Outsourcing or business transfer

Here is one extract from the majority judgment [para 113].

“It cannot be doubted that the word “by” must be given its ordinary meaning. We must ask these questions in the inquiry whether a transaction in issue contemplates a transfer of business by the old employer to the new employer. Does the transaction concerned create rights and obligations that require one entity to transfer something in favour or for the benefit of another or to another? If so, does the obligation imposed within a transaction, fairly read, contemplate a transferor who has the obligation to effect a transfer or allow a transfer to happen, and a transferee who receives the transfer?”

On 24 November 2011 the constitutional court delivered its judgment in Aviation Union of South Africa v South African Airways (Pty) Ltd [case CCT 8/11]. The court split six to five and this is the order of the majority of the court per Yacoob J.

Order

[128] I therefore make the following order:
1 Leave to appeal is granted and the appeal is upheld.
2 The orders of the Supreme Court of Appeal, the Labour Appeal Court and the Labour Court are set aside and replaced with paragraphs 3 and 4 of this order.
3 It is declared that the cancellation of the agreement between South African Airways (Pty) Ltd and LGM South Africa Facility Managers and Engineers (Pty) Ltd entered into in March 2000 obliges LGM South Africa Facility Managers and Engineers (Pty) Ltd to transfer a business as a going concern within the meaning of section 197(1) and 197(2) of the Labour Relations Act 66 of 1995.
4 South African Airways (Pty) Ltd is ordered to pay the costs of:
(a) the Aviation Union of South Africa, including the costs of two counsel whenever two counsel were employed in the Labour Court, the Labour Appeal Court, the Supreme Court of Appeal and in this Court; and
(b) the South African Transport and Allied Workers’ Union in this Court.

For ease of reference here are extracts from the two judgments (without footnotes) to show the reasoning of the two sides.

Minority: JAFTA J (Moseneke DCJ, Mogoeng J, Mthiyane AJ and Nkabinde J concurring):

[2] The key question raised in this matter is whether upon termination of an outsourcing agreement between South African Airways (Pty) Ltd (SAA) and LGM South Africa Facility Managers and Engineers (Pty) Ltd (LGM), the employees of LGM were transferred together with the business in which they were engaged, to a new employer. The business that forms the subject matter of these proceedings is the entity that provided certain services that were rendered to SAA by LGM. The applicants argue that the continued performance of these services by either SAA or a third party, after the termination of the outsourcing agreement, amounts to a transfer as envisaged in section 197 of the Labour Relations Act (LRA).

The provisions of section 197

[3] At common law the acquisition and transfer of a business that was in operation led to termination of contracts of employment. If the new owner wished to continue operating the business with the same workers, it would have to conclude new employment agreements with them. Section 197 changed this by providing that certain legal consequences would automatically flow from a transfer of a business as a going concern. One of these consequences is the transfer of the workforce engaged in the transferred business.

In the Labour Appeal Court

[20] Dissatisfied with the Labour Court’s judgment, Aviation Union appealed to the Labour Appeal Court. In that Court too the case turned on the proper interpretation of section 197, in particular whether the word “by” in the definition of “transfer” can be read to include “from”.

[21] The Labour Appeal Court rejected the proposition that the use of “by” signifies that the transferor has a positive role to play in bringing about the transfer. The Court held that the wording of section 197 does not support exclusively the connotation that the transferor must play an immediate and positive role in bringing about the transfer. The Labour Appeal Court rejected the literal meaning adopted by the Labour Court.

[23] Instead, the Court preferred an interpretation that would advance the purpose of job protection, as opposed to an interpretation that denies protection to employees affected by a second outsourcing agreement. It further held that the literal interpretation of the word “by” was subversive of the protection of employment. The Court held that a departure from the literal meaning of “by” was justified because that meaning would defeat the very purpose for which section 197 was enacted. The Labour Appeal Court concluded that the section applies to a second outsourcing agreement.

The Supreme Court of Appeal

[26] Upholding the construction contended for by SAA, the Supreme Court of Appeal, in a majority judgment, held that by interpreting the word “by” to mean “from” the Labour Appeal Court distorted the plain meaning of section 197. The majority further held that the Labour Appeal Court had erred in finding that a transfer of services had occurred. The appeal was upheld and the order of the Labour Appeal Court was set aside.

The proper approach to interpreting section 197

[34] It is important to identify the correct approach to interpreting provisions of the LRA at the outset. Section 3 of the LRA obliges any person interpreting the LRA to adopt a construction that complies with the Constitution and public international law while at the same time giving effect to the LRA’s primary objects. These objects are listed in section 1. They include the regulation of and giving effect to the rights entrenched in section 23 of the Constitution.

[36] Section 197 is located in chapter VIII of the LRA which deals with dismissals and unfair labour practices. It promotes the right to fair labour practices, guaranteed by section 23 of the Constitution. This right is enjoyed by the workers and the employers, and consequently the provision serves a dual purpose of advancing both their interests. These interests may sometimes come into conflict.

The meaning of section 197

[39] The scheme that emerges from the text is that section 197 alters the common law position flowing from the transfer of business as a going concern. Under the common law a transfer has the effect of terminating all contracts of employment between the transferring employer and the employees of the business. Section 197 is designed to keep all contracts of employment extant and substitute the new owner of the business for the previous employer under those contracts.

[40] Section 197(1) defines two key words used in the section. The first is “business” which is defined to include “the whole or a part of any business, trade, undertaking or service”. It is apparent from this definition that the section is designed to cover every conceivable business. The second is “transfer”. It is defined to mean “the transfer of a business by one employer (‘the old employer’) to another employer (‘the new employer’) as a going concern.”

[41] While the first word defines the types of businesses to which the section applies, the second word defines the act that triggers the application of the section. These definitions are complementary and their role is to facilitate the achievement of the purpose for which the section was enacted.

[42] Section 197(2) lists legal consequences that flow from a transfer of the kind envisaged in the section. These consequences are: …

[43] The text of section 197(2) makes it plain that its application is dependent on the existence of a transfer. It says if a transfer contemplated in the section takes place, the legal consequences it specifies will be activated. For the consequences to be triggered, a business must be transferred as a going concern. Once a transfer of this kind occurs, it automatically carries with it all contracts of employment that existed immediately before the transfer took place. The basket of what is transferred consists of the business and employment contracts. This simultaneous transfer of business and contracts of employment does not require any declaration by a court. The employment contracts are automatically transferred together with the business. The person to whom the business is transferred replaces the employer in terms of those contracts and assumes all obligations of the previous employer. He or she also acquires the contractual rights of the previous employer.

[44] It must be stressed that the key event which brings section 197 into play is the transfer of business as a going concern. The question whether the section applies to a particular case cannot be determined, as the Supreme Court of Appeal did, with reference to the label of the transaction effecting transfer. The section does not cite transactions to which it applies. Nor does it refer to any labels. Instead, its application must always be determined with reference to three requisites, namely, business, transfer and going concern.

Business

[45] As stated earlier the section would apply to any business provided that the other requirements are met. The aim is to cast the net as wide as possible.

Transfer

[46] For the section to apply the business must have changed hands, whether through a sale or other transaction that places the business in question in different hands. Thus the business must have moved from one person to the other. The breadth of the transfer contemplated in the section is consistent with the wide scope it is intended to cover. Therefore, confining transfers to those effected by the old employer is at odds with the clear scheme of the section.

[47] But whether a transfer as contemplated in section 197 has occurred or will occur is a factual question. It must be determined with reference to the objective facts of each case. Speaking generally, a termination of a service contract and a subsequent award of it to a third party does not, in itself, constitute a transfer as envisaged in the section. In those circumstances, the service provider whose contract has been terminated loses the contract but retains its business. The service provider would be free to offer the same service to other clients with its workforce still intact.

[48] For a transfer to be established there must be components of the original business which are passed on to the third party. These may be in the form of assets or the taking over of workers who were assigned to provide the service. The taking over of workers may be occasioned by the fact that the transferred workers possess particular skills and expertise necessary for providing the service or the new owner may require the workers simply because it did not have the workforce to do the work. Without the protection afforded by section 197, the new owner with no workers may be exposed to catastrophic consequences, in the event of the workers declining its offer of employment.

Going concern

[49] If the transaction in terms of which a business is transferred specifies that it is or will be transferred as a going concern, it would constitute sufficient proof of that fact. However, this does not mean that where the transaction is silent on this issue, a transfer as a going concern cannot come into existence. Its existence may still be established with reference to objective facts.

[52] Although the definition of business in section 197(1) includes a service, it must be emphasised that what is capable of being transferred is the business that supplies the service and not the service itself. Were it to be otherwise, a termination of a service contract by one party and its subsequent appointment of another service provider would constitute a transfer within the contemplation of the section. That this is not what the section was designed to achieve is apparent from its scheme, historical context and its purpose. The context referred to here is the alteration of the common law consequences on employment contracts, when the ownership of a business changes hands.

The interpretation by the Supreme Court of Appeal

[54] Tracking the construction of the section contended for by SAA, the Supreme Court of Appeal adopted a different approach in its interpretation of section 197. The majority singled out the word “by” in the definition of “transfer” and gave it an isolated literal meaning. Undue emphasis was placed on that meaning with little regard to the context in which the section appears in the LRA. No account was taken of the purpose of the section and the objects of the LRA.

[55] Determining the operation of the section with reference to a single word is not the correct approach to its interpretation. The whole section must be read in its proper context. Reading section 197 as a whole in the context of where it is located in the LRA and paying sufficient attention to its purpose and the objects of the LRA, reveal that it applies to any transaction that transfers a business as a going concern. It follows that the majority in the Supreme Court of Appeal erred in holding that the section does not apply to second generation outsourcing agreements.

[71] … It must be recalled that what is transferable in terms of the section is not a service itself but a business or entity that provided the service concerned. For a transfer to trigger the application of the section, it must constitute a transfer as a going concern.

[74] The phrase “going concern” has been construed to include not only that the business has changed hands but that it is exactly the same business that continues to operate. We are told that to determine this fact one must look at various factors, none of which is decisive. These factors include whether or not the same business is being carried on by the party who received it. Therefore, proof of the fact that performance of the same services was to continue, albeit under different hands, does not establish a transfer as a going concern. Something more is required.

[77] In the circumstances, the matter must be remitted to the Labour Court for it to deal with the case in the light of this judgment. It is desirable for the parties to seek leave from that Court to lead further evidence, encompassing what occurred to the business after the termination of the outsourcing agreement. The Labour Appeal Court offered this opportunity to the parties but they chose improper means of placing evidence before the Court.

Majority: YACOOB J (Ngcobo CJ, Cameron J, Froneman J, Khampepe J and Van der Westhuizen J concurring):

[80] I have had the benefit of reading the judgment of my colleague Jafta J. I agree with the conclusion that leave to appeal should be granted and have nothing to add on this aspect.

[81] There is no debate that section 197 “applies to any transaction that transfers a business as a going concern”, and that the majority judgment in the Supreme Court of Appeal erred in holding that “the section does not apply to second generation outsourcing agreements.” However, this judgment adopts a somewhat different approach to this question. This judgment holds broadly that a permissible meaning of the word “by” inevitably leads to the construction of the section favoured by the Labour Appeal Court (LAC), and that it is unnecessary to equate the word “by” with “from” and conclude that a transfer from one person or entity to another suffices for purposes of section 197.

[82] I cannot agree with Jafta J that a transfer must already have taken place in this case before the applicants are entitled to any relief, nor with the conclusion that the evidence does not justify relief being accorded to the applicants in this Court. There is therefore no need to refer the matter back to the Labour Court for further consideration and the interests of justice require the appeal to be finalised here.

[87] Before I present a short account of the decisions of the three courts that have already considered this case, it is appropriate to inform the reader that all these cases were concerned mainly with the meaning of the word “by” in the section, in the context that the section was applicable only in the event of the transfer of a business as a going concern by an old employer to a new one.

[102] I must emphasise immediately that the main area of dispute was not so much what was being transferred but really by whom. The only real issue was whether the transfer would be one by an old employer to a new one. I accept however that there must be evidence that the contemplated transfer is that of a business as a going concern before relief can be granted. I will deal with this issue briefly in the section of this judgment that is concerned with whether any relief is justified.

[105] A further general point must be made. An inquiry whether a transaction falls under the terms of section 197(1) and (2) would be misleading if it focuses solely or mainly on the “generation” of the transfer. It has the potential to bring about an incorrect result. It does not matter in principle what the “generation” of the outsourcing is, or even whether the transaction is concerned with contracting out at all. The true inquiry is whether there has been a transfer of a business as a going concern by the old employer to the new employer. That evaluation is complex enough without it being burdened with questions about the “generation” of outsourcing. A transfer of business may not be covered by section 197 even if it is a “first generation” contracting out. On the other hand, even a “fifth generation” outsourcing could be caught by the section if it is in reality the transfer of a business as a going concern.

[106] The final general observation is that, in determining whether contracting out amounts to the transfer of a business as a going concern, the substance of the initial transaction, more specifically whether what is outsourced is a business as a going concern rather than the provision of an outsourced service remains significant during subsequent transfers. If the outsourcing institution from the outset did not offer the service, that service cannot be said to be part of the business of the transferor. What happens here is simple contracting out of the service, nothing more, nothing less.

[107] There is no transfer of the business as a going concern. The outsourcee is contracted to provide the service, and becomes obliged to do so. And it is the outsourcee’s responsibility to make appropriate business infrastructure arrangements. These may include securing staff, letting appropriate property for office or other work space, and acquiring fixed assets, machinery and implements, computers, computer networks and the like. Cancellation of the contract in these circumstances entails only that the outsourcee forfeits the contractual right to provide the service. The whole infrastructure for conducting the business of providing the outsourced service would ordinarily remain the property of the outsourcee. As we shall see, that is not what happened here, either when the initial outsourcing contract was concluded between SAA and LGM, or when SAA cancelled it.

[108] If, on the other hand, the first outsourcing exercise is really a transfer of part of the business of the outsourcer who has been carrying on the business of the provision of the service until transfer, the question whether the subsequent transfer is merely the transfer of the right to provide the outsourced service or the transfer of a business as a going concern would arise. And that would require an analysis of the terms of the transaction that gives rise to the subsequent event.

[111] I agree with the approach of the Labour Appeal Court. I might add that it is quite impossible to determine in the air that a “second generation” outsourcing arrangement does or does not amount to a transfer of a business as a going concern.

[113] It cannot be doubted that the word “by” must be given its ordinary meaning. We must ask these questions in the inquiry whether a transaction in issue contemplates a transfer of business by the old employer to the new employer. Does the transaction concerned create rights and obligations that require one entity to transfer something in favour or for the benefit of another or to another? If so, does the obligation imposed within a transaction, fairly read, contemplate a transferor who has the obligation to effect a transfer or allow a transfer to happen, and a transferee who receives the transfer? If the answer to both these questions is in the affirmative, then the transaction contemplates transfer by the transferor to the transferee. Provided that this transfer is that of a business as a going concern, for purposes of section 197, the transferee is the new employer and the transferor the old. The transaction attracts the section and the workers will enjoy its protection.

Determination of application of section 197

[114] It will be necessary to examine the agreement in issue to determine whether the rights and obligations it creates provide for the transfer of a business as a going concern by a transferor, the old employer, to a transferee, the new employer. But before I do so, the question of the relevance and appropriateness of an inquiry of this kind must be addressed. This judgment proposes that courts are obliged, if a party to an appropriate case requires, to decide whether rights and obligations imposed by a transaction or an agreement are subject to the provisions of section 197. In other words, courts must determine, if required, whether the rights and obligations, properly interpreted, call for a transfer of a business as a going concern.

[120] Does this clause contemplate the transfer of a business or does it contemplate simply the outsourcing of a service? This question must be answered in context. SAA did not effect the mere outsourcing of a service to LGM through the agreement. It did much more. It transferred the business relative to delivering that service. Thus, LGM received transfer of fixed assets and inventory, the use of space at all airports, SAA computers, SAA computer network services and the lease of property necessary to conduct the service. In short as the agreement rightly states, LGM acquired the whole of the infrastructure necessary for the conduct of the business. It did not have to secure property, or computers, or network services or anything of the kind.

[121] The question to be answered now is whether clause 27 of the agreement contemplates merely outsourcing a service to SAA or to a third party or whether it contemplates the transfer of the business operation that delivered the service. The answer to this depends to a large extent on whether LGM, upon cancellation, would be entitled to continue to use the computers and airport space, to lease the property and to keep the fixed assets and inventory. If the assets necessary to operate the business stay with LGM, then the business would not be transferred. If they do not stay with LGM, but go back to SAA, or to another service provider, there is a transfer of business.

[122] And the answer is clearly that these assets will not be kept by LGM. LGM did indeed become obliged to assist SAA in transferring certain services to SAA or to a third party. But the agreement went further. LGM was also obliged to provide SAA with reasonable access to the services, assets and inventory of LGM. LGM became obliged to sell all fixed assets and inventory dedicated only to providing the services in terms of the agreement back to SAA and to transfer or assign all third party contracts to SAA. What is more, both parties were entitled to the surrender of all information pertaining to the scope of work belonging to the other party.

[123] Moreover, the cancellation of the agreement would necessarily mean that LGM would no longer be entitled to the use of property and to the leases already described. In my view, it would be quite impossible for LGM to continue to conduct the business upon cancellation of the agreement. LGM might win a tender or a part of it but that is another transaction.

[124] In the circumstances, the cancellation clause of the agreement contemplated a transfer of the business as a going concern. The only debate was about whether the business as a going concern was to be transferred to SAA or to an interim service provider. As long as there is a transferor, the identity of that entity or person is of no material significance. The agreement contemplates transfer by LGM to SAA or to the interim service provider. It requires a transfer by a transferor, the old employer, to the transferee, the new employer.

[125] The cancellation is thus hit by section 197.

[126] In the circumstances Aviation Union was entitled to a declarator.