Responsible or not: how effective are your outsourcing arrangements?

Outsourcing is an important aspect of many commercial enterprises and is a well‑established method of expanding the market reach of the business, containing costs, and ensuring business continuity. 

Outsourcing can be an effective way to access a larger and more diversified pool of resources, often at lower cost, with the benefit of wider market access, while freeing up key resources to focus on core areas of the business. Outsourcing can also assist a business to diversify and manage risk.

However, there are risks with outsourcing and risks despite outsourcing that businesses need to consider.  Risks associated with outsourcing include delays, lack of control and oversight, unforeseen costs, privacy and security concerns and quality assurance failures. In addition, outsourcing arrangements may give an organisation a false sense of security if the organisation does not understand its retained responsibilities.

Summary

A recent decision of the WA Court of Appeal put the outsourcing arrangements of a government sponsored entity into sharp focus. While the decision related to a government owned entity, some of the takeaways apply equally to private and public enterprises. 

One of the key lessons from the decision is that outsourcing arrangements may be a good, practical way of managing certain business activities (in this case checking power poles) but they may not enable an organisation to discharge all its responsibilities to third parties.

The consequences can be both unexpected and severe. In this case,¹ Western Power received an adverse judgment from the WA Court of Appeal, in proceedings arising out of the 2014 Parkerville bushfire, following a first instance trial at which it had avoided liability. 

The Court of Appeal held that Western Power owed a duty to inspect and maintain all equipment carrying its power infrastructure, including privately owned equipment, even where it had delegated responsibility for carrying out inspections of that equipment to a third party.

The judgment was handed down on 2 July 2021.

Background

On 12 January 2014, a pole supporting an electrical cable fell to the ground, sparking a fire that caused significant damage. The pole was made of jarrah wood and was affected by fungal decay and termite damage.  The Plaintiffs claimed Western Power should have tested the pole for damage, and if Western Power had done that, it would have replaced the pole before it collapsed.

Four class actions were commenced against Western Power, Thiess (who was engaged by Western Power to inspect the pole) and the landowner.   

At trial, the owner and Thiess were found negligent. The judge apportioned their responsibility on a 30%/70% basis. The trial judge dismissed the claim against Western Power, finding it had not breached its duty of care and was entitled to delegate the task of inspecting the pole to a reputable third party such as Thiess.

Court of Appeal Decision

The Court of Appeal acknowledged the need to determine the existence of a duty of care at common law so as to be coherent, consistent and compatible with the applicable statutory scheme. 

The Court of Appeal rejected Western Power’s argument that the statutory purpose of the Electricity Act 1945 (WA) was to place the responsibility for the maintenance of privately owned power poles on the property owner.  The Court found Western Power had a duty of care at common law to maintain all service apparatus belonging to the network operator on the premises of any consumer, in a safe and fit condition, for supplying electricity.  That required Western Power to monitor supporting equipment, even if privately owned. 

The Court held that Western Power was entitled to delegate the task of inspecting poles to a third party (so defeating the plaintiffs’ argument that the duty to inspect was non-delegable). However, the Court held that its arrangement with Thiess did not assist it to discharge its responsibility to establish a proper system of inspection, it had failed to establish a system for periodically inspecting all poles, and if it had established such a system, it probably would have replaced the pole before it collapsed.

The re-apportionment of liability was: Western Power 50%, Thiess 35%, landowner 15%.

Comment

The decision that Western Power retained responsibility for maintaining assets, regardless of its subcontract arrangements, should cause government agencies and statutory bodies to review whether they properly understand the scope of their responsibilities and the associated risks and whether their outsourcing arrangements are effective in managing those risks. 

The decision should also prompt private contracting parties to consider the scope of their outsourcing arrangements and how they may protect themselves from liability in the case of a failure in performance by a third party service provider.

There are numerous preventative measures that a party might take with a view to avoiding or mitigating the consequences of a failure in performance, including undertaking initial due diligence, establishing effective communication tools and audit programs, and preparing contingency plans. 

In addition, a party should seek advice on establishing a contractual framework that provides it with legal and financial protections. Contractual protections might include, for example, agreements to comply with certain standards, warranties and indemnities, proportionate liability provisions, insurance procurement clauses, confidentiality agreements, limitation periods and third‑party guarantees. 

As the Western Power case shows – none of those measures is full proof.  Identifying and understanding the organisation’s legal, commercial and operational risks is key to understanding how effective its outsourcing arrangements are in mitigating and addressing those risks. In Western Power’s case, the outsourcing of pole inspections did not enable Western Power to escape a finding of liability from the Court of Appeal. It retained a responsibility to establish an adequate system of inspection, including of third party owned assets, which it had not effectively addressed through its outsourcing arrangements.

The decision highlights some risks with outsourcing arrangements if not properly scoped and implemented and merits careful consideration by both public and private sector participants.