Misclassifying Employees as Independent Contractors can be Costly

Employers may face serious financial exposure when an individual the employer classified as an independent contractor is determined to be an employee entitled to employee benefits under the terms of one or more of a company's employee benefit plans. Two recent cases out of the Third and Ninth Circuits have heightened awareness of this issue.

In Vizcaino v. Microsoft Corp., 97 F. 3d 1187 (9th Cir. 1996), the Court concluded that a group of individuals hired as temporary employees and paid through Microsoft's accounts payable department were in fact employees for the purpose of inclusion in Microsoft's Savings Plus Plan and Stock Purchase Plan. The Court apparently relied on ambiguities in the plan document to conclude that several free lance employees of Microsoft were in fact regular full time employees and thus could not be excluded from the plan. The Ninth Circuit has recently granted a rehearing in this case.

Another recent case, Epright v. Environmental Resource Management, Inc., 19 EBC 2936 (3rd Cir. 1996), indicates a willingness to read employee benefit plans narrowly. In this case the plaintiff was initially hired as a temporary employee, but later granted full time status. However, two days prior to that grant he was severely injured in a non-work related accident. Plaintiff asserted that he was a full time employee and therefore entitled to medical benefits under the company's health care plan. The Court reasoned that because the company's health care plan did not specifically exclude temporary employees, plaintiff should have been covered.

The health care plan defined eligible employees as those "active, full-time employees" who have selected a particular option under the plan and defined eligibility date as the "date following 60 consecutive days of active full-time employment." The Court looked to the plan document and concluded that the definition of eligible employee was not ambiguous, did not exclude temporary employees who otherwise met the requirement (i.e. had worked full-time for more than 60 days) and thus the plaintiff ought to have been covered under the plan.

In a separate but related matter, we caution employers of the IRS's campaign to seek out companies who have wrongly classified workers as independent contractors for Federal Income Tax Withholding purposes. The IRS has offered such employers the option to reclassify such workers immediately but pay no penalty for the past violation. However, such a settlement with the IRS can trigger a lawsuit by a reclassified employee seeking retroactive benefits, as was the case for Microsoft.

The full impact of these two cases and the emerging trend of lawsuits by reclassified workers remains to be seen. However, a pattern of interpreting plan documents as including free lance and temporary employees appears to be emerging. Thus, it is imperative that plan documents be drafted tightly with a clear definition of eligible employee that unquestionably excludes those temporary employees or truly independent contractors who the employer wishes to exclude.

If you would like to have your plan documents reviewed to ensure that your company will not be exposed to potential unknown liability, or to restructure your plan to include or exclude certain groups of employees, please contact a member of the Employee Benefits and Executive Compensation Group.