President Barack Obama signed the Korean-U.S. Foreign Trade Agreement (KORUS FTA) on October 21, 2011 and it was ratified by Korea’s National Assembly on November 22, 2011. It is now in force.
Separate from the generally applicable multilateral obligations of the two countries under WTO trade agreements, the KORUS FTA opens new doors for service providers in Korea to compete with India, Latin America, Canada and other locations for contracts to deliver data processing and BPO services to U.S. customers. While Korea’s wage levels are comparatively high relative to other destinations, Korea can be expected to compete effectively in niche areas such as banking, finance, insurance and manufacturing support services.
What’s new, beyond the multilateral free-trade framework under the WTO, NAFTA and the EU, compared to other U.S. bilateral free-trade agreements? The KORUS FTA offers a few embellishments on the concept of admitting individuals for specific FTA-qualified visa categories (as under NAFTA). The KORUS FTA adds specific protections for conducting services businesses generally, including professional services licensure (lawyers, doctors, engineers, like NAFTA’s list). The agreement covers the “electronic supply of services,” “digital products,” electronic authentication, e-signatures and e-documents as instruments of bilateral e-commerce. Most significantly, the KORUS FTA hints at a new paradigm for bilateral FTA’s since it includes the principle that privacy laws will not be used for protectionism.
The United States and the Republic of Korea signed the United States-Korea Free Trade Agreement (KORUS FTA) on June 30, 2007. On December 3, 2010, the United States and Korea concluded new agreements, reflected in letters signed on February 10, 2011, that provide new market access and level the playing field for U.S. auto manufacturers and workers. Once it enters into force, the Agreement will be the United States’ most commercially significant free trade agreement in more than 16 years. SOURCE: US Trade Representative.
New Model of FTA: Privacy Issues Are Within Scope of Bilateral Agreements. The KORUS FTA adopts a novel attitude towards the scope of bilateral FTA’s. It recognizes that privacy laws can be an impediment to trade, and it opens markets in offshore data processing on the basis that a privacy law of a sovereign can, by agreement, be modified to enable cross-border data flows. While this conclusion is not expressly stated in such bald terms, the documents advert to it.
I. Cross-Border Services.
Scope of “Cross-Border Trade in Services.” The KORUS FTA applies to “measures” (laws and regulations) adopted or maintained by either party affecting cross-border trade in services by service suppliers of the other party.
- “Measures.” Any “measure” that “affects” the “production, distribution, marketing, sale” or “delivery” of a service is covered. The parties clearly contemplated remote transaction processing (BPO) by including “measures” affecting “the access to and use of distribution, transport or telecommunications networks and services in connection with the supply of a service.” KORUS, Art. 12.1(1).
- “Cross-Border Supply of Services.” The KORUS FTA covers the supply of services based on the location of the provisioning (from the territory of one of the parties), the location of receipt (in the territory of one of the parties), or the nationality of a service provider while operating within the territory of a party. Art. 12(13).
Outsourcing of Financial Services to Non-Bank Service Providers. Financial services are not covered by the KORUS FTA. Exceptionally, the FTA does cover “financial service” supplied by a “covered investment” (FDI) that is not an investment in a “financial institution.” Art. 12(4). In short, financial transaction processing is covered if the processing is done by a service provider not engaged in the business of banking or insurance. Hence, ITO and BPO services to financial institutions are within the scope, so that each party will provide market access to the other party’s service providers.
Core Freedoms. Subject to a list of non-conforming “measures” identified on “Annex I” and specific sectors and activities in “Annex II,” the parties granted each other national treatment, MFN treatment, open market access and the right to perform all services remotely. Art. 12.
- National Treatment. Under the KORUS FTA, “each party shall accord to services suppliers of the other Party treatment no less favorable than it accords, in like circumstances, to its own service suppliers.” Art. 12.2(2).
- Most-Favored-Nation Treatment. “Each Party shall accord to service suppliers of the other party treatment no less favorable than it accords, in like circumstances, to service suppliers of a non-Party.” Art. 12.3.
- Market Access. “Neither Party may adopt or maintain, either on the basis of a regional subdivision or on the basis of its entire territory, measures that impose limitations on” the number of service suppliers, the total value of service transactions or assets or the requirements of an economic needs test, the total number of service operations, or the number of natural persons performing such services. Art. 12.4. Of course, this does not grant any business visa rights, which are specifically excluded from the scope of the FTA. Art. 12(4).
- No Local Presence. The KORUS FTA prohibits each party from requiring any service supplier of the other party to maintain a representative office or any form of enterprise, or to be resident, as a condition of furnishing “the cross-border supply of service.” Art. 12(5).
Conditions to Grant of Authorizations to Perform a Service. The KORUS FTA does not prevent either country from requiring foreign service providers to obtain licenses to peform the services, or to escape local regulation. Any such domestic regulation must be based on “objective and transparent criteria, such as competence and the ability to supply the service.” The licensing procedures themselves cannot be, in themselves, a restriction on the supply of the service. Art. 12(7).
- Transparency. In the United States, the concept of “transparency” in government regulation flows from the Constitutional notion of “due process” and from the framework for administrative rulemaking under the federal Administrative Procedures Act. The KORUS FTA adopts similar assurances for public openness, or at least accountability in the absence of public openness, relating to the regulation of services providers. Art. 12(8).
- No Third-Party Controlled Service Providers. As with most U.S. income tax treaties, the KORUS FTA treaty denies the benefits of the bilateral agreement to service suppliers of a party that are “owned or controlled by persons of a non-Party.” However, this exclusion only applies where the government denying such benefits to that service provider (i) “does not maintain normal economic relations with the non-Party” (such as North Korea) or (ii) has economic sanctions against that non-Party. Art. 12(11).
II. Regulation of Privacy in Cross-Border Information Flows.
A “Wish List.” The e-commerce provisions of the KORUS FTA do not establish guarantees of free cross-border flows of information. However, the agreement does recognize “the importance of the free flow of information in facilitating trade” and “the importance of protecting personal information.” So the parties agreed to “endeavor to refrain from imposing or maintaining unnecessary barriers to electronic information flows across borders.” Art. 15.8. This is scant legal assurance but offers hope that purely protectionist prohibitions on certain data flows will not be enacted by either party.
Korean Privacy Laws. South Korea has enacted several laws on the collection, use and disclosure of personal information in the private sector. These include:
- the Medical Service Act(1973);
- the Telecommunications Business Act(1991);
- the Protection of Communications Secrets Act (1993);
- the Use and Protection of Credit Information Act (1995);
- the Real Name Financial Trade and Secrecy Act (initially 1997);
- the Framework Act on Electronic Commerce(1999); and
- the Digital Signatures Act (1999).
Although South Korea has privacy protection laws which in the past have hindered exportation of personal information, the KORUS FTA will open cross-border trade in financial data processing and related software.
III. E-Commerce, Digital Products and E-Signatures.
Chapter 15 of the KORUS FTA adds a new framework for avoiding barriers to trade in e-commerce.
Access and Use of the Internet for E-Commerce. The KORUS FTA does not set up a legal framework for protecting consumer choice in accessing and using services and digital products, or to run applications and services of their choice. The parties agree to “acknowledge” that consumers in their respective territories “should be able” to have such choices of services and digital products (unless prohibited by law) and choices of applications and services (subject to “the needs of law enforcement”). Art. 15.7.
ITO, BPO and other Remotely Performed or Remotel Provided Services. The KORUS FTA clarifies that “the supply of a service delivered or performed electronically” is subject to the other market-opening requirements governing investment, cross-border trade in services and financial services. However, any exceptions to open market access that apply to such other requirements will also apply to e-commerce and such electronically-delivered services. Art. 15.2.
Digital Products (not Services).
- Definition and Context. Digital products are treated separately from electronically performed or electronically delivered services. ‘Digital products” are “computer programs, text, video, images, sound recordins, and other products that are digitally encoded and produced for commercial sale or distribution, regardless of whether they are fixed on a ‘carrier medium’ or transmitted electronically. Art. 15.9.
- Market Opening. The KORUS FTA prohibits each party from imposing customs duties, fees or other charges on, or in connection with the importation or exportation of digital products, whether or not “fixed” on a “carrier medium” or transmitted electronically. Art. 15.3(1). However, this general prohibition does not apply to internal taxes or other internal charges on digital products, if “imposed in a manner consistent with this agreement.” In short, sales and use taxes by states and localities remain permitted.
This enables buyers, sellers, licensors and licensees of software to decide on physical delivery (on a CD-ROM, for example) instead of electronic delivery as a tool for avoiding customs duties. It supersedes current practices where sophisticated licensees often require an electronic delivery to avoid customs duties and sales taxes on the CD-ROM’s, but do so at the risk of an incomplete e-transmission. The KORUS FTA thus allows businesses to get both delivery and peace of mind. Further, e-delivery exposes the parties to the risk of deep-packet inspection of the software and thus governmental inspection and potential unauthorized examination and duplication.
- MFN: Equal Treatment of Different Digital Products. The “most-favored” nation provisions not only prevent discrimination on trade in digital products from the standpoint of rights and procedures for third-country “digital products.” Art. 15.3(3). The KORUS FTA also prevents discrimination between different types of digital products. This new approach thus requires equal treatment of software, video, audio recordings, visual arts (“images”) and other digitally recorded “products, “ and thus treats e-transmissions (such as via cable, VOIP or satellite) equally with television and radio. Art. 15.3(2) and 15.3(3).
- Exceptions. Exceptions are listed in other articles. Art. 15.4, citing Articles 11.12 (investment measures), 12.6 (cross-border trade in services) and 13. 9 (financial services) (collectively, “non-conforming measures”). Also, equal treatment between different digital products is not required where a Party subsidizes a service or service provider, such as by government-supported loans, guarantees or insurance, or services supplied in the exercise of governmental authority. Art. 15.5. Finally, a government can treat digital products with special rules if the e-content (digital product) is “scheduled by a content provider for aural and/or visual reception” and where the consumer cannot access such content on any other schedule. Art. 15.6.
- MFN: Jurisdictional Nexus for Avoidance of Free-Riders. The MFN treatment of digial products requires one of two jurisdictional connections. First, the digital products must be “created, produced, stored, transmitted, contracted for, commissioned, or first made available on commercial terms” by anyone (whether or not the persons doing so are Korean or American) in either South Korea or the United States. Second, as a alternative, the individuals involved in the chain of conception and distribution of digital products must be “a person of the other Party.” To enjoy non-discriminatory treatment, such individuals must include one of the following: authors, performers, developers, distributors and owners of digital products must be treated. Art. 15.3(2).
E-Signatures. The KORUS FTA promotes e-authentication and e-signatures.
- Definitions. “Electronic authentication” means “the process or act of establishing the identity of a party to an electronic communication or transaction or ensuring the integrity of an electronic communication.” E-signatures on documents cannot be valid without assurance that the parties intended to link the e-signature to the “e-communication” or “transaction.”
- E-Authentication Legislation. The KORUS FTA prohibits each government from denying commercial parties the right to mutually determine an agreed appropriate authentication method for a transaction. Also, private parties will be assured access to judicial and administrative review for determination, in disputes, whether “their electronic transaction complies with any [such mutually contracted] requirements with respect to authentication.” Most importantly, neither government may deny the legal validity of a signature “solely” on the basis that it is in electronic form. Art. 15.4(1).
- Exceptions. Each country’s government may still regulate by imposing performance standards or governmental certification requirements in respect of e-authentication for “a legitimate governmental objective” where the performance requirements are “substantially related to that objective.” Art. 15.4(2). Obviously, such regulations will apply to the exercise of a government’s regulation of a regulated industry, such as financial services, shipping, insurance, legal process outsourcing, finance and accounting, filing of tax returns and other official records.
Consumer Protection Online. The agreement preserves the right of each party to enact laws and regulations to protect consumers from fraudulent and deceptive commercial practices when consumers engage in e-commerce. The parties agree to cooperate in enforcement of their respective local laws “in appropriate cases of mutual concern.” Art. 15.5.
Paperless Trading. The two governments agreed to put online their “trade administration documents” to allow transparency in regulations under the KORUS FTA agreement. This is not a general e-government mandate. Art. 15.6.
IV. Conclusion. As intergovenmental agreements, FTAs paint the rules with a broad brush. Aside from opening the Korean markets to American automobiles and professional services forms, this FTA opens Korea’s ITO and BPO sector to foreign completition from the U.S.
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.
Insights by Bierce & Kenerson, P.C., Editors. www.biercekenerson.com
Vol. 10, No. 8-9 (August/September 2010)
1. Government Procurement: Civil Fraud and Debarment for Non-Disclosure of [Offshore] “Outsourcing.
2. U.S. Increases Visa Fees by $2,000 for H1-B’s and $2,250 for certain L’s: Sen. Schumer Leaps from “Chop Shops” to “Body Shops.”
September 13-15, 2010. 5th eDiscovery for Pharma, Biotech and Medical Device Industries, Philadelphia, Pennsylvania. Presented by IQPC, this event will bring together industry leaders from in-house eDiscovery teams, expert judges and outside counsel as they discuss:
- How the new Pension Committee decision will effect eDiscovery professionals in the life science industries
- The unique challenges biopharmaceutical and medical device companies face with respect to social media content
- Preparing and responding to FDA inquiries, patent issues, and other types of pharmaceutical litigation
- A progress report on the 7th circuit eDiscovery pilot program and its implications for Pharma and Biotech
- Reducing patient privacy risks and unnecessary disclosures due to indiscriminate document retention
- Discovering new technologies to reach your goal of gaining proactive control over all your data
To register and view the whole program, click here.
September 26-28, 2010. IQPC Shared Services Exchange™ Event, 2nd Annual, to be held in The Hague, Netherlands. Shared Service Centres have long been seen as the cost saving centre of HR, Finance & Accounting and IT processes, but with changing employment trends and global challenges facing organisations, how can SSC’s continually offer service value?
Unlike typical conferences, the Shared Services Exchange™, which will be co-located with the Corporate Finance Exchange™, focuses on networking, strategic conference sessions and one-on-one meetings with solution providers. The Exchange invites strategic decision makers to take a step back from their current operations, see what strategies and solutions others are adopting, develop new partnerships and make investment choices that deliver innovative solutions and benefits to their businesses.
To request your complimentary delegate invitation or for information on solution provider packages, please contact: firstname.lastname@example.org, call +44 (0) 207 368 9709, or visit their website at http://www.sharedservicesexchange.co.uk/Event.aspx?id=263014
September 27-28, 2010, CxO Dialogue Business Process Outsourcing Conference to be held in Berlin, Germany. The CxO Dialogue Business Process Outsourcing offers a neutral platform for about 50 decision makers from HR, finance, CRM and IT that allows to discuss individual projects regarding the outsourcing of business processes. Case studies, workshops and one-to-one meetings provide the opportunity to network on a level playing field and talk with speakers, colleagues from other companies and expert consultants from leading solution providers about topics that really matter.
Our extensive business matching process guarantees tailor-made agendas and really meaningful contacts. To learn more about econique’s business matching, click here. Participation is free of charge but an executive position is requisite. To reserve your spot, please contact email@example.com. To become an exclusive solution partner and meet executives from your target group, please contact firstname.lastname@example.org.
September 28-30, 2010, SSON presents Finance Transformation 2010, Chicago, Illinois. If you are facing challenges to meet your finance end-to-end and top quartile requirements, consider Finance Transformation 2010 – the most comprehensive event for anyone managing finance back office operations looking for end-to-end capability.
The main themes explore the strategic views of true transformation across the entire finance supply chain and highlight the roadmaps which will help you to achieve top quartile business outcomes you aspire to. Sessions will cover the key tenets that all of you in the industry – large and small, beginner and established, vendor and buyer, private and public – are required to confront. For more information and to register, visit Finance Transformation.
Gain value from High-caliber Keynote & Plenary Sessions and Three Conference Tracks:
- Sourcing Strategy: Achieving New Business Value Through Innovation
- Mastering Sourcing: Driving Outcomes Through Smart Partnerships & Delivery Models
- Best Sourcing Practices: Exceeding ROI Goals While Minimizing Risk
To register, and for the most up-to-date event information, please visit http://www.globalsourcingforum.com
October 21-22, 2010, American Conference Institute’s 5th National Forum on Reducing Legal Costs, Philadelphia, Pennsylvania.
The essential cross-industry forum for corporate and outside counsel who are truly motivated to create value and reduce legal costs through innovative fee arrangements, enhanced relationships, and streamlined operations
Come join senior corporate counsel responsible for cost-reduction success stories, as well as leaders from law firms that have pioneered the use of alternative fee arrangements and other innovative cost-reduction initiatives, as they provide a roadmap for navigating the complexities of keeping legal department costs in check. Now in its fifth installment, this event offers unique networking opportunities with senior practitioners from around the nation, including in-house counsel from a wide range of companies and industries.
Reference discount code “outlaw” for the discounted rate of $1695! To get more information, visit www.americanconference.com/legalcosts
October 25-27, 2010, The 8th Annual HR Shared Services and Outsourcing Summit, Orlando, Florida. This 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. We will review how to tackle change management, analyze current and future projects and further develop the instrumental key areas within HR shared services. Outsourcing Law contacts can receive 20% off the standard all access price when they register with the code HRSS5. Register by calling 212-885-2738. View the program brochure for more details by clicking here.
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: email@example.com. The 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: firstname.lastname@example.org . 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.
Many companies provide services to the U.S. government. Directly and indirectly, government contractors must disclose extensive information in their bid documents. Under a draft U.S. law, such bids would need to disclose whether the bidder has a history of “the laying off of a United States worker from a job, and the hiring or contracting for the same job to be performed in a foreign country.”
Under the draft “Stop Outsourcing and Create American Jobs Act of 2010”, introduced by Rep. Jerry Cranwell (D., Calif.) on June 29, 2010, all Federal government departments and agencies would be required to request each bidder for a Federal contract to provide information regarding whether the offeror engaged in “outsourcing” during the fiscal year preceding the fiscal year in which the contract is to be awarded. The bill attacks the restructuring of government suppliers who terminate the employment of a United States worker from a job and hire (or contract for) the same job to be performed in a foreign country.
The bill would punish bidders by debarment from future Federal government contracts and impose criminal fraud penalties under 18 U.S.C. 1001 (false statements to the Government).
Analysis. This bill requires disclosure and imposes civil debarment and criminal liability for non-disclosure. The disclosure relates to a lawful act of laying off a U.S. worker followed by a lawful act of hiring a foreign worker.
Comity and Reciprocity. Public International Law is built upon reciprocity and “comity.” “Comity” represents a respect in one country for the reasonable internal actions in another country for matters that have potential dual impact in both countries. This draft legislation is patently nationalistic, protectionist and xenophobic. On a reciprocal basis, an American worker would have no chance of replacing a foreign worker employed by a foreign employer where the foreign employer provides goods or services to a foreign government. Such legislation risks serious harm to American workers by foreign adoption of similar laws where foreign labor is replaced by American labor.
Multilateral and Bilateral Commitments. As a legal matter, a law that violates U.S. international commitments may be valid under local law but engage the international responsibility of the United States under a prior binding international convention. This law would punish American government contractors for practices that are protected under the WTO General Agreement on Trade in Services (“GATS”) and possibly the WTO Agreement on Trade-Related Investment Measures. Similarly, the U.S. would be in breach of its bilateral duties under NAFTA.
Bill of Attainder. This faces U.S. Constitutional challenge as a Bill of Attainder under Article I, Section 9. A “bill of attainder” was a law that banned a person because of some inherent status or the exercise of some freedom, right or privilege that is generally available to all citizens. It is a legislative declaration that a person or group of persons is guilty of some crime and punishing them without benefit of a trial. In such, the draft law would have the same effect as debarring contractors who fire U.S. workers for any lawful reason, such as a shortage of work, or such as the employee’s abuse of the employer’s computer system or use of office equipment for conducting a sideline business during off-hours.
Business Process Transformation. The draft legislation does not define what is the “same work” that is being done offshore. In many cases, globalization occurs because the functions and roles are changing to use new technologies, to access new markets and to obtain new skills. As in other cases of “follow the work,” the question is not just work, but organizational design, workforce planning (such as for knowledge workers) and marketing (getting closer to the customers). The draft law invites artificial determinations that offshored work is the “same” and omits any definition of “sameness.”
Hidden Agenda: Compiling a Little List. Since public procurement procedures are accessible to the public in the United States, the draft legislation invites inquiry into its effects. If enacted, the draft law would allow the Government to compile a list of all Government contractors and subcontractors (to the infinite level) who had done any “outsourcing” in the prior 12 months. Such a list would then be used for political purposes to harangue any enterprise “guilty” of such lawful behavior. Companies that are indirect subcontractors would face the same reporting, compliance, perjury and debarment risks.
Instead of outlawing “outsourcing,” the draft legislation would outlaw those who wrongfully deny that they outsource (under 18 USC 1001) and create a political stigma for actions that are not illegal. This is reminiscent of the frenzy and abuses of the anti-Communist witch-hunt of Senator Joe McCarthy in the 1950’s.
A simpler legislative solution would be to ban “outsourcing.” Of course, such a ban would be so offensive (and contrary to national commitments under NAFTA, WTO and bilateral treaties) that it would never pass. But, certainly, no offense could be taken by an innocuous bill to prevent frauds and plan a smear campaign.
Strengthening American Employability. It is regrettable that such defective and ill-conceived legislation does not address the core issues of American employability, such as education, language skills, competitiveness and use of technology to improve the human touch. In fact, in the tax-haven segment of this same draft bill, the test of whether a foreign jurisdiction is a tax haven (justifying anti-deferral and other retaliatory treatment) includes some factors that the Congress should consider for promotion of American employability, such as ”Incentives which may encourage a United States corporation to invest abroad rather than domestically.” H.R. 5622, Sec. 2 (111th Cong., 1st Sess.).
There are other methods of aiding job losses from outsourcing. A legally valid solution would require re-examination of American global commitments and a balancing of benefits and burdens, including enforcement of WTO violations. Such enforcement actions are at the discretion ofthe President and not congressional legislation.
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. www.biercekenerson.com
Vol. 9, No. 11 (November, 2009) Last Opportunity to Register - Webinar on Sourcing of Global Talent
Managing Knowledge, Compliance and Legal Risks in Sourcing of Global Talent
Thursday November 17, 2009, 11 A.M. – 12 Noon, Eastern Daylight Time U.S.
- William B. Bierce, Esq., Bierce & Kenerson, P.C. – Outsourcing Lawyer
- Larry Scinto, PA Consulting, Managing Consultant
- Neil McEwen, PA Consulting, Managing Consultant
Agenda. 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. In this webinar, some of the questions that will be discussed are:
- How do I put together an effective contingent workforce strategy to optimize my investment in contingent labor?
- How do I ensure that my business customers are engaged in the case for change and buy-in to common technology, process, policy and governance?
- How do I govern multiple providers and ensure effective performance and value for my investment?
- What technologies should I be using to track provider/contingent worker utilization and performance?
- How do I ensure that legal/regulatory/compliance risks are recognized and managed in all geographies where I operate?
- How do I ensure that there is effective governance across the entirety of my contingent workforce?
- How do I manage risk and compliance issues that arise through the implementation of a contingent workforce?
This webinar is by invitation only. To register, please click here. _________________________________________________________________________
1. “ObamaCare”: Promotion of Automation, Offshore Outsourcing and Job Losses; Penalizing Foreign Companies Based in Tax Havens (and Other Non-Treaty Countries).
1. “ObamaCare”: Promotion of Automation, Offshore Outsourcing and Job Losses; Penalizing Foreign Companies Based in Tax Havens (and Other Non-Treaty Countries). If enacted, President Obama’s healthcare reform would probably hurt domestic employment and accelerate automation, outsourcing and offshoring. It would change the economic incentives for keeping service industries in America. And it would hurt foreign-owned businesses whose ultimate parent company is based in a tax haven or other country that has no U.S. income tax treaty. On November 6, 2009, by a paper-thin margin of 220 votes to 215, the U.S. House of Representatives passed the “ Affordable Health Care for America Act,”H.R. 3962, the 1,990-page health care reform law that has been frequently called “ObamaCare.” If substantially adopted by the Senate and passed into law, the bill would impose significant new burdens on employers and self-employed persons. For the complete article, please click here.
Healthcare reform, n. (1) a plan to make healthcare “affordable” in America by making employment less affordable.
Independent contractor, n. (1) a staffing company, outsourcing service provider or personal service company working on projects under a defined scope, subject to change control procedures and never under the direction or control of the enterprise customer except by contract revision; (2) a free spirit, within the freedom of the statement of work.
December 6-8, 2009, IQPC and SSON’s 4th European Shared Services Exchange, The Hague, Netherlands. Following the success of our Shared Services Exchanges in North America we are now launching the new format for Europe, bringing together senior level conference topics in a highly productive and interactive meeting platform. The 4th European Shared Services Exchange is an invitation-only gathering for VP and C-Level senior Shared Services executives from successful European organizations. With a distinguished speaking faculty from Dell, Lafarge and Microsoft amongst others, the seats at the 2009 Exchange are limited and filling up quickly. We have limited complimentary invitations available for qualified delegates for a limited time. Please give us your reference when inquiring. There are solution provider opportunities also available for companies who want to be represented. You can request your invitation at email@example.com or call us at 1866-296-4580. Visit the website for more information.
December 7-9, 2009, Legal IQ and IQPC’s 8th Annual E-Discovery Conference in New York, New York. Legal IQ and IQPC present the 8th eDiscovery event this December in New York City. Bringing industry leaders together to explore current risks, opportunities and challenges facing eDiscovery, this event will offer best practices and possible solutions to the ever remaining question: How can we lower our costs? This event goes beyond the traditional basics by examining the critical, high level, and strategic issues. Some of the topics to be addressed by the expert speaker faculty will be:
- Organizing an effective records program by tapping into existing resources
- Developing a litigation preparedness plan
- Determining judges’ priorities when eDiscovery conflicts arise
- Aligning the interests of IT, inhouse and outside counsel
- Handling eDiscovery via social media sites and other new sources of ESI
- Controlling the cost of review while maintaining defensibility
- Saving money by employing Early Case Assessment tools and new technologies
For more information and to register for this event, please click here.
January, 24-26, 2010, IQPC Business Process Outsourcing and Shared Services Exchange 2010, West Coast, USA. This is an invitation-only gathering for VP and C-Level senior Shared Services and Outsourcing executives made up of highly crafted, executive level conference sessions, interactive “Brain Weave” discussions, engaging networking opportunities and strategic one-on-one advisory meetings between solution providers and delegates. With a distinguished speaking faculty from McGraw-Hill, Ingram Micro and Pfizer, amongst others, the seats at the 2010 Exchange are limited and filling up quickly. We have limited complimentary invitations available for qualified delegates for a limited time. Please give us your reference ‘Outsourcing Law’ when inquiring. There are solution provider opportunities also available for companies who want to be represented. You can request your invitation at firstname.lastname@example.org, call at 1866-296-4580 or visit their website.
February 22-24, 2010 ,SSON and IQPC 8th Procure-to-Pay Summit, Miami, Florida. Join Procurement, Accounts Payable and Sourcing professionals at the 8th Procure-to-Pay Summit to discuss new initiatives for procurement as IQPC and SSON continues with its Procure-to-Pay series in 2010. More information will be available shortly. In the interim, check out what happened at the 7th P2P Summit this past summer.
March 22-26, 2010, SSON presents the 14th Annual North American Shared Services & Outsourcing Week, Orlando, FL. Here’s a sneak peek of new and enhanced features, which include:
- Speakers from Top Companies:Aramark, Arbys/Wendy’s, AstraZeneca, Chevron, Coca-Cola, Conagra Foods, General Motors, Kellogg, Kraft, Microsoft, Monster, NASA, Northrop Grumman, Oakley, Perdue Farms, Schering Plough, Warner Brothers and more
- G8: Global Sourcing Think Tank Eliminating the White Noise: The first ever neutral platform to help shape a common industry agenda in the US
- Under the C-Suite Spotlight with Rene Carayol, An Exclusive Onstage CXO Interview: Board-room revelations regarding shared service & sourcing model strategy
- New, Strong, Business Outcome-Focused Content: 8 content-intense tracks, from Planning & Launching and BPO Evolution to IACCM’s Contracting to Collaboration
- Enhanced Annual Features: Quick Wins Energizers, Speed Networking, Blue Sky Innovation Room for Mature SSO’s, and more.
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Farmland Industries Inc., a federation of 1,700 rural farm cooperatives that is the largest farm cooperative in the United States, filed for bankruptcy protection on May 31, 2002, after reportedly rejecting an offer by Smithfield Foods Inc. for acquisition of Farmland’s meat business. The meat business is operated as a joint venture with U.S. Premium Beef Ltd., which has the right of first refusal.
In the 1990′s, Farmland Industries re-directed its capital and took on considerable debt to become a larger processor of farm commodities. The subsequent declines in crop prices resulted in a loss of $90 million for the fiscal year reportedly ended August 31, 2001, with additional losses of $46 million for the half year ended February 28, 2002. Investors in Farmland’s subordinated bonds reportedly aggravated the liquidity crisis by redeeming the cooperative’s bonds in droves. This story offers an example to vendors of the impact of massive changes in a customer’s business environment, as well as the inflexibility a customer faces when it has committed to joint ventures.
This bankruptcy could be bad news for Ernst & Young LLP (or its successor Cap Gemini Ernst & Young). In April 1997, E&Y and Farmland formed OneSystem Group LLC (OSG) as an IT joint venture to provide IT outsourcing and business process outsourcing services to Farmland Industries and the Farmland Cooperative System, the largest farmer-owned cooperative in North America. The joint-venture relationship reportedly introduced results-based metrics and gain-sharing through the establishment of unique payment methods for services funded by realized business savings.
In a bankruptcy, executory contracts may be terminated. In a joint venture where one of the parties is bankrupt, the bankrupt joint venturer may terminate future obligations to provide funding and services, but it still owns the joint venture interest.
In making the classic “buy vs. build” decision in relation to services to manage sophisticated business processes, enterprises may elect to establish a captive enterprise to perform “shared services” for affiliates. The “shared services captive” is an alternative to buying outsourced services. But it is also an alternative to internal administration of a business process separately by individual departments, divisions or lines of business. Shared services captives can provide key advantages for diversified multinational enterprises, particularly as a cost-reduction technique when sales and sales margins might be eroding in a global economic downturn.
Captive Internal Bank.
Sony Corporation, the Japanese-based electronics and entertainment group, announced in June 2003 that it was planning a major expansion of intercompany banking services to help reduce financing charges and manage currency risks for all affiliates.
According to Sony’s managing director for Global Treasury Services, Mr. Hiro Kurihara (as quoted in an interview with the Financial Times), the London-based shared services operation will generate cost savings of approximately $30 to $40 million per year.
In addition, Sony projected reduction of risks of changes in currency in connection with the settlement of intercompany transactions. Sony plans to offset foreign exchange risks with services — normally offered by money-center banks — of “automatic cashless settlements” and “automatic sweeping.” This requires investment in information technology and integration with others in financial services markets.
Centralization, Specialization and Scale.
Sony’s Global Treasury Services acts like a clearing bank for all affiliates. In this centralized function, the shared services affiliate can aggregate volumes of transactions that are generic, but whose handling requires specialized skills. As a result, economies of scale can reduce per-unit costs and increase focus on specialized transactions that internal financial executives in operating affiliates might not have, or might find difficult, time-consuming or costly to acquire. The Sony shared services affiliate reportedly manages 95% of the enterprise’s financial derivatives and exchange swap transactions.
Transition and Transformation.
The transition to an internal financial services captive is part of a global restructuring that will result in accounting charges of approximately $1.2 billion. Restructuring to include new, enhanced shared-services affiliates may help multinationals such as Sony to transform their services models by increased efficiency and cost management.
Integration with Insourced Transactions.
Establishment of a shared services affiliate requires careful attention to integration with other internal processes. The shared services affiliate must define its “services offerings” and enable managers in affiliated lines of business to use the services with minimal cost and delay. As a result, virtually all “shared services” are digitally integrated. The degree of integration may range from the use of telephones and e-mails to a web-enable Internet-accessible portal. As a result, shared service affiliates generally are purchasers of services and technology from third parties.
Integration with Outsourced Transactions.
Indeed, shared services providers may be the largest purchasers of outsourced transactions. For example, Proctor & Gamble was negotiating for a complete sale of its shared services affiliate to a global outsourcing services provider in 2002. When P&G was unable to obtain its desired sales price at for the services charges that it wanted, P&G chose instead to hire Hewlett-Packard to provide selective outsourced services to support its insourced “shared services” operation.
Advantages in Shared Services.
Shared services affiliates, or “captive” service companies, have many of the advantages of an outsourcing without any loss of ownership and control over business processes, technology, intellectual property and personnel. Shared services captives can develop and retain knowledge capital involving sophisticated business transactions that individual affiliates cannot acquire due to smaller volume of similar transactions. As the business process involved becomes more subjective and susceptible to business judgment, shared services captives retain an advantage over outsourcing because that very subjectivity might be a core competitive advantage and might not be scalable.
Risk Management in Shared Services.
Adoption of a “shared services captive” approach involves a number of risks that can be managed by treating the captive as an external service provider of outsourced services. Such techniques include:
- adoption of “service level agreement” obligations, with financial incentives and consequences for failure, applicable to the management and employees of the shared services affiliates;
- details concerning the integration of the captive’s services with those of the other operating companies or lines of business;
- suitable insurance coverages;
- suitable contracting procedures for outsourcing of certain perfunctory tasks of the shared services captive to independent outsourcing services providers;
- human resources and intellectual capital management techniques for aggregation and accumulation of related processes and improvement in business processes, quality of service and optimal alignment with the key performance indicators of the core business’s mainstream operations.
Shared Services on the Continuum of Insourcing and Outsourcing.
In conclusion, shared services companies, or captives, perform roles that run along the continuum of fully vertically integrated insourced operations to a skeleton of core competencies supported by a network of outsourced operations. If a business process can be outsourced, it can also be insourced after the outsourcing. If it has been insourced, it could be structured more efficiently as a captive to look like an outsourcing. And once structured as an outsourcing, it could become a true outsourcing service provider to support non-affiliated customers, and could even be spun off to shareholders or sold to a strategic buyer. Thus, the captive shared services organization can mutate according to trends affecting customers, suppliers, corporate strategies, changing processes and changing marketplaces. In establishing internal captives, the lessons of outsourcing can improve performance and flexibility.
Patents in Outsourcing: Strategy and Practice for Business Process Patents and International Trade in Services
Should a service provider develop a patent portfolio? In performing outsourced services, the service provider performs certain business processes that range from information technology to office procedures. Since U.S. courts have interpreted patent laws to make business processes eligible for patent protection, the patent law has played a small but growing role in business process outsourcing. This article addresses some key issues in patent law in outsourcing, including validity, infringement, extraterritoriality and the role of patents in outsourcing.
What is a Patent?
A patent is a statutory monopoly that allows the inventor to practice an invention, to allow others to use the invention under terms and conditions that the inventor considers acceptable and to prevent unlicensed persons from using the invention. Under U.S. law, an invention must be novel, useful and non-obvious to one skilled in the existing “art” (science). It is the specific claims in the specification of the invention that are entitled to the statutory monopoly. In patent applications, claims are written as independent (and therefore unrelated to any other claim) or dependent (and therefore viable only if the related independent claim is valid).
Impact on Competition.
Quite simply, patents stifle competition. For this reason, courts and regulators have adopted limitations on abuses of patents, such as tying the use of non-patented goods or services to patented goods or processes.
The patent application must set forth the “specification” that describes the exact scope of an invention and its method of “manufacture” in sufficient detail that it describes what is left to the public outside the scope. Markman v. Westview Instruments, Inc., 116 S. Ct. 1384, 517 U.S. 370, 373 (1996). The specification consists of two parts:
- a detailed “written description of the invention and of the manner and process of making and using it, in such full, clear and concise, and exact terms as to enable any person skilled in the art … to make and use the same.” 35 U.S.C. 112, para. 1.
- a conclusion “with one or more claims particularly pointing out and distinctly claiming the subject matter which the applicant regards as his invention.” 35 U.S.C. 112, para. 2.
General Definition of Patentable Processes.
Patentable process “inventions” must involve a “process, art or method, and include… a new use of a known process, machine, manufacture, composition of matter, or material.” 35 USC 100(b). “Whoever invents or discovers any new and useful process, machine, manufacture or composition of matter, or any new and useful improvement thereof, may obtain a patent therefore,” subject to the patent law’s other provisions. 35 U.S.C. 101.
Software patents have been issued in the United States since 1982, when Merrill Lynch patented a financial transaction software application that links securities brokerage accounts with” cash management accounts.” U.S. Patent No. 4,346,442. While early judicial decisions quibbled that the processing of data was not an eligible process, the courts and the U.S. Patent and Trademark Office have generally accepted the patentability of software.
Business Process Patents.
Business methods are the sequence of steps that are undertaken to engaged in a specific business activity. Until 1998, a business method was considered to be an idea, and business methods as ideas were not patentable. In July, 1998, the U.S. Court of Appeals for the Federal Circuit did away with that interpretation of the U.S. patent law. The case, State Street v. Signature Financial, legitimized the patentability of software that Signature had written to enable it to administer mutual funds more efficiently. The software merely embodied a business process. The court’s language was broad enough to embrace any business process (as long as it was new and “nonobvious” and had a “useful, concrete, and tangible result”). Congress has done nothing to restrict this judicial interpretation.
Once issued by the U.S. Patent and Trademark Office, a patent is presumed valid. 35 U.S.C. 282. The party who seeks to invalidate a patent or any individual claims has the burden of establishing invalidity. To meet this burden of proof, the party seeking to invalidate must prove the invalidity by “clear and convincing evidence,” a standard that is very high. Helifix Ltd. v. Blok-Lok Ltd., 208 F.3d 1339, 1346 (Fed. Cir. 2000). In making its proof, the party seeking to invalidate may rely upon a variety of arguments. Such arguments may include an assertion that the patent holder engaged in “fraud on the patent office” by failing to disclose relevant “prior art” that would have prevented the issuance of the patent in the first place.
In litigation seeking to invalidate a patent, the first issue is one to be decided by the judge: what is the scope of the claims in the patent? The second issue is one for the jury: has infringement occurred? Markman v. Westview Instruments, Inc., 116 S. Ct. 1384, 517 U.S. 370, 384-391 (1996).
Enforcement of Patent Rights.
Enforcement of patent rights presents problems both for the patent holder and for the alleged infringer. The patent holder risks invalidation of the patent, thereby losing the right to claim royalties from all licensees. The alleged infringer (who may include an unhappy licensee unwilling to pay future royalties) may risk heavy damages.
Doctrine of Equivalents.
Judicial interpretation of patent claims adopt two approaches: literal and interpretive. Under historical case law, the monopoly of a patent claim extents beyond the literal description and covers “equivalents” as well. Applying some judicial discretion in the interpretation of the literal scope, the doctrine thus allows an infringement claim where the differences between the accused device or process and the patent claim are “insubstantial” and represent only “trivial changes.”
Prosecution History Estoppel.
Affirming this principle, the U.S. Supreme Court has restricted it by noting that the patent applicant’s modifications to its application forms a “prosecution history” that can serve as estoppel for any purpose under the patent law, not merely relating to eligibility (by narrowing it to deal with prior art). Festo Corp. v. Shoketsu Kinzogo Kogyo Kabushiki Co., Ltd., 535 U.S.722 (2002). At common law, the equitable principle of estoppel serves as an enforceable bar to assertion of a right or claim of right. The Festo decision permits alleged infringers to review the file history and rely upon any concessions or limitations made by the patent applicant as a basis for limiting the scope of the patent claims. Prosecution history estoppel under Festo thus opens the flood gates for competition who read the file history and look for concessions made by the applicant.
In Honeywell Int’l Inc. v. Hamilton Sundstrand Corp., 2004 WL 1202997 (Fed. Cir. June 2, 2004), the Court of Appeals for the Federal Circuit ruled that, in the patent prosecution process, the applicant is deemed to have waived the full breadth of a broad independent claim when it re-writes the claim to be more specific. Historically, patent prosecution involves the normal process of writing a “stand-alone” (independent) claim followed by a subsequent dependent claim (relying on the “stand-alone” claim’s basic premise). When the patent examiner rejects the stand-alone claim and asks the applicant to rewrite it to convert the dependent claim into a new stand-alone claim, the applicant may do so. In doing so, the applicant is deemed to abandon the full scope of the original stand-alone claim, and to rely only on the dependent claim.
Under the Festo decision as interpreted in Honeywell, rewriting the dependent claim into an independent claim form, accompanied by abandonment of the original broad independent claim, creates a presumption of “prosecution history estoppel” that nullifies the “abandoned” claim. As a result, patent applicants will probably be more prudent and narrowly focused when considering use of broad independent claims.
For outsourcing, this means that only narrowly defined claims will pass muster. Outsourcing services providers hoping to rely on patent protections will therefore be exposed to greater risks of competition due to lack of broad patent monopoly.
Defenses by Alleged Infringers.
The alleged infringer may allege various defenses, such as:
- absence of liability for infringement
- invalidity of the patent or any claim for substantive or procedural reasons. 35 U.S.C. 282
Extraterritoriality in Patent Law.
Patent law is a creature of the national law. Each country applies its own rules. U.S. patents do not cover the business processes or manufacturing process used in another country. John Mohr & Sons v. Vacudyne Corp., 354 F. Supp. 1113 (N.D. Ill. 1973).
However, goods made abroad using processes patented in the United States are subject to exclusion, upon importation, unless licensed by the U.S. patent holder. Exclusion requires registration of the patent with customs services. Enforcement of exclusion is hardly 100% effective.
Services performed abroad that result in delivery of information in the United States are generally not subject to U.S. patent protection. In that case, where a portion of the services are rendered in the United States, a U.S. business process patent will cover the U.S. portion of the services.
A number of international conventions, beginning with the Paris Convention of 1886, accords certain procedural rights in countries that adhere to them. The World Trade Organization’s Agreement on Trade-Related Intellectual Property requires participating countries to comply with the Paris Convention and certain other intellectual property conventions. WTO members must treat foreign nationals on a non-discriminatory basis in respect of the patent laws. The Patent Cooperation Treaty provides a mechanism by which an applicant can file a single application that, when certain requirements have been fulfilled, is equivalent to a regular national filing in each designated Contracting State. There are currently over 112 PCT Contracting States.
Relevance to Outsourcing.
Patent protection — or the lack of it — can affect the service provider’s ability to perform the scope of work under the outsourcing services agreement. Patents may be relevant to outsourcing, but not necessarily.
In the field of business process outsourcing, the service provider can achieve competitive advantage by having a patented process, since it allows that provider to perform that process without paying royalties and without patent infringement claims or litigation.
Having a pool of patents can be useful to avoid having to pay costs of infringement litigation and infringement damages. Without any patents, the service provider has nothing to barter in a cross-licensing transaction that could be proposed as a settlement.
One service provider uses part of the title to a U.S. patent as the phrase that defines its service brand: “On Demand Process….” [U.S. Patent No. 6,370,676] Public relations consultants and business developers might review the service provider’s patent portfolio for similar defining clues to brand development. Conversely, branding strategists should be consulted for strategic nomenclature of patent applications.
Termination for Cause.
Ordinarily, the enterprise customer relies upon the service provider’s indemnity against infringement in lieu of adopting a right to terminate for cause in the event of infringement. Such indemnities are customary. Enterprise customers might wish to consider whether reliance on such indemnification is sufficient as a remedy in case the service provider’s business process is determined to be infringing on some third party’s rights. Similarly, service providers should engage in appropriate research to determine whether their method of performing or delivering the services infringes, or risks infringing, a valid U.S. patent. In either event, the issuance of new patents to cover existing processes could be problematic for the business relationship.
BPO Patent Strategy in Practice: Who Actually Patents What?
We conducted a search of U.S. patents issued to leading outsourcing service providers in information technology, human resources and manufacturing. The results were not surprising.
- ITO and Consulting.
Outsourcers that specialize in managing IT and in consulting services do not hold many patents. Such service providers generally engage in “ordinary” and “well known” business processes that are ineligible for patenting, such as installing, configuring, fine-tuning, hosting and maintaining current versions of some commercial “off-the-shelf” software. Where the customer requires extensive customization, the work product normally belongs to the customer as a special project for a separate fee. Alternatively, the parties agree that the service provider will own and market the work product under agreed financial and operating conditions.
To the extent that ITO service providers do apply for patents, the patents tend to be in:
- a niche area (e.g., a system for cashing checks for persons without bank accounts where the customer must engage in some self-service task, U.S. Patent No. 6,038,553), or
- a generic function (e.g., data processing apparatus and corresponding methods for the retrieval of data stored in a database or as computer files, notably, methods and systems to facilitate refinement of queries intended to specify data to be retrieved from a target data collection, U.S. Patent No. 6,678,679).
Outsourcers that specialize in human resources management generally do not hold any patents. For example, a search of two HRO industry leaders showed that neither owns any U.S. patent.
- Business Process Outsourcing.
Business process outsourcing that relies upon software may be a good candidate for patent protection, but only for patenting the software. At this stage, the difference between a software developer and a service provider gets murky. Generally, BPO outsourcers do not pursue patent strategies but use other methods for protecting intellectual property and competitive advantage. Exceptionally, they may patent their software to defend against third party software developers.
- Original Equipment Manufacturing.
Outsourcers that serve as contract manufacturers logically focus energy on preserving their rights to conduct “contract manufacturing” in the United States and other countries. Companies such as Celestica, Jabil Circuit, Sanmina-SCI and Solectron have each developed some patents that relate to generic operations, not to specific product designs or manufacturing processes unique to their customers. As to the latter, the contract manufacturers require their customers to license any customer technology used in the manufacturing process, or at least refrain from suing over the contract manufacturer’s use of such process or any equivalents.
Factors Affecting an Outsourcer’s Patent Strategy.
Limitations of a Patent Strategy in Outsourcing.
Patent strategies depend on obtaining global monopoly through global patenting. The limitations on patenting of business methods in a global digital economy suggest that patenting is not the solution for protecting a service providers proprietary processes.
- Costs of Global Patenting.
Assuming that a service provider wished to achieve global exclusivity, it would have to file patent applications in at least the 112 countries that are members of the Patent Cooperation Treaty, in addition to dozens more. The cost of prosecuting and maintaining patents is high, and could be worthless if “copycat” service providers were to infringe virtually all claims except for a few.
- Costs of Prosecuting Patent Infringers.
A “plain vanilla” patent infringement lawsuit costs an estimated $750,000 as a minimum. To such out-of-pocket costs, the patent holder must add the opportunity cost of the executive and technical personnel whose time is diverted towards the litigation process, the portion of their salaries, benefits and overhead allocable to the litigation process, and the costs of enforcing a judgment.
- Uncertainties of Patent Scope and Validity.
The patent application process contains many uncertainties. As to scope, under the Festo doctrine, any concession made by the applicant can be used as an “admission against interest” by a defendant. Patent holders making a concession to the patent examiner in any country may be deemed to have made the same concession in all other countries. Alleged infringers will scour the patent prosecution files in all relevant countries and look for such concessions. As to validity, any prior art (including customary usages of the trade, the technical literature and other pre-existing patents) that is not disclosed to the patent office could jeopardize the entire patent.
- Risks of Counterclaims of Patent Abuse.
In any litigation, the plaintiff risks counterclaims by the defendant. In patent cases, the counterclaims could include antitrust violations subject to triple damages under U.S. law or for simple damages as “abuse of dominant market position” under European Union law. For market leaders, the costs of defending counterclaims can be greater than the costs of pursuing a basic infringement claim. Also, where patent applications fail to disclose substantial prior art the use of the patents to monopolize a field of business activity could arguably constitute patent abuse.
- Inconsistencies of Law, Legal Systems and Results.
Given the exclusive right of each country to adopt its own patent rules, service providers considering a patent strategy must accept the fact that what is patentable in one country might not be patentable in another country. “Whipsaw” in application of legal principles leads to unpredictability and inequity.
- Loss of Secrecy.
Because patents must be published to be enforceable, the inventor immediately loses all secrecy. (Exceptionally, a few patents are not published where interests of “national defense” apply.) Thus, pure “software” or pure “business method” might not be patentable in countries where competitors could use the software or method to perform the same service and export the results to the country that grants patent protection. Given the availability (and advisability) of encryption technologies and privacy methods, the foreign use of the software or method would likely go undetected, with no resulting enforcement of patent rights.
- Gambling with “Best Embodiment” Rules.
Sophisticated businesses -whether service providers or enterprise customers – engage in a game of hiding trade secrets and patenting a business process. The rules of this game are limited by the principle that the patent application must disclose the “best embodiment” of the full process.
- The Business Process Paradox in the Outsourcing Life Cycle.
Both parties in an outsourcing contract should understand the implications of what we call “the business process patent paradox.” Patents owned by the service provider make it stronger against competition and may enable the enterprise customer to enjoy the benefits of the service provider’s innovation investments. Yet, upon termination the customer would need to be converted to a non-infringing process or be given an evergreen patent license usable by the customer or its successor service provider. Perversely, this patent paradox may inhibit the basic efficiencies of outsourcing, namely, scalability, portability, transparency, audit ability and periodic renewal or replacement. One exception applies. In contract manufacturing, the customer might wish to patent its processes in the countries where infringement is most likely, such as by the contract manufacturer at the end of the OEM manufacturing agreement.
Advantages of Trade Secrecy.
Many outsourcing service providers prefer to retain their comparative advantage by using trade secrets. Trade secret protection does not protect against patent infringement. Trade secrets do not provide adequate protection where the trade secret becomes generally known. This risk is high in a digital global economy where information can be copied and stored in many ways that are not traceable to the authorized recipient of the trade secret. Optimally, the service provider will develop and use proprietary software covered by patents. Even then, the patents might not disclose the full process.
Patents could play a pivotal role in the competitiveness, viability and continuity of services provided by a service provider.
- Enterprise’s Own Proprietary Processes.
An enterprise customer that wants its service provider to perform “proprietary” business processes will need to consider the impact of that contractual requirement on its own risk profile, its willingness to indemnify the service provider appropriately and its ability to do, or hire others to do, alternative processes that are not infringing. Hiring a service provider to perform such processes might contradict other commercial policies, such as not outsourcing “core” business processes and maintaining certain processes confidential as a competitive advantage, even though such confidentiality is customarily protectible under a non-disclosure agreement.
- Due Diligence and Selection Process.
Enterprise customers should ask the service provider for a description and list of all patents that the service provider owns or has pending.
The customary solution to patent infringement is to require the service provider to indemnify the enterprise customer in case of any alleged or actual infringement by the service provider of third-party patents and other intellectual property rights.
- Termination of Contract.
Historically, intellectual property infringement is not an event of default in outsourcing contracts. This situation will probably continue. Other contractual solutions exist that may allow the customer to enjoy the benefit of the contract or to terminate.
- Due Diligence.
The service provider should ask the enterprise customer about any patents and other protect able intellectual property that the customer would require the service provider to use (or that might be needed to perform the agreed services). As a defensive measure, the service provider should understand the applicability of any customer-owned patents and its impact on its own intellectual property strategies.
- Contract Provisions.
The infringement indemnity may extend to the interaction between the customer and the service provider’s business methods and processes. Appropriate allocation of liability and indemnification should be considered to avoid extending the infringement indemnity beyond processes that the service provider controls.
Today, virtually any contract, including a business process outsourcing contract, for the delivery of goods, services or licensed rights in applied technology contains an indemnification clause concerning possible infringement of third-party intellectual property rights. In the initial draft of the agreement, the typical clause provides for unlimited indemnification for patents, copyrights, trademarks and trade secrets. Increasingly, the suitability and evidentiary issues in such clauses are getting careful scrutiny. A recent U.S. federal judicial decision revoked a twenty-year old common law precedent relating to the measures that must normally be taken in order to eliminate certain special statutory damages and liability for attorneys’ fees.
Ordinary Infringement of a Patent.
Patent holders face a challenge in protecting their rights. The U.S. patent law ordinarily imposes actual damages for patent infringement.
Patent holders must think twice about suing for infringement. The stakes are high.
- Legal Fees.
Ordinarily, the patent holder has no right to recover its attorneys’ fees. The patent holder will have a significant amount at stake in order to justify paying the huge expense of attorney’s fees for complex litigation.
- Invalidation of Patent.
Invariably, the patent holder’s infringement lawsuit will invite a counterclaim for invalidation of the patent. As a result, the infringement litigation could risk termination of all license royalties from parties other than the alleged infringer.
Willful Infringement of a Patent.
The patent holder’s risk of an invalidation can be reduced if it raises the stakes in the litigation. It can do so by alleging that the infringement was “willful.” This puts into motion a threat that the alleged infringer will be liable for punitive damages.
Consequences of Willful Infringement.
If the infringement can be shown to have been “willful,” then the court may award attorney’s fees and triple the compensatory damages. 35 U.S.C. § 284 (“the court may increase the damages up to three times the amount found or assessed”); 35 U.S.C. § 285 (“the court in exceptional cases may award reasonable attorney fees to the prevailing party”).
The Definition of “Willful” Patent Infringement.
In determining whether a patent infringement was “willful,” the court must balance the totality of the circumstances. Many circumstances may be taken into consideration. See compilation in Rolls-Royce Ltd. v. GTE Valeron Corp, 800 F.2d 1101, 1110 (Fed. Cir. 1986) and Read Corp. v. Portec, Inc., 970 F.. 2d 816, 826-27 (Fed. Cir. 1992). “Willfulness” is not an absolute, based on “all or nothing,” but is a matter of degree. Knorr-Bremse Systeme fuer Nutzfahrzeuge GmBH v. Dana Corporation, __ F.3 __, NYLJ (Sept. 24, 2004), p. 21, cols. 1-4, p. 22, cols. 1-2 (2nd Cir. 2004) Judge Newman.
The Service Provider’s Defensive Strategy: Get an Attorney’s Opinion.
Under a 1983 decision by the U.S. Court of Appeals for the Federal Circuit, judicial precedent required that, as a precaution, the potential infringer of a patent should obtain a review by a patent lawyer of the patents at issue. Underwater Devices, Inc. v. Morrison-Knudsen Co., 717 F.2d 1380 (Fed. Cir. 1983). In the context of a flagrant disregard for the patent owner’s demand for payment of a royalty for infringing presumptively valid patents, that court ruled that “where, as here, a potential infringer has actual notice of another’s patent rights, he has an affirmative duty to exercise due care to determine whether or not he is infringing,” including “the duty to seek and obtain competent legal advice from counsel before the initiation of any possible infringing activity. Id. at 1389-90.
The “duty” or “best practice” of getting a legal opinion is not specified in the patent statute. Instead, the defensive strategy was raised to the level of a common-law duty by interpretation of the patent statute. Courts applied the common law rule as a matter of evidentiary procedure. This applied specifically to cases where a patent holder had warned the potential infringer and asked that the infringement cease.
Change in Common Law.
This “legal opinion” requirement was applicable as judicial precedent from 1983 to 2000. In September 2004, the same court, in the Knorr-Bremse decision, overruled this precedent because the evidentiary principle promoting caution violates an even more fundamental principle, the attorney-client privilege. The court ruled that, while the issue is not one of legal privilege, it is the related issue “whether there is a legal duty upon a potential infringer to consult with counsel, such that failure to do so will provide an inference or evidentiary presumption that such opinion would have been negative” and would have concluded the potential infringer had no right to use the patented process.
Having framed the issues, the Knorr-Bremse court decided that, as a matter of public policy, it is so important to continue the general principle that courts should decline to impose, as a procedural rule of evidence, any “adverse inference” on invocation of the attorney-client privilege. Expanding this principle to the treble-damage and attorney’s fee provisions of the patent law, the court concluded that no such adverse inference may be drawn:
- when the potential infringer (such as an service provider in outsourcing) invokes attorney-client privilege, and/or attorney work-product privilege, or
- when the potential infringer fails to consult with counsel.
Impact on Outsourcing.
This decision eliminates a negative presumption against potential infringers of U.S. patents. Since the U.S. patent law permits registration of patents on business methods, this judicial decision will make it easier to defend, and harder to prosecute, business method patent infringements. The impact on the ordinary business process outsourcing should be small, but it will give some comfort to service providers. When notified of an alleged infringement, consultation with an attorney will still be highly advisable, but no adverse presumption will apply if no consultation occurs.
When is the Service Provider Liable for its Customer’s Compliance with Laws, including Payment of Fines and Penalties for Non-Compliance?
When is the service provider liable for its customer’s compliance with laws, including payment of fines and penalties for non-compliance? Most outsourcing agreements require each party to comply with applicable laws. However, as business process outsourcing (“BPO”) services move up the value chain, legal compliance obligations can get somewhat tricky. Consider the scenario where the service provider’s services substitute for the enterprise customer’s normal compliance with laws governing the enterprise customer’s operations. If you are a candidate for public office, your consultant might just be liable for your compliance, fines and penalties. If you stay out of politics, you can still learn about a critical BPO contracting issue that played out in a New York City election campaign.
Context: Compliance with Election Laws.
If you are a candidate for public office, your consultant might just be liable for your compliance, fines and penalties. While laws vary, it is instructive to consider the liability of a political consultant. The consultant’s client, a New York City political candidate, failed to timely respond to the Campaign Finance Board’s draft audit report and filed late four disclosure statements. The consultant acknowledged its office failures. It offered two excuses. First, its failures were due to its own disorganization (and not its client’s). Second, the candidate’s records were on a computer affected by a computer virus. This is hardly a case involving the usual due diligence, site visits and other critical infrastructure offered by the usual “big ticket” outsourcing. But the case illustrates what happens in case of “worst practices.”
The particular statute imposes liability on “agents” as well as the political candidates. Under the New York City Administrative Code, §3-711(1), an “agent” includes individuals and entities who have undertaken the responsibility for campaign law compliance.
The Service Agreement.
The political consultant claimed that it had developed computerized systems designed to keep its clients’ political campaigns in compliance with the campaign finance regulations. The agreement provided that the service provider would complete all filings with the regulatory agency and explain to the candidate and monitor all rules and regulations applicable to the political campaign.
The Course of Dealing.
The political consultant actually performed as promised, at least to the degree sufficient to be designated as an “agent” liable under the regulations for compliance. The candidate’s Candidate Certification listed the service provider as the mailing address for notices from the regulatory agency. The service provider’s employee represented to the regulatory agency that she represented the committee for the candidate’s election with respect to compliance. The candidate’s disclosure statements were generally delivered by hand by the service provider’s messenger. The service provider’s contacts with the regulators outnumbered those of other representatives of the candidate’s election committee.
Implications for Enforcement of Other Types of Regulatory Legislation.
This decision represents an enforcement action by the governmental agency responsible for administering a regulatory law. The regulators targeted enforcement action directly against the “BPO service provider” by reason of its contractual undertakings, its actions for compliance and its direct communications with the agency. The same analysis might not apply to non-delegable compliance duties, such as these of the CEO and the CFO under the Sarbanes-Oxley Act of 2002.
In this case, the court, without setting forth a theory of law, concluded that it would be inappropriate to allow a service provider to act as agent and not have the liability of an agent.
To allow any entity, that has agreed to fulfill the compliance requirements of behalf of a candidate to shoulder the blame for a candidate’s non-compliance, and then to allow that same entity to escape liability because it claims it is not an “agent” of the candidate, would not serve the purpose of the Campaign Finance Act. To accept [the service provider's] argument would defeat the policy behind the Campaign Finance Act.
As a result, the court found that it was not “arbitrary and capricious” to impose the candidate’s penalty on the consultant, and that such an imposition did not lack a rational basis.
By assuring compliance with laws, the service provider agrees to guarantee the result. Unlike a commitment to use “best efforts” or some other type of “efforts,” a BPO service provider’s guarantee of results implies an agreement to shoulder the fines and penalties imposed on the service provider’s customer by reason of any failure to comply.
Matter of The Advance Group v. New York City Campaign Finance Board, __ N.Y.S.__, NYLJ (Feb. 3, 2004), p. 18, cols. 3-4 (N.Y. Co. Sup. Ct. 2004), per Justice Shafer.