Canada: Information Technology Outsourcing—Part I

Increasing numbers of Canadian businesses and other institutions are outsourcing their information technology requirements: 1) to reduce costs and internal staffing commitments; 2) to release capital to more productive uses; 3) to gain access to specialized expertise; and, in some cases, 4) to establish or strengthen strategic business relationships. Business arrangements which fall under the broad rubric of IT outsourcing include the outsourcing of specific activities such as web site hosting or applications development, the outsourcing of responsibility for the operation of information technology systems, either as a single service offering or a part of a broader combined outsourcing of business and IT functions, and the transfer of IT systems, which may include the transfer of ownership of physical assets, real estate and employees, in connection with the outsourcing of IT functions to the service provider.

This article identifies some of the legal issues which may be expected to arise when structuring and negotiating IT outsourcing arrangements. As with other complex transactions, the duration and difficulty of the negotiation of outsourcing arrangements will largely depend on the quality and extent of the due diligence and the preparatory work which precedes the negotiation. The early involvement of experienced outsourcing counsel, preferably from the outset of the transaction, can facilitate the required due diligence and the structuring of the outsourcing transaction, and help the customer to avoid problems which could have been dealt with more effectively and efficiently if identified earlier in the process.

This article briefly discusses some of the regulatory constraints, contractual commitments, employment and labour issues and tax issues which may arise in the context of an IT outsourcing. Part II, to be published in a future Blakes Bulletin on Information Technology, will discuss the contracting process and arrangements and also some of the issues which frequently arise when negotiating the specific terms and conditions of IT outsourcing agreements.

Consider whether applicable laws or regulations restrict the customer’s ability to outsource or impose additional obligations on the customer and/or the service provider in connection with the outsourcing transaction. For example:

OSFI Outsourcing Guidelines. The Office of the Superintendent of Financial Institutions ("OSFI") issued a policy statement on outsourcing in 1997 and has more recently, on August 11, 2003, issued revised draft guidelines which set out OSFI’s expectations for federally-regulated entities and foreign financial institution branches which outsource one or more of their business activities. The revised guidelines emphasize the requirement that institutions retain ultimate accountability for all outsourced activities and ensure that OSFI’s ability to exercise its supervisory powers with respect to such institutions is not compromised by outsourcing.

Privacy. An expanding range of federal and provincial restrictions on the collection, use and disclosure of personal information must be observed in all outsourcing arrangements which involve such information.

Competition Act. Check whether the proposed outsourcing will require the filing of a pre-merger notification or raises other potential questions under the Competition Act.

Investment Canada Act. Acquisitions by a non-Canadian outsourcer of a business carried on in Canada will usually be either notifiable or reviewable under the Investment Canada Act.

Permits and Licenses. Consider whether any government issued permits or licenses which are to be transferred as part of the proposed outsourcing will require governmental or regulatory consent or are subject to restrictions (for example, Canadian ownership requirements) which the service provider may be unable to satisfy.

The identification and assessment of the impact of an outsourcing transaction on the existing contractual arrangements of the customer is an important element of the legal due diligence process. The types of contracts which may be affected by IT outsourcing transactions include:

Software Licenses. What consents to the assignment or sublicensing of software are required in connection with the outsourcing?

Maintenance and Service Contracts. Are consents to the assignment of maintenance and service contracts required (or may such contracts be freely transferred with the equipment to which they relate)?

Other Supply Arrangements. Are there other supply arrangements which will have to be either terminated, assigned or otherwise replaced as a result of the outsourcing?

The human dimension is frequently the source of some of the greatest challenges encountered in the course of an IT outsourcing transaction. It is important that the customer develop and implement a clear strategy with respect to communications with employees so as to avoid problems such as the loss of key personnel or drop in morale which may occur in the absence of a coherent and comprehensive HR communications strategy. Specific issues may arise with respect to:

Collective Agreements. Will the outsourcing involve the transfer of unionized personnel? If so, which bargaining units and collective agreements will be affected?

Employment Contracts. Which employment contracts will be terminated or otherwise affected by the outsourcing arrangements?

Termination and Severance Obligations. Which termination and severance payments are to be borne by each party? Should different rules apply prior to and after the implementation of the outsourcing arrangement?

Relocation Arrangements. Are employees to be relocated? If so, on what terms?

Pension Plans and Post Retirement Benefits. What pension and post retirement benefit obligations apply with respect to the transferred employees? (Will the outsourcing trigger the performance of a valuation of the customer’s pension plan?)

Other Benefits, Plans and Programs. Will the service provider be required to compensate the transferred employees for the loss of other employment benefits?

The outsourcing of IT functions may give rise to a number of unforeseen tax consequences which result from the performance by an external supplier of functions previously performed inside the firm. Questions which should be considered in this regard include:

Income Tax Implications. What taxes will be payable in respect of the outsourced services? If the services are being provided by a non-Canadian, will the customer be required to withhold and remit any amounts on account of income taxes?

Commodity Tax Implications. What sales and commodity taxes will be payable on the outsourced services? What steps can be taken to minimize non-recoverable sales taxes?

Scientific Research Tax Credits. Are such tax credits available? If so, which party is entitled to claim such credits?

Blakes’ lawyers have assisted clients with a variety of outsourcing transactions or related matters, including:

One. Assisting Bell Canada with the sale of its interest in Certen Inc. to Amdocs Limited. As part of this transaction, Bell Canada and Certen extended, to December 2010, the term of their billing operations outsourcing agreement, under which Certen is to continue to provide enhanced billing services to Bell Canada.

Two. Assisting ENMAX Corporation with respect to its 10-year business process outsourcing agreement with Accenture Business Services for Utilities, under which the parties are to work together to provide enhanced customer care services to ENMAX’s customers.

Three. Assisting Bell Canada to amend and extend the outsourcing and alliance agreements under which Bell Canada and CGI Group provide telecom and IS/IT services to each other and certain of their customers.

Four. Assisting Canadian Imperial Bank of Commerce in negotiating with Hewlett Packard (Canada) Co. to sell the Bank’s 51% interest in their joint INTRIA-HP technology support services venture and concurrently entering into a seven-year outsourcing contract for IT infrastructure support having a value of $2 billion.

Five. Assisting Bell Canada with the outsourcing of mainframe and mid-range managed operations services to IBM Canada Ltd., the outsourcing of IBM Canada’s managed network operations services to Bell Canada and a related joint marketing initiative.

Six. Assisting the Canadian Internet Registration Authority with bid documentation relating to an online dispute resolution system and the final contract with the successful bidders.

Seven. Assisting Bell Canada with its strategic alliance with Microsoft to deliver next generation Internet services and a single co-branded portal for the Canadian market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.