Employers of Record

We are frequently asked by international clients looking to expand their workforce into new jurisdictions about the potential benefits and risks of engaging individuals via an Employer of Record (“EORs”) or Professional Employer Organisations (“PEOs”), i.e. rather than hiring directly.

For the purposes of this article, we refer to these organisations as “EORs”; however, in practice, the terms EOR and PEO are used fairly interchangeably to refer to a business which offers to contract with an individual in one country (i.e. the employee “on the ground”) to provide services to an entity in another country (known as the “end user”). We also note the developing trend of Global Employment Organisations (“GEOs”), which are entities set up by a company in a particular jurisdiction to “house” talent who work remotely from multiple locations. Unlike EORs, GEOs are part of the same group as the end user.

On paper, EORs provide an elegant solution for expanding international companies; especially when seeking to onboard talent at speed.  In particular:

• They tend to provide a wide array of administrative services, including dealing with payroll, tax, benefits, insurance and other local employment requirements.
• There is no need for the end user to incorporate an entity in the jurisdiction to administer the employment relationship (assuming this is required by local laws).
• The end user retains responsibility for directing the individual’s day to day activities.

In this article we explore some of the potential legal risks that arise from using the EOR model. While we approach the topic primarily from a UK perspective, it is worth keeping in mind that different legal issues will arise depending on the particular local legal framework in the jurisdiction in which the employee will be engaged. 

Legality

When considering whether to use an EOR to hire the staff in any jurisdiction, the first question for an end user is likely to be whether the proposed arrangement is in fact permitted under local laws.  For example:

• There may be restrictions on the types of businesses who are able to supply labour, e.g. this may be limited to licensed temporary work agencies.
• The duration of the proposed arrangement may also be relevant to the legality of the arrangement. In some jurisdictions, contracts for the supply of labour must be for a limited duration, and so would be incompatible with an indefinite engagement under an EOR arrangement.

Fortunately, these issues are unlikely to be relevant to the use of EORs in the UK. However, approaches differ greatly across Europe and elsewhere, and particular risk arises in countries where the EOR arrangements could breach legal restrictions on “employee leasing”. In some countries this is a criminal offence.

In light of the above, the precise nature and scope of the services provided by the EOR may vary from country to country to reflect local legal requirements, even where services are provided by the same global provider.

Management responsibility

While for practical purposes the end user may consider itself the “employer” of the individuals hired via an EOR arrangement, the direct employment relationship is likely to be between the individual and the EOR. This gives rise to potential uncertainty and risk in relation to issues such as management responsibility and terminations. Much will turn on the practical arrangements and commercial terms set out in the services agreement between the end user and the EOR.

In our experience, the extent to which EORs will expect to be involved in management issues depends on the size and resourcing of the EOR. More established EORs may have a sophisticated local HR team such that they are able to play an active role in supporting the end user with management issues (e.g. disciplinary and grievance processes and absences). On the other hand, some EORs tend to act as employer in name only, and in practice management issues are handled by the end user, which potentially undermines the basis of the EOR relationship.

Similarly, an EOR arrangement may give rise to uncertainty in relation to the lawfulness of a dismissal, given the EOR will usually need to rely on the end user’s reason for termination. At least insofar as the UK is concerned, termination risks may be mitigated on the basis that: (1) in many cases the employees may have under two years’ service with the EOR and so would have limited grounds to challenge the termination reason and process (as they would not have the right to bring a statutory claim for unfair dismissal); and (2) in practice, dismissals may be handled by way of a negotiated termination under a settlement agreement (at the end user’s cost), particularly where more senior employees are involved. However, these circumstances will not always apply and issues around terminations of employees engaged via an EOR have not been fully tested by the courts. It will, therefore, be important to ensure that the service agreement between the EOR and end user contains clear provisions requiring the EOR to cooperate with the end user (and follow all instructions) with regard to the termination of any employee(s). Note that the EOR will, generally, expect to be fully indemnified against any liabilities that it may incur as the employer of record when dismissing an employee.

An effective EOR relationship is likely to require a cooperative and harmonious approach between the EOR and the end user as well as clear agreement for the division of responsibilities, including in relation to any litigation arising from the employment relationship. Absent this, there is certainly scope for risk factors to arise, particularly where contentious issues arise in relation to the underlying employment relationship “on the ground”.

Business protection

The key terms of an employment contract, from an employer’s perspective, tend to be those dealing with business protection, e.g. notice of termination, outside interests, confidentiality, intellectual property ownership and post-termination restrictions. In an EOR situation, the employer will not have direct contractual terms in place with the individual in relation to any of these matters – albeit these items may be covered: (1) in the individual’s terms of employment with the EOR; and/or (2) indirectly in the terms of service between the EOR and the end user.

An EOR arrangement may give rise to uncertainty as to the end user’s ability to enforce standard business protection provisions against the employee. Similarly, from a legal perspective, there may be uncertainty as to the EOR’s ability to enforce protections relating to the end user’s interests, as it is not the party that has suffered or will suffer loss resulting from the individual’s breach.

Of particular concern to end users is likely to be enforceability of post-termination restrictions, i.e. contractual terms that purport to restrict a former employee from taking certain actions that would damage the end user’s business for a specific period following the termination of their employment, e.g. joining a competitor and soliciting/dealing with the end user’s customers and personnel (“PTRs”). In particular, it is not clear whether the EOR, which has the contract with the employee, could enforce the PTRs against the employee, as it is not the party that would suffer loss as a result of the employee’s breach, or whose legitimate business interests the PTRs are intended to protect. There are various approaches that could be adopted in this situation, e.g. (1) the EOR could seek to enforce the PTRs on the basis that it has a legitimate interest in protecting the business of its client (i.e. the end user); (2) the end user could seek to enforce the PTRs as a third party beneficiary or assignee; or (3) requiring the employee to enter into a separate side agreement with the end user to include PTRs (although this is likely to require careful drafting and specific consideration). However, at this stage these approaches have not been fully tested by the UK courts, which are traditionally restrictive in their approach to enforcing restrictive covenants. 

In terms of intellectual property rights, in most cases the end user can ensure that it obtains the benefit of rights created by the employee in the course of their duties by ensuring that it secures a valid assignment of such rights in its service agreement with the EOR. Again, attention should be given to the terms of the agreement and legal advice should be taken accordingly.

End users should also be mindful that EOR arrangements will come under scrutiny to the extent any corporate transactions are envisaged down the line (e.g. share or asset sales). In particular, a potential buyer will want to understand the basis of the engagement of the EOR employees and ascertain whether this provides adequate protection for the business, particularly in relation to the matters outlined above. It is also currently unclear whether employees engaged via an EOR would be in scope to transfer to a buyer on an asset transfer by virtue of the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) and commercial terms would need to be agreed with the buyer to deal with the potential implications of a TUPE transfer.  

Immigration

While immigration rules will vary widely by jurisdiction, another issue to bear in mind is whether an EOR will be able to obtain a working visa for any proposed hire of the end user who does not have the right to work in the jurisdiction. It is not possible for an EOR to sponsor migrant workers in the UK since they are not the organisation that is responsible for the individual’s day to day activities and duties. There are similar rules and limitations in other jurisdictions. 

Tax issues

In considering whether to use an EOR, end users are also likely to be influenced by their tax circumstances, including whether their use of an EOR could avoid triggering a taxable presence or permanent establishment. In many jurisdictions employing through an EOR will not eliminate the possibility of triggering a permanent establishment, and this would be a matter of fact and degree taking into account the nature and extent of the business and workforce in the relevant jurisdiction. Tax authorities will look behind the EOR arrangement, if necessary, such that it may sometimes be better to incorporate a local entity (and hire employees directly) to ringfence tax and profit in that jurisdiction. 

Conclusion

It seems that the use of EORs and PEOs is likely to become more widespread, as end users expanding internationally continue to be attracted by the convenience they can provide, particularly in the short term. However, the model remains under development with significant variances in the market as to the level of services offered and apportionment of risks and responsibilities, meaning end users should always review the EOR’s terms carefully to ensure that the arrangements meet their business requirements. At this stage there has been minimal employment litigation involving employees engaged via EORs and we expect this to be an “area to watch” over the coming years.