to privacy. The right to privacy is a fundamental right that is protected under South African common law and under section 14 of the Constitution, which provides individuals with the right to have their private or personal information protected against disclosure by other persons.
Mechanisms to ensure compliance. The only protection available at present to a person who alleges that private information has been obtained and/or used without his consent is under the common law's general protection of privacy as well as the protection afforded to all individuals in the Constitution. The general principles of the common law limit the ability of people to gain, publish or use information about others without their consent. In deciding whether information is private or not, the courts will consider whether a claimant has elected not to disclose the information in question and whether he is entitled to (reasonably) expect that such information will not be disclosed. A claimant suing for invasion of privacy must meet three requirements, that:
His privacy was infringed.
The infringement was wrongful or unlawful.
There was a subjective intention on the part of the defendant to infringe the plaintiff's privacy.
A number of defences are available to a defendant in a privacy claim, the best of which is consent, which is a complete answer to any privacy claim.
Parties should also be mindful of the provisions of the Protection of Personal Information Bill (POPI Bill) (which was tabled in Parliament on 25 August 2009). The POPI Bill aims to introduce measures to ensure that the personal information of an individual (the data subject) is safeguarded when it is processed by a responsible party. Once the POPI Bill comes into effect, it will regulate any processing of personal information by a responsible party whether the personal information is that of its employees, contractors, suppliers or customers.
International standards. There are currently no requirements to comply with international standards.
General requirements. Under the banking code of good practice, a bank has a duty to treat client's information as confidential. A duty of confidence arises when confidential information comes to the knowledge of a bank in circumstances where a bank has agreed, that information is confidential. Any information acquired by the bank in connection with the relationship the bank has with the customer will be confidential, unless the information is regarded as public information. Banks are not permitted to disclose client information to anyone except in exceptional circumstances permitted by law, such as an instance where a bank is legally compelled to do so or where the disclosure is made with the client's request.
Confidentiality of customer data
See above, Data protection and data security.
Service specification and levels
The parties generally draft the services specification jointly, taking into account the services required by the customer and the supplier's expertise. It is, however, common for a draft service specification to be provided by the customer (which can be prepared by a third party intermediary engaged by the customer). A customer may use a third party intermediary to assist in negotiating the terms of the agreement, including the service specification.
The parties to an outsourcing agreement generally identify and agree on the quantitative and qualitative performance levels to measure the supplier's performance of the services.
It is important for the customer to carefully draft the provisions relating to service credit or penalty regimes, in light of the provisions of the Conventional Penalties Act 15 of 1962.
Where service credits apply, the parties will typically include a regime where:
The parties agree a portion of the monthly service fees which are deemed to be "at risk".
The at-risk amount is apportioned (in the form of percentages) to certain service levels which are identified as material (with the customer being able to vary the apportionment and the service levels which are subject to a service credit).
The service credits are calculated on a monthly or quarterly basis (or other period as agreed) and are set-off against future fees or against outstanding invoices (depending, once again, on what has been agreed). Service credits will typically only be applied where the customer makes an election to claim the service credits. In this regard, in light of the provisions of the Conventional Penalties Act, it will be important for the agreement to be clear that the customer can elect to claim damages instead of the service credit and that the customer is not obliged to claim the service credit.
There are detailed reporting requirements (normally on a monthly basis) in which the supplier must report compliance with service levels and the calculation of service credits which may be payable).
In some service credit regimes, an earn-back mechanism is introduced allowing for the supplier to recover service credits paid or payable by it where it achieves certain service levels for a defined period of time thereafter.
Charging methods and key terms
Various pricing models and methodologies can apply to outsourcing agreements.
Cost-plus pricing is where the parties agree that the supplier will be able to recover its proven costs and additional percentage of the costs. The agreement requires adequate open-book provisions and suitable controls over the costs of the vendor.
Fixed price arrangements
In these arrangements, the supplier typically links the costs with specified volumes or assumptions. Where the volumes or assumptions are exceeded, a mechanism is included for the adjustment of fees. The agreement would also have a clause allowing for inflationary adjustments.
Gain share or cost-saving arrangements
In these arrangements, the supplier is entitled to a percentage or portion of any savings or quantifiable improvements achieved by the customer as a result of the supplier's performance.
Minimum revenue commitments
In these arrangements, the supplier is guaranteed to receive a minimum fee, irrespective of the scope and volume of services being provided. This is typically adopted in circumstances where the volumes and scope of the services are available, or where they are such that the contract would not be commercially viable for the supplier. A supplier can also insist on minimum revenue commitments where it is required to commit to certain undertakings, or levels of resources. Minimum revenue commitments can also be included in contracts where the customer has the right to terminate whole or part of a contract for convenience.
Variable charges or volume based charges
These arrangements are linked to the volume or scope of services actually used by the client. They are often accompanied by a minimum revenue commitment.
Resource based charges
This is typically used in a "staff augmentation" arrangement where the customer pays for the services of the supplier's actual employees on an hourly, daily or monthly basis (rather than as a service based charge). This is not common to outsourcing agreements, particularly where the supplier remains responsible for the services performed by the employees.
The following key terms are normally included in contracts in relation to costs:
Cost of living adjustments, or inflationary increases, allowing for annual adjustments to fees.
Audit rights which allow for the customer to audit the charges levied by the supplier. This is also used in open-book arrangements.
Change control provisions entitling the supplier to adjust the fees where the customer requests or makes a change to the services.
Benchmarking provisions entitling the customer to assess the competitiveness of the supplier's charges and potentially adjust the charges.
Most-favoured customer provisions, under which the supplier guarantees that the customer's pricing is no less favourable than those offered to other customers, or similar customers.
Rights to recover fees paid to third parties where the customer is obliged to procure services from a third party as a result of any failure by the supplier.
Rights to increase fees on the occurrence of certain changes in law.
Rights of the supplier to recover additional fees where it is prevented or delayed in performing by the customer or a third party.
In respect of services which have a foreign currency component, provisions can be included to apportion or pass the risk of exchange rate fluctuations.
Customer remedies and protections
Common law provides that on a material breach of the agreement, the aggrieved party can either:
Cancel the agreement and claim damages.
Elect to claim specific performance and claim any damages as a result of the breach.
Claim only damages.
In certain circumstances, injunctive relief (for example, in the form of an interdict) can be available and appropriate.
It is common to provide the supplier an opportunity to remedy the breach.
There are various protections that parties can include in an outsourcing agreement to address circumstances of breach by the supplier (in addition to those available under general law). These additional protections include:
Step-in rights and rights to engage third parties to provide the services.
Transition and exit management provisions (addressing, among other things, transfer of employees, contracts and assets used or required to provide the services).
Penalty clauses or liquidated damages provisions.
The ability to withhold or suspend payment of fees.
Source code escrow clauses entitling the customer to access source code placed in escrow.
Termination rights for repeated non-material breaches.
Warranties, indemnities and insurance (see Question 25).
Warranties and indemnities
The kind of warranties given depends on the kind of services outsourced and the complexity of the agreement. They can include warranties relating to the following:
Observance of applicable laws.
Authority to sign and perform.
Required approvals or licences.
Use of customer materials and property.
Skill and expertise.
Implementation and application of identified policies, process, systems and controls.
The indemnities included generally relate to the following:
Any damage to or destruction of property.
Death or injury of any person.
Breaches of confidentiality.
Breaches of certain warranties.
Actual or alleged infringement of rights, including intellectual property infringements.
Claims by any third party (including claims by employees of either party).
The customer and supplier are protected by warranties and indemnities (see Question 25). An indemnity is given by the customer to the supplier for claims by employees transferred to the supplier relating to events occurring before the date of transfer. Similarly, the supplier gives an indemnity to the customer for claims by employees transferred to the vendor relating to events occurring after the date of transfer (see Question 10, Employee benefits).
Term and notice period
There is no legislation requiring a maximum or minimum notice period to terminate an outsourcing agreement. Termination of an agreement is largely regulated by the terms of the agreement and the parties are free to agree the circumstances or events which will entitle either of them to terminate the agreement.
Termination and termination consequences
Events justifying termination
South African courts will uphold termination for convenience clauses (that is, a clause that enables one contracting party to terminate an agreement with another contracting party in the absence of a breach). In circumstances where a party lawfully invokes a termination for breach clause or termination for convenience clause, it will not be held liable for damages which the other party might suffer as a result of termination. Customary termination rights include termination as a result of:
An unremedied material breach.
Cessation of business.
Change of control of the vendor.
Depending on the nature of the intellectual property and the circumstances in which the IP right came into existence, there may be circumstances in which the supplier will have an implied non-exclusive right and licence to continue using that intellectual property. These rights can be excluded or included by contract, typically in the agreement.
Liability, exclusions and caps
The supplier can exclude liability for indirect and consequential losses and also loss of business, profit and revenue. Limitations and exclusions of liability will always be considered by a court taking account of public policy.
Section 61 of the CPA relating to product liability will always apply (regardless of the fact that the CPA generally does not apply to outsourcing agreements (see Question 1)). It is unclear whether the parties are able to exclude or limit liability for product liability under section 61. Section 61 states that an entity in the supply chain can be held liable to a consumer for harm caused wholly or in part as a result of:
Supplying "unsafe" goods.
A product "failure, defect or hazard" in any goods.
Inadequate instructions or warnings provided to the consumer in respect of any "hazard" arising from the use of the goods.
This provision applies irrespective of whether the harm resulted from any negligence on the part of the producer, importer, distributor or retailer. A supplier of services, who, in conjunction with the performance of those services, applies, supplies, installs or provides access to any goods, must be regarded as a supplier of those goods. If more than one person is liable under section 61, their liability is joint and several.
The parties are free to agree to a cap on liability. This is typically fixed by reference to the value of the contract, a percentage of the value of the contract, or the value of the contract over a certain period (for instance the preceding 12 months). While it is most common for caps on liability to apply to all claims in the aggregate, it is not unusual for the parties to agree caps on liability on a per claim basis, or separate caps depending on the nature of the claim.
It is also common to exclude certain caps or events from the cap on liability (for instance, in the case of indemnity claims).
Transfers of assets to the supplier
The transfer of assets will almost invariably trigger capital gains tax (CGT) consequences for the transferor. If no consideration for the assets has been given by the transferee, the transfer will be regarded as a donation for which donations tax will be payable. The transferor may also be subject to income tax in the form of a recoupment on the assets transferred.
Transfers of employees to the supplier
The transfer of employees could potentially create a conflict for a company as its residence in one country may contradict with a source from another. Generally, employees are subject to pay-as-you-earn (PAYE) tax in South Africa and the employer withholds the employee's tax. In the absence of a double tax agreement, employees working in South Africa for an offshore company may be taxed twice on the income earned.
VAT or sales tax
Depending on the circumstances and the supplier's status and the goods themselves, VAT may be charged on disposal.
There is no service related tax.
Stamp duty has been abolished in South Africa.
Companies pay corporation tax on taxable income at 28%. Income earned by companies not ordinarily resident in South Africa, but whose source of income is in South Africa is also taxed at 28%. Income tax on branches of foreign entities is 33%.
If the agreement is between connected parties, it is likely that transfer pricing requiring potential value adjustments will apply.
All cross-border agreements may have deferred tax asset implications so it is important that they are kept in mind.
Qualified. South Africa, 1991
Areas of practice. IT; electronic business; media and telecommunications.
- Advising on general commercial agreements in respect of development, outsourcing supply and maintenance, and systems acquisitions.
- Advised Anglo American on outsourcing of data processing and IT services.
- Advised De Beers on outsourcing of information technology infrastructure.
- Advised the MTN Group on outsourcing of information systems infrastructure.
- Advised on the procurement and establishment of electronic data warehouses/enterprise data warehouses and finalisation of agreements relevant to the process.
- Advised on commercial agreements relevant to e-Commerce.
- Provided advice regarding the regulatory environment.
Qualified. South Africa, 2001
Areas of practice. IT; media; telecommunications; IP; data protection; consumer protection.
Recent transactions. Preparing, reviewing and negotiating a range of technology related agreements, including amongst others:
- Outsourcing agreements.
- Infrastructure and applications related outsourcing agreements.
- Software licence, implementation, development and maintenance agreements.
- Hardware procurement and systems acquisition agreements.
- Disaster recovery and business continuity agreements.
- Consulting agreements.
- Hosting and data centre agreements.
- Website development and internet related agreements.
- Escrow agreements.