Vizcaino v. Microsoft Raises the Stakes on Worker Classification; Other Major Changes Give Guidance to Employers


Microsoft serves as a warning to employers whose independent contractors could be reclassifed as employees.

"Large corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits" said Justice Stephen Reinhardt of the Ninth Circuit in Vizcaino v. Microsoft Corporation, 97F.3d 1187 (CA-9,1996). Justice Reinhardt's political commentary notwithstanding, the decision in Vizcaino v. Microsoft sent a shock wave through the high-tech community, where employers routinely hire temporary workers to meet their fluctuating workforce needs. Vizcaino v. Microsoft held that certain workers, originally hired as independent contractors, were entitled to benefits under Microsoft's 401(k) plan (the "Savings Plus Plan" or SPP) and Microsoft's Employee Stock Purchase Plan (ESPP).

The timing of the Microsoft decision was somewhat ironic, given that several months prior to the decision Congress enacted two pro-employer provisions relating to worker classification issues as part of the SBA '96 (the "1996 Act"). The first strengthened Section 530 of the RA '78, which provides relief to employers whose workers are reclassified as employees by the IRS, and the second narrowed the definition of "leased employee" under Section 414(n) in connection with tax-qualified retirement plans. More recently, in January 1997, the Fourth Circuit held in Clark v. DuPont, in an unpublished opinion, that a worker who performed contract work for DuPont and who was not on DuPont's payroll was not entitled to benefits under DuPont's plans. As a result of these developments, employers should review their worker classification guidelines and employee benefit plans to gauge their exposure.

Vizcaino v. Microsoft

In beginning its analysis, the court reviewed Microsoft's relationship with its employees. The court noted that Microsoft has a core staff of regular employees, which it supplements "with a pool of individuals to whom it refuses to pay fringe benefits." Microsoft currently classifies these workers as temporary agency employees, since they are employed through a Microsoft-owned agency. Previously, Microsoft had classified the workers as independent contractors or freelancers.

The workers who brought the action worked for Microsoft between 1987 and 1990 as freelancers. Although hired to work on specific projects, seven of the eight workers had worked for Microsoft for at least two years. They worked on site, shared the same supervisors, performed the same functions, and worked the same core hours as the regular employees. Unlike Microsoft's regular employees, who were paid through the payroll department, these workers were paid through Microsoft's accounts payable department.5 In addition, the workers were told when they were hired that they would not be eligible for benefits and signed agreements which stated they were independent contractors and were responsible for all their own benefits.

In 1989 and 1990, the IRS reclassified the workers as employees. Thereafter, Microsoft made offers to some of the workers to become regular employees and gave others the option of terminating employment or continuing to work, but in the capacity of employees of the new Microsoftowned employment agency. Those individuals who became employees of the employment agency continued working the same hours on the same projects and under the same supervisors as before.

Following their reclassification by the IRS, the workers sought certain Microsoft benefits, including those under Microsoft's SPP. The SPP provides that "each employee who is 18 years of age or older and who has been employed for six months shall be eligible to participate in this Plan," and defines "employee" to mean "any common-law employee ... who is on the United States payroll of the employer."

Microsoft conceded that the workers were generally common-law employees who rendered personal services to Microsoft, but defended their exclusion from the SPP on the grounds that they were not "on the United States payroll of the employer." Microsoft argued that the workers were ineligible because they were paid through the accounts payable department and not through the payroll department.

Rationale. The court first determined that the phrase "on the United States payroll of the employer" was ambiguous. It then looked to the agreements signed by the workers when they were hired and concluded that the waivers of benefit provisions in the agreements were not controlling because they assumed that the workers were independent contractors. The court then applied the rule of contra proferentum, which provides that a document will be interpreted most strongly against its drafter, and construed the ambiguity in the SPP against Microsoft. Consequently, the court held that the workers were eligible to participate under the terms of the SPP C that the plan must be construed as extending participation to all persons employed by Microsoft and paid from its U.S. accounts.

Also at issue in this case was whether the workers were entitled to ESPP benefits. Microsoft argued that the workers were not entitled to participate in the ESPP because the workers (1) had no right to enforce Section 423 of the Code; (2) signed agreements stating that they would receive no benefits; and (3) did not rely on the terms of the ESPP in continuing their employment because the ESPP was never communicated to them. The court dismissed Microsoft's arguments and held that the workers were covered by the ESPP.

The court found that because Microsoft intended to qualify the ESPP under Section 423, Microsoft intended to make all common-law employees eligible for participation in the ESPP. Section 423 states that the "options are to be granted to all employees of any corporation whose employees are granted any of such options by reasons of their employment by such corporation." Further, the term "employees" in Section 423 refers to common-law employees. Consequently, the court held that the ESPP, construed in a manner consistent with Section 423, extends participation to all common-law employees not otherwise excepted under the plan. The plan contained only two exceptions, neither of which applied: (1) employees whose customary employment was 20 hours or less per week and (2) employees whose customary employment was for not more than five months in the calendar year. Thus, the court found that the workers could enforce the ESPP in the same manner as any of Microsoft's other employees.

Moreover, the court found that neither the agreements the workers signed when hired by Microsoft, nor the fact that Microsoft did not communicate the terms of the plan to the workers, made the workers ineligible to participate in the ESPP. The court asserted that the agreements the workers signed did not control their employment status, were overridden by Microsoft's incorporation of Section 423 into its ESPP, and were consistent with the workers' participation in the ESPP. Finally, the court noted that Microsoft's public promulgation of the plan was enough to establish the workers' reliance on the ESPP, if this reliance is even required in the context of benefit plans.

Clark v. DuPont

In this case, the plaintiff-worker ("Clark") asserted that he was entitled to (1) benefits under DuPont's health, welfare, pension, and retirement plans established pursuant to the ERISA, and (2) damages because of DuPont's failure to provide Clark with the plan documents he requested.

The court began its analysis in much the same way as did the Ninth Circuit in Microsoft C by reviewing Clark's relationship with DuPont. It noted that DuPont employed Clark directly from 1962 until 1970, when he was terminated. Clark subsequently found work with several companies which performed contract work for DuPont, including an employee leasing firm called Belcan Engineering Group. Clark worked for Belcan from 1975 until 1993 and during his employment submitted time sheets to Belcan listing DuPont as the client and participated in Belcan's health benefits program. In addition, the leasing agreement between Belcan and DuPont stated that leased workers should be considered employees of Belcan and not DuPont.

When he left Belcan, Clark listed Belcan as his former employer for purposes of unemployment benefits. However, Clark applied for coverage under DuPont's plans, asserting that he remained a DuPont employee while he was working for the contracting agencies. DuPont denied Clark coverage on the ground that his employment with DuPont ceased in 1970 and that the language in DuPont's plans clearly excluded him from coverage.

Rationale. Based on these facts, the court determined that it was "undisputed that Clark was a Belcan employee ... and that he was not on DuPont's payroll." However, for purposes of this case, the court did not focus on Clark's status, but on the language in DuPont's plans.6 The court noted that under ERISA, an action for benefits under a plan may be brought only by a "participant" of the plan. A "participant" is a common-law employee of the employer maintaining the plan, who is eligible to receive benefits under the plan according to the language of the plan itself. Any individual who is not a participant lacks standing to bring a claim for benefits under an ERISA plan and thus, the court lacks subject-matter jurisdiction to hear the claim.

After reviewing the language in DuPont's plans, the court found that the plan administrator had the authority to make benefits determinations, acted within the scope of its authority, and did not abuse its discretion when it denied Clark benefits under the plans. Unlike the Ninth Circuit in Microsoft, this court did not apply the doctrine of contra proferentum, but reviewed the plan administrator's decision under an ERISA abuse-of-discretion standard.

The court noted that DuPont's first set of plans, which included life insurance plans and a medical plan, defined an eligible individual as "any person designated by the Company as a full time employee. Any full-time employee on the roll as of 12/1/85 who continues to work at least 20 hours per week...will be considered a full service employee." The plan administrator had always construed the phrase "on the roll" to exclude contract and leased employees. Moreover, Clark even admitted "...if you're not on the DuPont roll, you don't get benefits." Because Clark was not on the DuPont payroll and was not a full- time DuPont employee, the court found that Clark was ineligible for benefits under this set of plans.

The second group of DuPont plans, which included a savings and investment plan, excluded individuals "who must be treated as employees of the Company for limited purposes under the leased employee provisions of Section 414(n) of the IRC."7 To achieve favorable tax treatment for these plans, DuPont had to count all employees, both payroll and leased, as part of the covered employees for those plans. The court found that Clark was ineligible to participate in the second set of plans because he was a leased employee and all leased employees were excluded from participation in that set of plans.

Finally, because Clark was not a participant under DuPont's plans and did not have a colorable claim that he would fulfill the eligibility requirements under any of the plans, the court affirmed the dismissal of Clark's claim for statutory damages.

Section 530. Section 530 of RA of '78 was enacted to protect employers from IRS penalties that might otherwise be imposed following a reclassification of the employer's workers as employees. To qualify for this protection, the employer must show that the employer (1) consistently treated individuals doing similar work as independent contractors; (2) never treated the independent contractor as an employee; (3) filed Form 1099-MISC for independent contractors; and (4) had a reasonable basis for treating the worker as an independent contractor. An employer has a reasonable basis for treating the worker as an independent contractor if (1) the employer relied on similar judicial rulings, IRS letter rulings to the employer, or IRS TAMs to the revenue agent and employer; (2) in a past IRS audit, the employer prevailed with respect to the same individual or other workers holding substantially similar positions; or (3) it is a recognized, long-standing practice for a significant segment of the employer's industry to treat the workers as independent contractors.

1996 changes. The SBA '96 amendments to Section 530 liberalized these rules in several respects: 1. The IRS is now required to notify an employer undergoing an audit that Section 530 may provide relief. 2. The "significant segment" rule now requires a showing of no more than 25% of the industry, without taking the employer's practices into account. 3. The amendments abolish the IRS's rule that "long-standing" means more than 10 years. 4. A taxpayer no longer loses Section 530 protection merely because the employer changes its treatment of a worker as an independent contractor to an employee. 5. For Section 530 to be available, it is no longer necessary that the worker involved is determined to be an employee. 6. If the employer can make a prima facie showing that it is entitled to Section 530 relief, the IRS has the burden of proving that the employer is not entitled to such relief.

CONCLUSION

Microsoft and DuPont, as well as the amendments to Section 530, significantly change the worker classification landscape. DuPont highlights the importance of careful drafting of leasing agreements and benefit plans. Amended Section 530 offers more protection to employers facing an IRS audit of their worker classifications. On the other hand, Microsoft serves as a warning to employers whose independent contractors could be reclassified as employees. Although Microsoft demonstrates that reclassification of an employer's workers may invite a claim for benefits under the employer's benefit plans, employers can take steps to reduce this risk. They should review their worker classification guidelines to determine whether the workers they are hiring as independent contractors really fit that category. Employers should also review the eligibility provisions of their benefit plans to determine whether the plans properly exclude those workers to whom the employer does not wish to provide benefits. In particular, they should make certain that the eligibility provisions of their benefit plans are clear with respect to coverage of employees of temporary agencies, temporary employees, and independent contractors. By drafting their plans to exclude these workers, employers can reduce if not eliminate their exposure to Vizcaino v. Microsoft type claims.