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Outsourcing Law & Business Journal – March 2011

March 31, 2011 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL™ : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services.  www.outsourcing-law.com.  Visit our blog at http://blog.outsourcing-law.com.

Anti-Corruption Open letter by Wipro’s Chairman and Others: Corporation Social Responsibility in Outsourcing in India (and other Emerging Countries)

March 31, 2011 by Bierce & Kenerson, P.C.

Outsourcing has created a middle class and an educated wealthy elite in India and other emerging countries. The legal framework that promotes private industry and international trade in services also distributes the benefits unequally.  In a January 2011 “open letter” to the Indian Government, business leaders of Wipro and Mahindra (and other Indian industry) asked the Indian government for more attention to civil rights, social equity and clean and responsible government.

Open Letter. The public letter calls on India’s government to reform “the widespread governance deficit almost in every sphere of national activity, covering government, business and institutions.”  The key focus was to improve the quality of the rule of law through:

• attacking corruption “with a sense of urgency, determination and on a war footing,” including the establishment of anti-corruption special public commissioners.
• “creation of genuinely independent and constitutionally constituted regulatory bodies, manned by persons who are judicially trained in the field concerned.”
• elimination of excessive administrative discretionary decisionmaking that has been “routinely subjected to extraneous influences.”
• making governmental “investigative agencies and law enforcing bodies independent of the executive.”
• unrelenting action to pursue a national mission without dilution or digression from the challenges of achieving growth and alleviating poverty.

For the online version, see http://www.rediff.com/business/slide-show/slide-show-1-an-open-letter-to-our-leaders/20110118.htm

Globalization of “Governance” and “Compliance.”   The inspiration from this Open Letter draws upon the governance and compliance mandates imposed by well-drafted outsourcing contracts on the service providers in countries such as India.  Governance, compliance and transparency are:

• legal mandates under U.S. securities laws (Sarbanes-Oxley), the U.S Foreign Corrupt Practices Act (and similar non-US laws) and U.S. federal sentencing guidelines;
• accounting mandates under SAS 70, Type II audit guidelines;
• generally accepted “Business Process Management” principles that have evolved from ITIL software development guidelines and project management principles, and
• shareholder democracy as reflected in principles of fiduciary duty of directors and officers; and
• contingency planning and risk management for multinational enterprises seeking to concentrate back-office operations in a few specialized service centers.

Wipro’s Chairman Premji understands this linkage.

Social Impact, Legal Framework and Effective Sourcing. The January 2011 open letter highlights the social impact of global sourcing on India and, probably, other countries that have engaged in privatization and promotion of global entrepreneurship

Service Buyers. Enterprise customers now operate in an environment where “corporate social responsibility” (“CSR”) is measured by investors, local community groups, government and non-profits.   When assessing prospective sourcing partners, enterprise customers should add the Open Letter criteria to their checklist and communicate the CSR issues for a dialogue.  By addressing issues on the “rule of law” (versus “rule by bureaucrats”), the vendor selection process can serve the enterprise customer’s search for “viable” vendors, improve local legal frameworks and achieve more stable, predictable and resilient sourcing outcomes.

Service Providers.  This plea by Wipro’s Chairman Premji and other Indian business leaders highlights the role of the service provider in promoting good governance in the host government. Service providers have a “bully pulpit” to promote social responsibility so that the benefits of globalization and outsourcing are distributed widely to the larger community in their countries. Focusing on a more transparent, less corrupt, less bureaucratic government will invite further foreign direct investment and avoid loss of opportunities for sustainable economic growth.

Global Sourcing Council. The Global Sourcing Council is a non-profit corporation dedicated to promoting sustainable business practices and corporate social responsibility in global sourcing.  See www.gscouncil.org to join. (Full disclosure:  the author of this article is a member of the Board of Directors of this organization.)

Outsourcing Law & Business Journal™: Feb/March 2010

March 20, 2010 by Bierce & Kenerson, P.C.

OUTSOURCING LAW & BUSINESS JOURNAL (™) : Strategies and rules for adding value and improving legal and regulation compliance through business process management techniques in strategic alliances, joint ventures, shared services and cost-effective, durable and flexible sourcing of services.  www.outsourcing-law.com. Visit our blog at http://blog.outsourcing-law.com for commentary on current events.

Insights by Bierce & Kenerson, P.C., Editors.  www.biercekenerson.com

Editor’s Note: Back by popular demand, we are repeating  our Webinar on Sourcing of Global Talent on Tuesday, March 23, 2010.  If you missed this event last November, you can register for it now by clicking here.   This webinar will discuss the human capital management for the contingent workforce in our current economic climate. The speakers will address issues in designing a contingent workforce strategy, managing this contingent workforce, effective governance and the managing risks and legal issues that arise with the implementation of such a workforce using internal and external resources.

Managing Knowledge, Compliance and Legal Risks in Sourcing of Global Talent
A webinar, Tuesday, March 23, 2010, 11 AM Eastern Daylight Time U.S. (45 minutes)
Speakers:
· William B. Bierce, Esq., Bierce & Kenerson, P.C. – outsourcing lawyer
· Chris Nuttall, PA Consulting, Member of PA’s Management Group
· Larry Scinto, PA Consulting, Managing Consultant

Vol. 10, No. 2 (Feb/March 2010)
_______________________________

1.  How to Achieve Innovation Through Outsourcing: Shifting the Paradigm.

2. U.S.-India Bilateral Cooperation on Trade and Investment:  Impact of Joint “Framework” upon Global Services Industries.

3. Humor.

4. Conferences
_______________________________

1.    How to Achieve Innovation Through Outsourcing: Shifting the Paradigm. Can an enterprise customer get real innovation through outsourcing?    It depends.  After looking at a case study in contract manufacturing and finance and accounting outsourcing, we can draw some lessons on the squeaky wheel that will need lubrication beyond effective governance.

New Product Development.  Recently, Bierce & Kenerson, P.C. was engaged by a global enterprise to assist in a two-phase deal with a supplier.   In phase one, the parties entered into an agreement for the joint development of a new type of product to retrofit an old product using new energy-efficient technology.  In phase two, the enterprise customer agreed to either buy the new product from the supplier or to pay a royalty for the value of the supplier’s intellectual property and development efforts.  The risk of failure was essentially nil, since the enterprise customer could have developed the product alone.   Yet it chose to work in tandem with the supplier to achieve a speedier path to market  for a hot product with a big potential demand in order to avoid loss of market share to well-financed agile competitors.

The contract development process took much longer than the product development process….For the complete article, please click here.

2. U.S.-India Bilateral Cooperation on Trade and Investment:  Impact of Joint “Framework” upon Global Services Industries. On March 17, 2010, the U.S. and India signed a “Framework for Cooperation on Trade and Investment” to strengthen bilateral economic cooperation.  The three-page agreement is short on details and relies upon inter-ministerial meetings and “Focus Groups” to identify and overcome impediments to bilateral l trade and investment.   Five Focus Groups cover agriculture, innovation and creativity, investment, service industries and tariff and non-tariff barriers to bilateral trade in goods.   The Framework agreement responds to a number of complaints by American businesses about the Indian legal framework governing intellectual property protections.  For the complete article, click here.

3.  Humor.

Innovation, n. (1) an improvement that is clearly better than mere continuous improvement; (2) any cost saving that merits a special reward; (3) a joint venture in “process management” clothing.

Framework agreement, n.  (1) a house with wall-size windows and no roof; (2) statement of work for unspecified deliverables; (3) a milestone with no end in sight.

Investor, n. (1) someone willing to give up a sure thing in the hope for a better sure thing; (2) hostage to hope; (3) optimist.

Investor protection, n. (1) shield for avoiding an instant capital loss; (2) a one-handed wind-shifter.

Publicity, n.  (1) good news, even if it’s bad news; (2) bad news when it’s not good news; (3) what a public figure craves but a private individual avoids.

4.  Conferences.

March 22-26, 2010, SSON presents the 14th Annual North American Shared Services & Outsourcing Week, Orlando, FL.  This event goes above and beyond the typical conference, with 8 tracks, 13 workshops/site tour, 1 Master Class, the Shared Services Excellence Awards and 7+ hours of networking!  This year, the platform has been completely revitalized and revamped, featuring raw and honest onstage interviews to the “no personal agendas” G8 Panel discussions.  The expert speaker faculty comes from leading companies including Coca-Cola, NASA, General Motors, Unilever, AstraZeneca, Schering-Plough, CA, Microsoft, Orbitz Worldwide and more!  View the complete agenda on http://www.sharedservicesweek.com/brochure.php.

Receive an exclusive 20% discount with special code SSW-MP10.  Contact Kim Vigilia at kim.vigilia@iqpc.com.

March 25-26, 2010, American Conference Institute’s 4th National Forum on Reducing Legal Costs, Dallas, Texas.  This essential cross-industry benchmarking forum gathers together more than 30 senior corporate counsel and legal sourcing managers responsible for cost-reduction success stories, as well as leaders from law firms who are pioneers in the alternative fee world, to guide those in attendance on the complexities of keeping legal department costs in check. Now in its fourth installment, this event also offers unique networking opportunities with senior practitioners in the field, includingin-house counsel across a wide spectrum of companies and industries. For more information, visit their website.

April 26-28, 2010, Legal IQ and IQPC present its 9th Annual eDiscovery Conference, San Francisco, California, bringing industry leaders together to explore eDiscovery project management, best practices for preserving and producing ESI, defending keyword searches, and protecting privileged ESI.  Topics include:

• Cloud Computing and eDiscovery – What’s in it for you?
• Emerging Technologies and Social Networking: Ethics and New Challenges
• New Models and Structures for Managing eDiscovery
• Statistical Validation and Data Analytics in eDiscovery
• Protecting Privileged Communications and Rule 502
• Vendor Partnership and What Happens After the End of Litigation
• ESI Preservation and Collections

Outsourcing-law.com subscribers receive a 20% discount off All-Access conference pricing using code IUS_OSL_#5.  Click here to get more information.

May 10-12, IQPC’s 7th Annual HR Shared Services and Outsourcing Summit, Chicago, Illinois. This event will be a gathering for corporate HR & shared services executives from companies across North America to exchange ideas, develop new partnerships and discuss the latest tools, technologies and strategies being employed in the profession to enhance departmental efficiencies and propel corporate growth.  The event will focus on the most current topics in the HR shared services industry including metrics, automation, outsourcing, globalization, compensation & rewards, benefits and an overall focus on the new strategic role of HR shared services.how to tackle change management, analyze current and future projects and further develop the instrumental key areas within HR shared services.  Visit their website to register and get more information.

May 17-19, IQPC presents its Information Retention & E-Disclosure Management Summit, London, UK. This is Europe’s premier event in this field, designed to help you steer your organisation successfully through lawsuits and regulatory inquiries.  Topics include:

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FEEDBACK: This newsletter addresses legal issues in sourcing of IT, HR, finance and accounting, procurement, logistics, manufacturing, customer relationship management including outsourcing, shared services, BOT and strategic acquisitions for sourcing. Send us your suggestions for article topics, or report a broken link at: webmaster@outsourcing-law.comThe information provided herein does not necessarily constitute the opinion of Bierce & Kenerson, P.C. or any author or its clients. This newsletter is not legal advice and does not create an attorney-client relationship. Reproductions must include our copyright notice. For reprint permission, please contact: publisher@outsourcing-law.com. Edited by Bierce & Kenerson, P.C. Copyright (c) 2010, Outsourcing Law Global LLC. All rights reserved. Editor in Chief: William Bierce of Bierce & Kenerson, P.C. located at 420 Lexington Avenue, Suite 2920, New York, NY 10170, 212-840-0080.

Social Security Tax Agreements: The Cost of Expatriate Workers

January 21, 2010 by Bierce & Kenerson, P.C.

Whenever citizens of one country set up operations or perform services in another country, they face the challenge of dual taxation. Dual taxation can be particularly oppressive where two countries tax the same income, or require payments of some form of tax on the same business activities. To avoid such burdens, model income tax treaties and estate tax treaties have evolved under the aegis of the OECD. Other treaties may apply to allow workers from one country to avoid paying social security to the government of another country.

This article addresses the question whether bilateral social security tax agreements have a material impact on mobility of technical service workers moving between a service delivery center (such as India) and a service recipient’s facilities (such as in the United States).

Double tax treaties allocate the rights of the two countries to tax the same income or activities. In the case of income tax treaties, the key determinant is whether the activities form a “permanent establishment” that serves as a sufficient nexus for the host country to tax the income and the activities. In the case of workers visiting on work visas, social security treaties allocate both the social security charges deducted from local wages and the liability of each state for payment of the social benefits (such as medical care and retirement income) from the workers’ activities.

The Times of India reported on January 18, 2010, that India and the United States are negotiating a Bilateral Investment Promotion Agreement and a Social Security Treaty. Http://timesofindia.com/articleshow/5462979.cms. U.S.-visiting personnel of Indian outsourcers (and Indian service captives of U.S. companies) have been paying U.S. Social Security taxes from the first day of their secondment to the U.S. locations. Payments are due from both the employer and the employee at the rate of 7.65% for various combined federal social taxes. Their visas (typically H1-B) may permit work in the U.S. only for 6 years. However, under U.S. Social Security rules (applicable in the absence of a treaty), such personnel are not entitled to receive any U.S. social security benefits unless they remain in the U.S. for at least 10 years (40 quarters).

The U.S. Social Security Administration (“SSA”) has its own explanation of the various social security treaties:

Since the late 1970’s, the United States has established a network of bilateral Social Security agreements that coordinate the U.S. Social Security program with the comparable programs of other countries. This article gives a brief overview of the agreements and should be of particular interest to multinational companies and to people who work abroad during their careers.

International Social Security agreements, often called “Totalization agreements,” have two main purposes. First, they eliminate dual Social Security taxation, the situation that occurs when a worker from one country works in another country and is required to pay Social Security taxes to both countries on the same earnings. Second, the agreements help fill gaps in benefit protection for workers who have divided their careers between the United States and another country.

Agreements to coordinate Social Security protection across national boundaries have been common in Western Europe for decades. Following is a list of the agreements the United States has concluded and the date of the entry into force of each. Some of these agreements were subsequently revised; the date shown is the date the original agreement entered into force.

Country	Entry into Force
Italy	November 1, 1978
Germany	December 1, 1979
Switzerland	November 1, 1980
Belgium	July 1, 1984
Norway	July 1, 1984
Canada	August 1, 1984
United Kingdom	January 1, 1985
Sweden	January 1, 1987
Spain	April 1, 1988
France	July 1, 1988
Portugal	August 1, 1989
Netherlands	November 1, 1990
Austria	November 1, 1991
Finland	November 1, 1992
Ireland	September 1, 1993
Luxembourg	November 1, 1993
Greece	September 1, 1994
South Korea	April 1, 2001
Chile	December 1, 2001
Australia	October 1, 2002
Japan	October 1, 2005
Denmark	October 1, 2008
Czech Republic	January 1, 2009
Poland	March 1, 2009

Source:  http://www.ssa.gov/international/agreements_overview.html

The list of such countries shows that the U.S. typically has a significant incentive to avoid the imposition of double social security taxes on U.S. citizens and residents who are expatriates abroad than for incoming foreign workers who come to the United States. U.S. expatriates are entitled to U.S. social security coverage, and must contribute, if they work for a foreign subsidiary of the U.S. employer that elects, by agreement with the Internal Revenue Service under section 3121(l) of the Internal Revenue Code, to pay Social Security taxes for U.S. citizens and residents employed by the affiliate.

U.S. Social Security Treaties. Aside from South Korea, Chile, Australia and Japan, virtually all such treaties are with European Union countries. A brief review of the most recent treaties (Czech Republic and Poland) shows that the dual social security taxes are waived based on residency for under 5 years, not the 10 years that applies to individuals from other countries (such as India) without a social security agreement. The requirement of some minimum residency before entitlement to local social security program participation serves public policy by not entitling foreign workers in the U.S., for example, to enjoyment of such programs without making substantial contributions. On the other hand, such minimum residency requirements conflict with the H1-B visa limitation of a six-year maximum stay. As a practical matter, H1-B visitors can convert their visa status to immigrants (after a long wait), so the minimum residency requirement promotes immigration of highly qualified managerial or skilled workers.

Indian Social Security Treaties. According to the Times of India, India has signed social security totalization agreements with Belgium, France and Germany, which are significant markets for Indian-based ITO and BPO service providers. The article did not specify any minimum residency period under such agreements.

Impact on Outsourcing and Foreign Captives. Social security totalization agreements serve to allocate between two national governments two separate cash flows: (i) income (contributions by local employer and the locally present expatriate employee) and (ii) expense (a future stream of social security benefits after satisfaction of the minimum residency requirements). Where the host country such as the U.S. charges social security deductions to the wages of foreign workers (e.g., Indians seconded to a U.S. customer or affiliate), the U.S. reaps a windfall if the minimum residency is never satisfied. The Times of India article claims that this windfall amounts to $1 billion per year. Where the minimum residency is satisfied, there is no windfall, and indeed the host country could suffer a loss if the expatriate acquires residency.

The Times of India article suggests that there is an additional burden on Indian workers who work in the USA under H1-B visas. This is questionable, since American employers (whether as affiliates of Indian captives or as enterprise customers of Indian service providers) will still pay their employer’s share of U.S. social security, regardless of the nationality or tax residency of the worker. The only impact is that the Indian workers do not get a discount, exemption or benefit unless they come to the U.S. for the minimum residency period. In short, it appears that the only party disadvantaged is the Indian Treasury, and the absence of a social security totalization agreement between the U.S. and India does not serve as an impediment for hiring of local workers in the U.S. It does, however, play a role in balance of payments in the long term.

In the scenario at hand, the lack of a social security agreement will also delay liberalization of American investment in India under a separate agreement on protection of investors. Thus, there could be some adverse impact on American companies seeking to invest in India if both agreements are not signed together, or unless one country blinks.

For related topics:

See Employment Law.

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Courts of India as an Inconvenient Forum: Impact of Long Delays in Access to Court Procedure

October 9, 2009 by Bierce & Kenerson, P.C.

“Justice delayed is justice denied.”   Enforcement of contract rights depends on a viable system that not only applies the rule of law, but does not delay the application of law to the aggrieved party’s petition for judicial redress.   In one recent judicial decision in New York, the court addressed the question whether a possible ten year delay in adjudication in the courts of a foreign country was a sufficient balancing factor to justify retention of the case in New York rather than in the foreign forum.  The foreign forum was India.

Forum Non Conveniens.

Under the basic principle of judicial jurisdiction, a court may exercise its competency to adjudicate disputes.  Competency derives from the applicable constitutional delegation of authority to adjudicate, as well as the existence of a sufficient connection between the parties, the subject matter or the location of the events in dispute.

Under the common law system, courts have adopted the principle that they will not exercise their jurisdiction in all situations.  They have adopted the principle of “forum non conveniens”, or “inconvenient forum,” to send the adjudication of the dispute to another forum that has a greater connection, a greater public interest or tighter connection with the subject matter and/or the parties.

Under New York law, the factors to be considered in a defendant’s motion to dismiss include:

• the burden on the New York courts.
• the potential hardship to the defendant.
• the unavailability of an alternative forum in which the plaintiff may bring suit.
• the fact that both parties are nonresidents of New York.
• the fact that the transactions out of which the cause of action arose occurred primarily in foreign jurisdiction.

No one factor is decisive.  Islamic Republic of Iran v. Pahlavi, 62 NY2d 474, 479 (cert. denied 469 U.S. 1108).

Delays in India as Basis for Denial of Motion to Dismiss.

In a dispute concerning the interpretation of a letter of credit, the New York Supreme Court, Appellate Division, ruled that a trial court must consider factors in addition to the fact that the courts of India are clogged for many years.  The case involved a letter of credit issued in India to the Japanese seller of commercial goods.

The plaintiff, a Japanese corporation with principal offices in Japan, submitted an opinion of Bhupinder Nath Kirpal, a former Chief Justice of India, who expressed his conclusion that because of the huge backlog of existing cases, the fact that no preference is given to commercial cases or newly submitted cases and the shortage of judges in India, it would take the New Delhi High court at least ten years to decide this type of case.

In contrast, the  defendant bank tendered an affidavit of Aziz Mushabber Ahmadi, another former Chief Justice of India, explaining that India provides an adequate alternative forum, and that the Indian Code of Civil Procedure had been amended in 1999 and 2002 in order to expedite the resolution of commercial matters.  Former Justice Ahmadi expressed the view Indian courts could dispose of a commercial case within a year.  Another reference suggests that the case could be disposed of within one to three years.

The trial court in New York relied on the delays in India and the fact that the Indian defendant has an office in New York.  Consequently, the trial court retained jurisdiction, denying the Indian defendant’s motion to dismiss for inconvenient forum.

Other Factors.

On appeal, the Appellate Division overruled the lower court for not considering any other factors.

• Interpretation of Foreign Law; Need for Expert Testimony.
  The New York appellate court considered that the need to interpret foreign law outweighed the risk of a lengthy delay in the foreign court system.

…[The motion court failed to consider the burden of having to interpret Indian banking law.  The applicability of foreign law is an important consideration in determining a forum non conveniens motion [citation] and weighs in favor of dismissal [citation], given that expert testimony is essential.   NYLJ, May 24, 2004, p. 31, at cols. 3-4 (1st Dept. May 18, 2004).

• Comity and Interest of Foreign Courts.
  The New York appellate court also underscored the importance of the principle of judicial restraint in respect of the public interest of foreign courts and foreign legal systems.   This principle of restraint, adopted early in U.S. judicial history with Marbury v. Madison, serves to enhance the respect of foreign courts for judicial decisions of New York courts reciprocally under the principle of comity.   Thus, in considering a motion to dismiss for forum non conveniens, New York courts should:

defer to India’s interest in resolving its own affairs.  New York courts have recognized that where a foreign forum has a substantial interest in adjudicating an action, such interest is a factor weighing in favor of dismissal.   [Citation.]  As the affidavit of former Chief Justice Ahmadi noted, Indian courts are keenly interested in governing the affairs of its financial institutions to insure uniformity and consistency in the processing of financial transactions and in the interpretation of Indian banking statutes and laws.

In conclusion, the appellate court ruled that the lower court erred in concluding that India was not an adequate forum because of the delays in its court system.  The lower court had relied on an earlier decision finding that delays in Indian courts were from 15 to 20 years.  That earlier decision had been decided before the Indian judicial procedure reforms in 1999 and 2002.

Lessons in Outsourcing.

This decision highlights the critical importance of properly drafting dispute resolution clauses in outsourcing contracts.

• Foreign Governmental Interest.
  While the dispute related to letters of credit, the appellate court noted the critical interest of Indian courts in adjudicating matters relating to “processing of financial transactions.”  The same interest could be said to exist for virtually any IT-enabled transaction processing in India.  This covers all business process outsourcing.
• Choice of Law.
  This decision relates to interpretation of foreign law.  Parties to international commercial contracts in outsourcing should understand the applicable law and its role in the decision-making process under the principle of forum non conveniens.
• Choice of Forum.
  This case underscores the need for the parties to choose the relevant forum.  The New York decision did not have any discussion of the terms of the Indian bank’s letter of credit.  This litigation might have been avoided if the letter of credit had not only identified the mutually chosen applicable law, but also a mutually agreed exclusive forum for resolution of the disputes.  Perhaps the issuing bank chose not to include that choice of forum in its letter of credit terms, possibly due to the pre-reform decisions that had adjudicated that Indian courts were not a viable solution to dispute resolution.
• Guarantees.
  A guarantee is a contractual obligation to pay money or perform certain acts under pre-defined conditions.  In this situation, the dispute related to a bank guarantee in the form of a letter of credit.  In outsourcing, enterprise customers should consider the availability and suitability of possible guarantees of performance.  In view of the recent infamous bankruptcies of Enron and WorldCom, service providers may also take note of the possible value of guarantees of payment by the customer, or alternative contractual provisions assuring the service provider of its own rights of enforcement or alternatives to judicial enforcement.
• Role of Arbitration.
  An arbitration clause may overcome issues of forum non conveniens. But arbitration still retains the risk (albeit small) of non-enforcement under the rules governing recognition and enforcement of foreign arbitral awards.
• Role of Offshore Judicial Reform in Offshore Outsourcing.
  This case is a beacon and warning for foreign governments that have byzantine, poorly administered, politically influence or backlogged judicial systems.  If your government wishes to promote exports of services, you should offer a judicial system that is accessible and viable as an alternative forum under the principle of forum non conveniens. In the absence of a credible judicial system, your service providers will be forced into courts such as those of New York, and the customary international financial and practical guarantee structures in offshore outsourcing transactions might serve as barriers to entry for new  service providers.   Development of a credible judicial system does not occur overnight, but failure to make steps in that direction may retard economic development.

Decision:

Shin-Etsu Chemical Co., Ltd. v. ICICI Bank Limited, __ N.Y.S.2d __, NYLJ May 24, 2004, p. 18, cols. 1-6, p. 31, cols. 1-6 (1st Dept. May 18, 2004), by Sullivan, J. (Docket No. 3033).

Published: May 26, 2004

Insider Theft of Trade Secrets in India: Employee of Captive R&D Subsidiary Accused of Source Code Theft (and What You Need to Know About Protecting Your Trade Secrets Abroad)

October 9, 2009 by Bierce & Kenerson, P.C.

In a global economy, which risks are greater: theft of trade secrets by a service provider or theft of trade secrets by an employee of a foreign subsidiary?  How can a global enterprise contain such risks in either case?  The story of theft of source code by an employee of an Indian research and development center highlights the need for proper strategies for risk mitigation in the face of the inherent risks of human nature.

Indian R&D Center, Site of Source Code Theft.

On August 4, 2004, Jolly Technologies, a division of U.S. business Jolly Inc., publicly reported that one of its employees at its Mumbai, India R&D center had misappropriated key ports of source code being developed along with confidential documents.   The trade secrets relate to one of its key products for the labeling and card software for the print publishing industry.

Profile of a Thief and a Theft.

Jolly Technologies was new to India.  Its center was established only three months prior to the trade secret theft.   The employee alleged to have stolen the trade secrets was a new hire.  The theft was done by simply uploading the source code to her Yahoo account.

Consequences to the R&D Center.

Jolly reportedly shut down its R&D center immediately to assess and contain the damage.  It also sought assistance from Indian police to deal with the matter as a criminal act.  The company’s investment may be a loss, and it may need to expend further resources to prevent the use by its competitors and other third parties of any stolen source code.

Security Precautions.

The theft shows how simple it is for any person with Internet access to misappropriate trade secrets.

• Data Export Controls on Internet Access.
  Internet access may be essential to virtually all knowledge-economy employees, so management may consider that shutting off Internet access may be impossible.  The Affaire Jolly suggests that software development might need to occur in an environment that allows employees access to information but does not allow them to transfer certain types of information from a company computer to anyone via the Internet.   The advent of network administration software, XML metatags, html, virus sniffers and spam blockers may introduce technology that allows a company to prevent the transfer of source code to unauthorized Internet addresses.
• Segregation of Function.
  Most software development projects start with modules and build into integrated suites of modules.  In the manufacturing sector, complex trade secrets may be protected by separating multiple manufacturing processes into separate functions and separating the component processes.  This can be done by either putting the component processes into different operations or by separating subassemblies from final assembly.  Software development could be structured similarly, though segregation of function reduces efficiency.
• Background Checks.
  The new hire at Jolly Technologies might have been investigated for a possibly criminal background.  But background checks probably do not help with curious employees interested in studying stolen code or restructuring it for possible other purposes.

Legal Precautions.

The trade secret theft also highlights the weakness of national legal systems where, in the case of India, courts have historically taken a decade to decide civil disputes.  Whether establishing a foreign captive service subsidiary or hiring a foreign service provider, the legal environment and legal precautions are critical to risk management.

• Statutory Protection for Trade Secrets.
  Most countries hosting R&D centers or outsourcing service centers are members of the basic international conventions on the protection of intellectual property.  Even China, by adhering to the World Trade Organization, now officially grants intellectual property rights under the WTO Agreement on Trade-Related Intellectual Property right (“TRIP’s”).  India has long been a member of the Paris Convention on Industrial Property and protects copyrights, patents and trade secrets.  As the Affaire Jolly demonstrates, it is not sufficient to have a legal right.  You need to have a credible forum for enforcing those rights.
• Contractual Commitments.
  Well-advised enterprises require their employees by contract to abide by various policies and procedures, including respect for intellectual property rights and trade secrets of the employer and third parties doing business with the employer.  Contractual commitments are a basic requirement of any IPR protection.
• Security Surveillance.
  Jolly’s security surveillance, by an internal audit, discovered the theft.  Pre-emptive security precautions cannot prevent fraud or theft, but surveillance can discover it.
• Risk Mitigation after the Theft.
  After the horse has left the barn, how do you get it back into the barn?  In a global digital economy, the only solution might be to find some way to tag the digital works, just as ranchers did for their cows in the 1880’s.
  • Court Systems.
    Indian courts now have a commercial part that is intended to accelerate adjudication. It is not clear whether the Mumbai courts offer any real adequate forum, and even adjudication of civil liability does not automatically result in enforcement of a money judgment.  Access to court systems are so fundamental to investors and employers that the issue should become one of diplomatic entreaty (as the U.S. has done with China), investor due diligence, and recommendations by intermediaries such as trade associations (such as Nasscom and ITAA), venture capitalists, private equity funds and investors and multinational enterprises and their advisors such as international business lawyers and business process and sourcing consultants..  Ratings on access to judicial systems should be part of the due diligence in all international operations.

Other Measures.

Insurance may be available, but the consequential loss may be too high for a fair premium.

Conclusion.

In captives and outsourcing, IPR protection needs practical and legal protections.  Blatant misappropriation will continue as a matter of human nature, so risks can only be mitigated.   Effective methods of mitigation will continue to evolve.  Technology and IP lawyers should be consulted before international operations are launched.

Death of Captive Paradigm? Business Transformation of a Shared Services Captive: Legal and Business Issues in Conversion from SSO to Independent BPO Service Provider

October 9, 2009 by Bierce & Kenerson, P.C.

General Electric Company’s announcement on November 8, 2004, that it has agreed to sell 60% of its Indian captive services company GE Capital Information Services (“GECIS”) marks a turning point in the trend towards establishment of offshore captive services companies.  This article considers the legal and business issues in a conversion of a foreign captive shared services organization (“SSO”) to an independent business process outsourcing (“BPO”) service provider.   It is a lesson in management strategy, risk analysis and, most importantly, return on investment for shareholders.

Disclaimer: The author has not seen the documentation among the parties on this transaction.

GECIS as Captive SSO.

GECIS was established to provide specialized talent and resources to GE’s affiliates globally.  Most recently, it has been providing Six Sigma productivity improvement methodology and training, cost savings advisory services and back-office business process support to GE’s affiliates.  The legacy of GECIS as a captive organization demonstrates GE’s success in managing services as a core competency across the world.  GE’s press release noted:

As a captive, GECIS probably had reached the limit of its ability to scale the processes and generate business value. Even GE globally has limited capacity to absorb shared services.

The Business Transformation to BPO Services Provider.

Sale of Shares.
GE converted the SSO to a BPO service provider by selling a majority share to two private equity firms, General Atlantic Partners and Oak Hill Capital Partners.  After the sale, GE will own 40%, with each of the other two shareholders owning 30%.

Recapitalization.
The GECIS company will also be recapitalized.  Recapitalization of a healthy, growing company in a booming services economy suggests that the new investors will be contributing new capital.   The pricing of the share sale, as well the relative contributions to capital, may depend on an “earn-out” based on on post-sale performance of the company.

Allocation of Shareholdings; Impact on Corporate Governance.
GE could have chosen to sell to one other shareholder.  By selling to two investment groups, it dilutes the individual power of the other shareholders and retains an opportunity, by persuasion or other alignment of interests, to potentially share majority control with one of the two investors.  Thus, for accounting and regulatory purposes, GE ceases to own control.  For corporate governance purposes, it may retain an option (explicit or in a shareholders agreement) to share voting control with one of the two investors.

Expansion of Markets.
GE’s Press Release announced an expansion of into new markets, which will be generate new value for the new private equity investors.  GECIS “will accelerate its third-party sales, marketing and delivery capability to significantly expand its client base, especially in China and Eastern Europe, where it began operating two years ago.”

Management.
As announced, Mr. Pramod Bhasin will remain as president and chief executive officer, supported by the current Gecis global management team.

Board of Directors.
Thee new board, comprising four representatives from GE and six from the new investors, will be constituted by the end of 2004.

GE as Customer.
As announced, Gecis will continue to serve GE under a multiyear contract. That contract undoubtedly gives GE a priority claim on some of Gecis’s resources, most-favored-nation pricing and other preferences afforded to the best customers.

International Capital Structure.
The admission of new investors requires an appropriate capital structure.  Capital structures are driven by considerations of corporate law, taxation, effectiveness of controls and predictability of the rule of law.  Generally, international investments are structured to interpose an offshore holding company so that sales of the portfolio company are sheltered from income tax on disposition.

Corporate Governance.
Selection of the jurisdiction for the holding company, that will be co-owned by the investors, has an important bearing upon the corporate governance.   Corporate governance involves the rights to elect and terminate the board of directors, to approve important business decisions that might affect corporate operations, policies, financing, growth, mergers, acquisitions, dispositions, recapitalizations, joint ventures and liquidation.

Each of these corporate governance elements depends on the voting rights established under the applicable corporation or company law, the shareholders’ agreement, if any, the by-laws and resolutions of the board of directors.  Every country has its own corporation law, and nomenclature and rights vary across the world.  “Offshore” jurisdictions specialize in attracting foreign investment by offering highly flexible corporate structures, with minimal protections for minority shareholders.

Minority Holder’s Statutory Rights.
The right of a minority shareholder to block a major corporate action — such as an acquisition, major divestiture or restructuring — may be greater in some countries than others.  In India, the holder of a 25% ownership interest in a limited company are entitled to block such major corporate actions.  In Delaware and New York, for example, the minority has no such right, and the holder of a majority of the voting rights can effectively dictate major corporate actions.  As a result, when a 100% owner of an Indian shared services captive wishes to recapitalize the Indian company, it will normally choose a jurisdiction that allows absolute control by the majority owners, subject to fiduciary duties to minorities.

Recapitalization vs. Sale of Shares.
For sole owner of an operating company like an Indian captive services provider, sale of shares could trigger a capital gains tax.  By having the operating company (or a holding company) issue new shares, the funding of new investment capital into the business can be achieved without capital gains tax because capital contributions are not taxable events.

Classes of Shares.
Frequently, new capital contributions are paid in consideration of the issuance of a new class of common shares.  A capital structure with multiple classes of shares has several implications.  The same results can be achieved without multiple classes of shares, but to do so would require extensive negotiation and drafting of a complex shareholders’ agreement.

First, by statute, each class may have the right to approve or disapprove certain corporate actions.  Thus, if one shareholder has all shares in a class, that shareholder may effectively veto major changes that require the consent of all classes of shares.

Second, if there are three shareholders in any class of shares, it ownership can be structured so that none has a majority control of that class.  By loading up the number of minority shareholders in one class of shares, none has any control.  Such a structure strengthens the de facto control of the holders of a majority of any other class of shares.

Third, each class of shares can have different rights of voting, dividends and liquidation preferences.  This feature can allow different investors to design a plan for their own particular investment parameters, including cash flow and the timing and conditions of exit from the investment.

Impact on GE.

Strategic Redirection.
GE’s sale of the 60% stake in the GECIS subsidiary does not mark any withdrawal from the Indian market.  GE’s businesses in India represent annual revenues of $1 billion and 22,000 employees.  Rather, the sale suggests a change in strategic direction.

• The competitive advantage of having a captive BPO service provider appears to have already been achieved.  GE will continue to be a customer, with preferential benefits, of the restructured GECIS.  But there appeared no compelling competitive reason not to expand the clientele of the BPO service provider across global markets.
• The sale of the 60% stake will support expansion of GECIS’s business.  GECIS will accelerate its efforts in marketing, sales and delivery to “underserved” areas that have not experienced productivity improvements, such as China and Eastern Europe.  Opportunities for expansion into new markets will take additional capital investment, which will be provided by the new investors as part of the recapitalization.   It was not clear whether GE would make an additional investment, but it would be normal to do so if the expansion were to require a staging of capital expenditures.

Human Resources.
The transfer of ownership control can have significant effects upon an entity’s employees.

• New Management.
  The recapitalization using private equity investment may be accompanied by a change in management.  In the GECIS case, the operating management will continue in place, but the board of directors will be controlled by the investors in proportion to their respective ownership percentages.  This approach contrasts with the clash that occurs when a strategic acquirer seeks to impose its own management structures and approach upon a new acquisition.  In the GECIS situation, the employees and customers have some assurance that, despite the change in control of the board of directors, the new management will do “more of the same” and seek to expand operations rather than integrate them with a strategic acquirer.
• Pension Plans.
  Rules governing employment law, taxation of deferred compensation and pension rights tend to be territorial in nature.  Under the U.S. pension law (“ERISA”), an employer is not required to cover foreign-based employees, whether directly or employed by foreign subsidiaries or affiliates, include in its U.S. profit sharing, pension, retirement and medical insurance plans.  In this situation, GECIS probably has its own Indian-based pension plans, and there will probably be no impact on any U.S. ERISA plans.  A few exceptions might apply for certain senior executives, and as to them the recapitalization to include new majority ownership will likely result in some special price adjustments over time..
• Exit Strategies.
  With new capital, the company should grow.  But the new investors have predictable time horizons for realizing the return on their investment.  Employees and suppliers should anticipate a strategic sale or initial public offering in five to seven years.  At that time, a change in control may be expected.

Intellectual Property Rights.
Private equity investments do not normally come with significant intellectual property that can be licensed to the newly acquired portfolio company or can be exploited as part of commercial services to customers.  In this case, there might be some cross-licensing of intellectual property rights of the private equity portfolio companies owned by the private investors.  Press reports were silent on this issue.  In each new private equity investment, the integration and cross-licensing of technologies across portfolio companies of private equity funds merits further exploration.

“Captive of Multiple Unrelated Owners.”

Private equity investors may bring synergies and, like Internet Capital in the late 1990’s, even develop a strategy of assembling service companies that can support each other in the classic conglomerate or Daibatsu intercompany strategic relationships.  In this case, the private equity investors will clearly be acquiring a crown jewel that can not only grow by expanding to new markets, but which can develop new synergies, efficiencies and productivity improvements for other portfolio companies.  To the extent that other portfolio companies of General Atlantic and Oak Hill Partners can benefit from the GECIS productivity improvement services, the purchase price will yield multiples of value.   This intrinsic portfolio enhancement consideration might have been an important factor in pushing up the purchase price.

Local Ownership and Selection of Business Partners.
The BPO market is not protected by local restrictions on foreign ownership.  Accordingly, it is entirely normal for foreign investors to share in foreign ownership.    One may inquire why GE did not consider a local Indian private equity fund instead of two American-owned funds. This can probably be explained by an affinity of culture and a long-standing relationship among the parties in the American market.  Also, the Indian private equity funds are not as liquid and highly developed as American private equity funds.

Conclusion

The transformation of a captive services organization to a BPO service provider presages increased reluctance of global organizations to own their shared services operations, at least where the “first-mover” advantages of having in-house resources have been achieved.   Senior managements of global organizations will now face ever so starkly the question whether their shared services organizations are part of the aligned vision of the global enterprise.  If the SSO is not efficient, it should be replaced by an efficient paradigm.  If the SSO is efficient, it can be used as a launchpad for growing a “sideline” business, generating additional return on shareholder equity.

Conversion from captive to BPO provider requires extensive strategic planning.  It involves substantial degree of complexity in execution.  Time will tell whether other companies will follow in GE’s footsteps.

International Outsourcing: Legality of Xenophobia in Outsourcing

October 9, 2009 by Bierce & Kenerson, P.C.

Summary:

In the United States, layoffs during the downward economic cycle following the dot.com bubble and then the 9/11 attack have had a severe impact on the local economies.  In the resulting legislative debate over the impact of outsourcing, some state legislators have proposed a reversion to the “Buy American” principle that conflicts with international trade under the World Trade Organization.  This issue underlines an emerging internal public policy debate on the desirability of international outsourcing.

NOTE: Posted in 2003, this seminal article could be updated for more recent manifestations of xenophobia in outsourcing.

“Buy American” in State Government Contracting.

In March 2002, a New Jersey State Senator, Shirley Turner, introduced a bill that would impose a “Buy American” rule on all purchases in the state.

N.J. Sen. No. 1349, 210th Legislature, intro. Mar. 21, 2002, passed in the Senate (40-0), Dec. 16, 2002.

The bill was inspired by the fact that “Recent published reports have indicated that telephone inquiries by welfare and food stamp clients under New Jersey’s Families First Program were being handled by operators in Bombay, India after the contractor moved its operations outside of the United States as a cost-cutting measure.”  The bill was intended to ensure that State funds are used to employ people residing in the United States and to prevent the loss of jobs to foreign countries.

As a “mini-Buy-American” Act, this legislation does not provide any exception for:

• a determination that a domestic procurement is “not in the public interest,”
• a determination that the cost of a domestic procurement is “unreasonable,” or
• a determination that the particular goods or services being procured are not available in such commercially available quantities or quality as are available abroad.

All of these are exceptions under the federal “Buy American” act.

If enacted, such laws would apply only to government procurement.  But such legislation could have repercussions on the image of offshore outsourcing throughout the United States.

The bill does not address issues of cost, or availability of local American services in the particular procurement.

Legality for Governmental vs. Private Purchases of Foreign Services.

As a matter of law, “Buy American” (or “Buy Local”) laws are illegal under the World Trade Organization’s General Agreement on Trade in Services (“GATS”) when they relate to purchases by private buyers.  But for governmental buyers of services, the GATS allows such favoritism to local service providers.

Impact on International Outsourcing by Private Customers.

Legislation limiting government procurement to local service providers should not have any impact on the right of private companies, as customers, to hire any service provider worldwide to render any service.

• Freedom of Contract.
  In our view, nothing in the various laws of individual states in the United States that currently are in consideration could validly overcome such freedom of contract.
• War.
  In case of a war involving Iraq or other country, the United States federal government could validly adopt rules to safeguard its economy from foreign interests.   As discussed below, this raises risks for contracting parties, but such risks may be surmounted through customary technical means for security, business continuity planning, redundancy and disaster recovery.

Buy American – Revival of the Past.

The “Buy American” legislation was originally adopted by the Federal government as a means of promoting local business.  This legislation, at 41 U.S.C. 10a, is limited to the purchase of goods:

This law has been rendered largely moot by the Government Procurement Agreement adopted at the Uruguay Round of the General Agreement on Tariffs & Trade.  See Agreement Establishing World Trade Organization, Annex 4, Plurilateral Agreements, Government Procurement Agreement.

More recently, state legislatures in the United States have considered imposing some restrictions or prohibitions on the use of foreign service providers for contracts involving payment of  state or local funds.  In New Jersey, State Senator Shirley K. Turner introduced a bill that would prohibit any contracting or subcontracting to foreign service providers where the work could be done by American citizens or lawful permanent resident aliens.  Similar legislation is reportedly under consideration (as of February 2003) in Connecticut, Maryland, Missouri and Wisconsin.

Policy Debate: Validity vs. Wisdom of Xenophobia.

As a matter of public policy, we must distinguish between law and policy.  Would such legislation be lawful?  Under the World Trade Organization (WTO) General Agreement on Trade in Services (“GATS”), it would appear valid for government procurement of services.  As a “beggar-thy-neighbor” policy of keeping jobs at home, such legislation would help generate employment at a time of economic decline, reducing the costs of public welfare and other social costs.

Would such legislation be good public policy?  Such legislation would deprive local governments of purchasing services at the cheapest price.  It would hurt local taxpayers as consumers of government services.

World Trade Organization: No “Non-Tariff Barriers” for Private Trade.

Free trade under the World Trade Organization (formerly known as the General Agreement on Tariffs and Trade, or GATT) is based on certain fundamental principles:

• national treatment of foreign suppliers of goods and services, where each member state must “accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favorable than that it accords to its own like services and service suppliers.”   General Agreement on Trade in Services, Art. XVII(1), MTN/FA II-A1B, p.19).
• transparency of the laws and regulations governing international trade (subject to the supervening principle that disclosure is not required where it “would impede law enforcement or otherwise be contrary to the local public interest or would prejudice the legitimate commercial interests of particular enterprises, public or private.”   See, e.g., Agreement on Trade-Related Investment Measures, Art. 6, MTN/FA II-A1A-7, p. 3.)
• non-discrimination.

Market Access to Foreign Services Providers under GATS.

The WTO’s General Agreement on Trade in Services embodies the principle that, in sectors where a member state undertakes to grant market access to service providers from another member state, that market access cannot be restricted either nationally or regionally.    Specifically, it is a violation of GATS for a member state to impose any restriction on market access in any of the following forms:

• Number of Service Providers: limitations on the number of service providers (such as in the form of numerical quotas, monopolies, exclusive services providers or the requirement of a “economic needs” test as a condition of market access).
• Value of Service Transactions: limitations on the total value of service transactions or assets (in the form of numerical quotas or the requirement of an “economic needs” test).
• Quantity of Services Provided or Service Operations: limitations on the total number of service operations or on the total number quantity of service output expressed in terms of designated numerical units, in the form of quotas or the requirement of an “economic needs” test.
• Number of Employees: limitations on the total number of natural persons who may be employed in a particular service sector or that a service provider may employ and who are necessary for, and directly related to, the supply of a specific service in the form of numerical quotas or the requirement of an economic needs test.
• Type of Legal Entity or Joint Venture: measures that restrict or require specific types of legal entity or joint venture through which a service supplier may supply a service.
• limitations on the participation of foreign capital in terms of maximum percentage limit on foreign shareholdings or the total value of individual or aggregate foreign investment.

General Agreement on Trade in Services, Art. XVI(2), MTN/FA II-A1B, p.18.

Exceptions to GATS Protections.

Several exceptions expressly permit a member state to disregard its obligations on trade in services.
Services Supplied in the Exercise of Governmental Authority.

By definition, the GATS does not apply to “services supplied in the exercise of governmental authority.”  General Agreement on Trade in Services, Art. I(3)(c), MTN/FA II-A1B, p.14). In some countries, “governmental authority” involves the performance of functions that are considered commercial or otherwise not “in the exercise of governmental authority.”

In the United States, for example, in November 2000, President George W. Bush’s administration adopted regulations requiring that all governmental functions be evaluated and classified as governmental or non-governmental, and non-governmental functions are to be contracted out to outsourcers (or possibly even privatized).

National Security.
National and international security considerations take precedence over trade in services under GATS. In particular, member states may take actions that they may deem necessary to protect “essential security interests” relating to services for provisioning military establishments, nuclear fuels or their materials, or any other action “taken in time of war or other emergency in international relation.”   As a procedural matter, the member state must notify the WTO’s Council for Trade in Services when such “security exceptions” have been adopted and when they have been terminated.  General Agreement on Trade in Services, Art. XIV bis, MTN/FA II-A1B, pp.16-17.

War.
As a “national security” measure, a member state might impose an embargo on trade in services with one or more other WTO member states during a time of war.  The exception applies “in time of war.”

This “war” exception leaves open a number of vital questions about the legality and viability of discrimination, trade embargos and other acts normally prohibited by GATS.  The “war” exception does not specify that the embargo must only apply to another member state that is at war with the buying member state.  But it is not clear whether the right to impose an embargo applies to a country that is perennially in a “state of emergency” or has never entered into a formal cessation of armed hostilities with a particular other member.

In a sense, this exception could arguably serve as the basis for a member state’s attempt to circumvent the WTO principles of free trade in services.  In our view, such an attempt could invite trade reprisals and dispute resolution before a WTO dispute tribunal.

Deceptive and Fraudulent Practices; Contract Default and Enforcement of Rights.
Under GATS, member states may adopt and enforce measures of a general, non-discriminatory nature relating to “the prevention of deceptive or fraudulent practices or to deal with the effects of a default on service contracts.   Accordingly, laws governing enforcement of rights and remedies under contract breach are not subject to GATS rules, so long as the laws are “not applied in a manner that would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services.”   General Agreement on Trade in Services, Art. XIV(c)(i), MTN/FA II-A1B, p.15.

Data Protection.
Similarly, under GATS, member states may adopt and enforce non-discriminatory laws for “the protection of the privacy of individuals in relation to the processing and dissemination of personal data and the protection of the confidentiality of records and accounts.”  General Agreement on Trade in Services, Art. XIV(c)(ii), MTN/FA II-A1B, p.15).

Safety.
Laws governing safety are also generally exempt from the rules of GATS, except if they are discriminatory or disguised trade restrictions.  General Agreement on Trade in Services, Art. XIV(c)(iii), MTN/FA II-A1B, p.15.

Collection of Taxes.
Laws for the “equitable or effective imposition or collection of direct taxes,” or for the avoidance of double taxation under a tax treaty, may be somewhat discriminatory against foreign service providers.  General Agreement on Trade in Services, Art. XIV(d) and (e), MTN/FA II-A1B, p.15).

Government Procurement.
Exceptionally, under GATS, the WTO principles of most-favored-nation treatment, market access and national treatment do not apply for governmental procurement of services. General Agreement on Trade in Services, Art. XIII(1), MTN/FA II-A1B, p.14). (The other principles, such as the “transparency” duty to publish applicable laws and regulations, remain unaffected.)   The Government Procurement Code, adopted prior to the GATS, relates to trade in goods and does not require any treatment different from GATS.

Safeguard the Balance of Payments.
This exception allows a government to escape from GATS requirements to open its economy to free trade in services in order to safeguard the country’s balance of payments “in the event of serious balance-of-payments and external financial difficulties or threat thereof.”  General Agreement on Trade in Services, Art. XII(1), MTN/FA II-A1B, p.12). This exception is not directed at measuring bilateral trade imbalance between two countries that are trading partners.  Rather it focuses on multilateral trade and generalized imbalances in the balance of payments.

Conclusions for Outsourcing Services Providers.

If you are promoting the sale of your services from a foreign country, you should focus on the practical economic benefits of your service.  This may include:

• abundant labor supply.
• rapid deployment of a large pool of skilled workers for early completion of a complex project.
• high quality standards, such as the Software Engineering Institute Capability Maturity Models for both software and services.
• low cost to the taxpayers whose governments are acting as purchasing agents.
• local presence in the host country, and the role of the host country employee pool for the service provider.

Conclusions for Purchasers of Transborder Services.

There are undoubtedly substantial risks of force majeure in outsourcing.  But the WTO principles of national treatment for private-sector transactions and other fundamental protections of international trade in services are well established.  Legislation by state legislators is not likely to have any impact on your ability to procure services at low cost under a clear outsourcing contract. Despite the risks and problems, using technological methods as well as legal contracts, you can protect your investment in foreign services.

Conclusions for National Governments.

The opening of borders to “free trade” under WTO principles leaves everyone exposed to the risk of loss of value of their knowledge in a rapidly changing information economy.  Governments should focus on building a workforce that is skilled in knowledge tools.

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