Temporary employees, part-time employees, and independent contractors ("contingent workers") account for almost 25 percent of the total U.S. workforce. These employees typically agree to work without company-sponsored employee benefits in exchange for a higher pay. Over the course of the past few years, American business has greatly expanded the use of contingent workers as a way of lowering costs and as a means of providing "flexible" staffing. Both ERISA and the Internal Revenue Code generally permit employers to exclude contingent workers from participating in employee benefit plans. Unfortunately for employers, the legal status and the rights of contingent workers is in a state of flux. Probably the best example of how this uncertainty can adversely affect employers can be found in the recent Ninth Circuit Court of Appeal case entitled Vizcaino v. Microsoft, ____ F.3d _____, 1997 U.S. App. Lexis 18869 (9th Cir. 1997). The contentiousness of the contingent worker debate has even spilled over into the collective bargaining arena: The recent Teamster strike against United Parcel Service ("UPS") was reportedly caused by UPS's poor treatment of its part-time workforce.
On October 3, 1996, Microsoft learned for the first time that its decision to exclude independent contractors from its employee benefit plans was probably a costly error. Judge Reinhardt, writing for the three-judge appeals panel, began his opinion as follows:
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. This practice has understandably led to a number of problems, legal and otherwise. . . .
97 F.3d 1187, 1189 (9th Cir. 1996).
The court concluded that since there were no plan provisions excluding these contingent workers, they were entitled to participate in Microsoft's retirement plan and stock purchase plan. Microsoft Corp. was unhappy with the Ninth Circuit's October decision and so it asked for a review of the three-judge panel's decision by an eleven-judge panel. Microsoft's request was granted. Unfortunately for Microsoft, on July 24, 1997, the 11-judge panel affirmed the three-judge panel's decision.
In 1987, Donna Vizcaino began working for Microsoft Corporation as a "freelance" production editor. Ms. Vizcaino, as a "freelancer," signed two form agreements stating that she was an "independent contractor." Donna agreed that she was not eligible for Microsoft employee benefits, that she would purchase her own employee benefits and that she would pay for her own employment taxes. Once at work, Ms. Vizcaino came to believe that the only real difference between her job and the jobs of "regular" employees was not what they did, but what they received. "Regular" employees received pension, stock purchase and other employee benefits. Ms. Vizcaino did not. Although hired to work on specific projects, seven of the eight named plaintiffs in Microsoft had worked on successive projects for a minimum of two years prior to the time they filed suit, while the eighth had worked for Microsoft for more than a year. The freelancers performed services as software testers, production editors, proof readers, formatters and indexers. Microsoft fully integrated the freelancers into its workforce; they worked on teams along with regular employees, shared the same supervisors, performed identical functions and worked the same hours. Because Microsoft required the freelancers to work onsite, they received admittance card keys, office equipment and supplies from the company.
In 1989 and 1990, the Internal Revenue Service audited Microsoft's books and decided that as a matter of law the "freelancers" were employees for employment tax purposes rather than independent contractors. After the IRS made this determination, the freelancers claimed they were entitled to participate in Microsoft's employee benefit plans. Microsoft disagreed, and the freelancers then asked Microsoft's plan administrator to determine if they were eligible for these benefits. Not too surprisingly, Microsoft's plan administrator determined that the freelancers were ineligible.
The eleven-judge panel took two different views of the freelancers' agreements with Microsoft. The majority (eight of the judges) stated that Microsoft had overreached and had erroneously imposed independent contractor status on the freelancers. The majority implied that they viewed independent contractor agreements as no more than adhesion contracts. Adhesion contracts occur where one party to a contract impermissibly reduces the other contracting party's legal rights. A common example would be parking lot signs that state that the parking lot owner is not responsible for anything that happens to your car while it is parked in the lot. Because the parking lot owner impermissibly diminishes your legal rights without your consent, this contract is normally not enforceable. The majority then ruled that Microsoft had given away the case when it conceded to the Court that in light of the IRS audit the independent contractors were employees. The independent contractor agreements signed by the freelancers were thus dismissed by the court as unenforceable contracts as they were based upon a "mutual mistake" of fact.
The Ninth Circuit stated that the earlier decision of the Plan Administrator that the freelancers were ineligible for benefits under the retirement plan was obviously wrong as Microsoft had now conceded that the freelancers were, in fact, employees. Microsoft argued to the Ninth Circuit that the freelancers should still be excluded from the retirement plan because the plan restricts benefits to Microsoft's common-law employees who are "on the United States payroll." Astoundingly, the eleven-judge panel stated it was premature for it to rule on that issue because the Plan Administrator had not yet considered it! Consequently, Microsoft's Plan Administrator will get a second bite at this apple.
The freelancers also contended they were entitled to immediate participation in Microsoft's stock purchase plan. The Ninth Circuit ruled that the stock purchase plan had been offered by Microsoft to all "employees." As such, the freelancers were aware of it, even if they were not aware of the plan's exact terms, and their work for Microsoft gave them a right to participate in it. The Ninth Circuit concluded that the freelancers were entitled to retroactively participate in the employee stock purchase plan as a matter of law since the ESPP was not a benefit plan regulated by ERISA.
The three judges in dissent observed that the "freelancers" had already received the benefit of their bargain--they had agreed to receive higher pay in lieu of receiving employee benefits. None of the Plaintiffs contended they were entitled to benefits and none thought benefits was a part of their compensation package at Microsoft. According to the dissent, participation in the employee stock purchase plan and other Microsoft benefit plans was a pure windfall.
Other federal courts of appeal have rejected similar claims of contingent employees to employee benefits. For example, in Abraham v. Exxon Corporation, 85 F.3d 1126 (5th Cir. 1996), "special agreement" employees of Exxon sued to participate in Exxon's employee benefit plans. Id. at 1128. The Fifth Circuit Court of Appeal rejected the plaintiff's claim stating that the Internal Revenue Code permits employers to exclude "leased employees" from retirement plan participation. Id. at 1131. Similarly, in Trombetta v. Cragin Federal Bank Ownership Plan, 102 F.3d 1435 (7th Cir. 1996), independent contractors (loan originators) for Cragin Bank sued the bank for participation in Cragin's employee stock ownership plan. In rejecting the loan originators' attempt to participate in the employee stock ownership plan, the Seventh Circuit deferred to the decision of the plan administrator. Id. at 1438.
Life is stranger than fiction. In Microsoft, independent contractors who had agreed to receive higher pay in lieu of employee benefits ended up receiving employee benefits on a retroactive basis. Much of the concern among employers about Microsoft may be unwarranted, given the unusual facts of the case (e.g., the intervening IRS audit finding the freelancers to be employees). Nonetheless, employers need to be especially careful when engaging independent contractors so as to ensure that what happened to Microsoft does not happen to them. Clearly, employers need to review the eligibility criteria for participation in their employee benefit plans to ensure that these criteria provide a basis for excluding contingent workers. In addition, the contractual agreements with independent contractors should include a specific waiver of participation in employee benefit plans that is not dependent on the contingent worker's status as a nonemployee. Finally, Microsoft reinforces the importance of carefully administering the claims review procedure in each employee benefit plan so as to ensure that a court on review will defer to the plan administrator's decision.