Employer Alert: Negotiating the Hidden Hazards of Employing the Contingent Workforce


In recent years employers have substantially increased utilization of independent contractors and temporary (or "temps") and leased workers. In 1985, temporary agencies supplied approximately 500,000 workers to American companies. By 1995, the number of temporary workers had increased to two million. A survey of American businesses determined that the "number of companies whose workforces consist of at least 10 percent contingent workers grew from 12 percent in 1990 to 21 percent in 1995 and is expected to reach 35 percent by the turn of the century." Ninety percent of American businesses have at one time or another used contingent workers.

Contingent workers hold a variety of positions. Contingent workers may be attorneys, physicians, chief financial officers, blue collar workers, or sales and marketing representatives, in addition to clerical workers, the most commonly-held contingent position.

Advantages of Contingent Workers

Employers use contingent workers for many reasons. Employers are able to quickly fill vacancies with contingent workers. Many employers are able to put a contingent worker on the job the day after the need arises.

Employers are also able to achieve flexibility with contingent workers. "An employer can hire a temp for just a few days when a permanent employee is ill, absent or leaves the company. Additionally, the temporary arrangement allows the company to terminate the relationship whenever it sees fit."

The principal reason employers use contingent workers is cost. Contingent workers typically work for lower wages. Contingent workers are provided with few if any benefits. "[T]he enormous influx of contingent workers into the American workforce is partly a result of employers who 'do not want to be saddled with the high costs and management tasks associated with full-time employees, including medical insurance, disability insurance, social security taxes, workers' compensation benefits, recruiting, training, career development costs and so on.'"

Cost savings are also achieved because the employer does not invest as much time and money in contingent workers as it does with permanent employees. The employer is usually relieved of such personnel matters as interviewing, the administration of payroll and benefits, and training.

Contingent workers offer employers many benefits. However, the utilization of contingent workers is not without risk. "There are several state and federal statutes, as well as common law theories, that can create liability if an employer/employee relationship is formed." Employers, therefore, must be aware of the risks and act accordingly.

This paper will analyze the potential liability in utilizing temporary workers and independent contractors and the legal implications when contracting with temporary agencies and independent contractors. This paper will also offer suggestions to assist employers in avoiding liability.

Independent Contractors

Simple economics drives many companies to use independent contractors. Withholding of federal or state taxes and payment of payroll taxes are not implicated. Similarly, employee benefits and workers' compensation are not required. The only requirement is IRS Form 1099, where a contractor has been paid more than $600.00. The contractor is responsible for declaring in his or her tax returns the compensation received.

As noted, however, the financial reward obtained in utilizing independent contractors is accompanied by the risk that a court or government agency may conclude the contractor does not meet the "independent" criteria and in the eyes of the law is an "employee". With employee status comes significant potential liability to the employer.

A misclassification may be costly. In Vizcaino v. Microsoft, Microsoft supplemented a core staff of permanent employees with freelancers, who signed contracts agreeing that they were independent contractors. The IRS determined, and Microsoft acknowledged, that the freelancers were not independent contractors but rather employees for withholding and employment tax purposes. These workers then filed a class action suit alleging a violation of ERISA and state law, because the company had denied those workers the opportunity to participate in Microsoft's stock purchase and deferred savings plans, which were available to all Microsoft's "employees".

The Vizcaino Court held that because the Microsoft deferred savings plan provided that an eligible employee is one "who receives remuneration for personal services rendered to the employer and who is on the United States payroll of the employer," all persons employed by Microsoft and on its U.S. payroll must be eligible for participation. The freelancers were allowed to participate in the savings plan. Further, the stock purchase plan stated Microsoft's intention to have the plan qualify as an employee stock purchase plan under the Internal Revenue Code ("IRC"). The Court, therefore, relied on the IRC's definition of employee, which is the common law definition of employee. The Court concluded that the stock purchase plan extends participation to all common law employees. Microsoft took a huge financial hit. The decision, therefore, to treat workers as independent contractors must be made only after an in depth analysis of the facts underlying the relationship and the actual functions performed by the person providing the service. Whatever may be agreed upon in a contract will be subordinated to the realities of the workplace. Substance and not form will be the controlling factor in the decision - Employee or Independent Contractor?

The IRS uses twenty (20) factors in determining whether a worker is an employee or independent contractor:

  1. Instructions as to how, when and where the work is to be performed;
  2. Training;
  3. Integration of the individual's work into the business operations;
  4. Whether services must be rendered personally by the individual;
  5. Whether hiring, paying and supervising of assistants is done by the principal;
  6. Whether there is a continuing relationship between the parties;
  7. Set hours of work;
  8. Full-time work required;
  9. Whether work is done on principal's premises;
  10. Order or sequence set for performance of services;
  11. Oral or written reports required by the principal;
  12. Whether payment is by hour, week or month or on a commission basis;
  13. Payment of business and travel expenses;
  14. Furnishing significant tools, materials and other supplies;
  15. Investment in facilities, equipment, or other supplies;
  16. Opportunity for profit or loss;
  17. Working for more than one firm at a time;
  18. Making services available to the general public;
  19. Principal's right to discharge; and
  20. Worker's right to terminate the relationship.

Under the Fair Labor Standard Act ("FLSA"), five (5) factors are analyzed by courts to determine whether an employee or independent contractor relationship exists. These include:

  1. Degree of control exerted by the alleged employer over the worker;
  2. The worker's opportunity for profit or loss;
  3. The worker's investment in the business;
  4. The permanence of the working relationship; and
  5. The degree of skill required to perform the job.

Independent contractors are not included within the meaning of the terms "employee" or "worker" as defined in other federal or state laws. Instead, the common-law definition is used in determining whether a worker is an employee or independent contractor. The 9th Circuit applies the "economic realities" common law test. The relevant factors for the economic realities test are:

  1. The nature and degree of the alleged employer's control as to the manner in which the work is to be performed;
  2. The alleged employee's skill;
  3. The alleged employee's investment in equipment or materials required for the task, or its employment of workers;
  4. Whether the service rendered requires a special skill;
  5. The degree of permanency and duration of the working relationship; and
  6. The extent to which the service rendered is an integral part of the alleged employer's business operation.

The focal point of the "economic realities" test is whether the individual is "economically dependent on the business for which the services are being performed."

Nevada has a statute which defines "independent contractor" for workers' compensation matters. NRS 616A.255 states:

"Independent contractor" means any person who renders service for a specific recompense for a specific result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished.

Companies treating workers as independent contractors should revisit the relationship and workplace realities, several times a year to ensure that an independent contractor has not undergone a transmutation and has become, in actuality, an employee. The potential retroactive liability for even an innocent misclassification should not be underestimated.

Temporary Employees

Many companies are in the business of supplying workers to employers with temporary needs. A contract usually exists between the supplier and the employer requesting the workers. The contract may provide that the employer requesting the temporary workers is responsible for "protecting its intellectual property rights and its confidential and proprietary information." The supplier employer usually has the "burden of withholding and payroll taxes, workers' compensation insurance, unemployment insurance and employee benefits". The supplier employer may also be contractually responsible for complying with any employment laws regarding recruiting, interviewing, testing, discipline, and termination of the workers. However, there are several statutes and common law theories, such as the joint employer theory, which create liability for both the supplier and customer employers, whether the contract is silent on the matter or fastens liability on one or the other.

Fair Labor Standards Act ("FLSA")

Under the FLSA, "the Department of Labor often seeks to find both the supplier employer and the customer employer jointly [and severally] liable for violation of the FLSA's minimum wage, overtime, equal pay, child labor and record keeping requirements." Joint liability for the supplier and consumer employers is usually sought because "employer" is broadly defined under the FLSA as "any person acting directly or indirectly in the interest of an employer in relation to an employee."

Courts construe the FLSA broadly. In Donovan v. New Floridian Hotel, the court held that to constitute an employment relationship under the FLSA, "it is sufficient that the business suffer or permit another to work." Thus, it is easy to see how both supplier and customer employers may be liable under the FLSA.

Family and Medical Leave Act ("FMLA")

Under the FMLA, employers with 50 or more employees must provide up to 12 weeks of unpaid leave to all covered employees. A covered employee is one who has been employed by his or her employer for at least 12 months and for at least 1,250 hours during the 12-month period immediately preceding commencement of employment.

Courts generally find the supplier employer and the customer employer to be joint employers under the FMLA. The FMLA regulations, in fact, provide that where "two or more businesses exercise some control over the work or working conditions of the employee, the businesses may be joint employers under FMLA." "[J]oint employment will ordinarily be found to exist when a temporary or leasing agency supplies employees to a second employer."

National Labor Relations Act ("NLRA")

The NLRA provides the process for, among other things, adjudicating disputes over which employees are appropriately included in a proposed bargaining unit. Under the NLRA, "the trend also has been to find joint employer status between the customer and supplier employers." In NLRB v. Browning-Ferris Industries, Etc., the court held that where two or more employers exert significant control over the same employees and they share or co-determine those matters governing essential terms and conditions of employment, they are joint employers within the meaning of the NLRA.

Antidiscrimination Laws (Title VII, Americans With Disabilities Act ("ADA") and Age Discrimination In Employment Act ("ADEA"))

Customer employers are often under the mistaken belief that they do not have to comply with antidiscrimination laws because they usually do not hire or directly pay the temps. However, as is the case with other employment laws, courts are "making it easier for employees to establish a joint employment situation" under antidiscrimination statutes. In Owens v. Rush, the Court held that in order to effectuate the humanitarian policies of Title VII, a liberal construction is given to the definition of "employer" for purposes of that statute. With that objective in mind, the Equal Employment Opportunity Commission ("EEOC") has issued new guidelines which specifically indicate that both the supplier and customer employers may be liable for discrimination against a temporary worker.

Employment Retirement Income Security Act ("ERISA")

An employee is defined in ERISA as "any individual employed by an employer." In Nationwide Mut. Ins. Co. v. Darden, the Supreme Court stated this definition was circular and adopted the following common law test in determining employee status under ERISA:

  1. The hiring party's right to control the manner and means by which the product of employment is accomplished;
  2. Skill required;
  3. Source of instrumentalities and tools;
  4. Location of work;
  5. Duration of relationship;
  6. Whether hiring party has right to assign additional projects;
  7. Discretion over when and how long to work;
  8. Method of payment;
  9. Hired party's role in hiring and paying assistants;
  10. Whether work is part of regular business of hiring party;
  11. Whether hiring party is in business;
  12. Employee benefits;
  13. Tax treatment of hiring party.

If a worker is an employee under this test, the employer must make its ERISA benefits available to that worker on the same basis as other employees. "Of course, most plans have waiting periods before an employee becomes eligible (often six months), so if the individual is engaged on a short-term basis, ERISA eligibility may never arise."

Worker Adjustment and Retraining Notification Act ("WARN")

Under WARN, an employer must give advance notice to employees when an event covered by WARN, (i.e., plant closing, mass layoff) is to occur. "The WARN Act covers employers having 100 or more employees, excluding part-time employees, and employers who have 100 or more employees who in the aggregate work at least 4,000 hours per week, excluding overtime." Where temporary workers comprise a majority of the regular workforce, temporary workers are entitled to the same notice by the customer employer as permanent workers.

Internal Revenue Code ("IRC")

The IRC defines "employer" as a "person for whom an individual performs or performed any service." However, if that person does not have control of the payment of wages, the "person having control of the payment of . . . wages" is the "employer".

In Earthmovers, Inc. v. United States, the Court held the customer employer was the employer for tax purposes even though the supplier employer was contractually responsible for payment of wages, filing tax returns, and withholding taxes. According to the Court, the fact these workers are leased is not a defense for the customer employer. Therefore, "if the supplier employer defaults on its payroll tax or withholding obligations, the customer employer may be liable for those obligations concerning its temporary workforce. This is true even if the customer employer has remitted the taxes to the supplier employer for payment to the IRS."

Joint Employers

"Courts employ two main tests to determine whether a joint employment relationship exists."

The first test is the mutual control test. The focus of the mutual control test is the joint control over labor relations or working conditions of the employee. Five factors are analyzed:

  1. Does the employment take place on the premises of the company;
  2. How much control does the company exert over the employees;
  3. Does the company have the power to fire, hire or modify the employment conditions of the employees;
  4. Do the employees perform a 'specialty job' within the production line; and
  5. May the employee refuse to work for the company?

The other test, and the test applied by the 9th Circuit, is the integration test. "The integration test for joint employment requires that the employment relationship not only meet the standards for the mutual control test, but also that a certain degree of integration exist between the two employers." Four factors are analyzed:

  1. Interrelation between the companies;
  2. Whether or not the companies have common management;
  3. The extent of centralization of labor relations;
  4. Common ownership.

The 9th Circuit has held that these four (4) factors should be applied, but the element of common ownership is not as important as the other three factors.

Suggestions

The following is a list of suggestions for employers to assist in avoiding potential liability:

Analyze the duties of all workers.

Each worker's job duties should be analyzed to determine whether the worker is an employee or independent contractor.

Avoid situations where independent contractors work side by side with employees, and if possible, reduce control over independent contractors.

Written Contracts

A written contract should be executed by the supplier employer and customer employer which clearly states both employers' responsibilities.

The contract should provide which employer is to withhold, pay wages and payroll taxes, provide workers' compensation insurance, employee benefits and unemployment insurance. The contract should also specifically address the consequences of a legal action by a temporary worker and who is responsible for complying with the various employment and labor laws. Liability insurance that will protect both parties should be addressed in the contract.

In essence, the contract should provide that the supplier employer controls the worker.

Workplace Policies

Apply anti-discrimination, privacy and related laws to a temporary worker or independent contractor in the same manner as you apply those laws to employees.

The employer should not discriminate toward any worker.

Use Reputable Temporary Agencies

"The single most important factor in obtaining qualified temporary employees is a reputable supplier employer. Customer employers should remember that they will be joint employers with any supplier employer for the purpose of many employment-related laws. For this reason, if temporary employees are desired, the customer employer should exercise great care in selecting a supplier employer partner." Additionally, require the supplier employer to show proof of financial stability and insurance coverage.

Conclusion

Careless use of workers an employer classifies as independent contractors, leased or temporary, is a lawsuit waiting to happen. The cost savings, which in most cases is the motivating factor in a decision to use such workers, should be critically quantified, so that a realistic risk reward analysis can be made.