Avoiding Misclassification of Independent Contractors in the New Year

With the new year, taking the time to review the status of your independent contractors may create valuable savings.  Independent contractors, when properly classified, can often be a valuable and efficient means for both businesses and individuals to conduct business.  Many businesses engage workers on an independent contractor basis as means of avoiding rigorous requirements associated with an employment relationship, including payment of minimum wages and overtime; provision of benefits, workers’ compensation insurance and unemployment benefits; and protections under discrimination and safety laws – all of which may result in significant costs to the operation of a business.  If employees are misclassified as independent contractors, however, the company risks the potentially hefty damages resulting from a misclassification. 

The downturn in the economy has changed the face of independent contractor arrangements for a variety of reasons.  For workers, being classified as employees often means that they receive benefits, including paid vacation time, subsidized health insurance, workers compensation insurance benefits and unemployment benefits.  For many government agencies, classifying workers as employees often generates greater revenue from employment taxes that should have been paid, plus penalties and interest.  According to the National Employment Law Project’s Summary of Independent Contractor Reforms, New State and Federal Activity (November 2011), misclassification of independent contractors has resulted in a loss of as much as 30 percent of employment-related taxes to state and federal government, and workers without unemployment insurance, workers’ compensation, minimum wage and overtime pay, and the protections of discrimination and other workplace laws.  Let us also not forget the plaintiffs’ class action attorneys who have been quick to recognize the significant potential for sizable awards resulting from claims for misclassification of workers as independent contractors.  Industries whose models have long incorporated independent contractors as a substantial portion of their business have been targeted by class action attorneys and government agencies alike.  Because of the increased government scrutiny and the targeting by plaintiffs’ class action attorneys, businesses are advised to carefully review and consider independent contractor relationships.

In Massachusetts, the threshold to be properly deemed an independent contractor is especially high.  A worker is presumed to be an employee unless all of the following requirements are met:

  1. The individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and
  2. The service is performed outside the usual course of the business of the employer; and
  3. The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

For many individuals treated as independent contractors, all three of these criteria may not be met, which means that they are misclassified as independent contractors.  While misclassification alone does not per se trigger penalties, a misclassification paired with a violation of another law – such as the Massachusetts wage laws set forth in Massachusetts General Laws, Chapter 149; the minimum wage, overtime and payroll records laws set forth in Massachusetts General Laws, Chapter 151; the workers’ compensation law set forth in Massachusetts General Laws, Chapter 152; and the payroll tax requirements in Massachusetts General Laws, Chapter 62B – could result in penalties as dictated by those respective laws.  In the case of a violation of any of the wage laws, the damages could include up to treble the actual damages suffered by the employee plus attorneys’ fees, with liability falling not only on the company that received the services, but also individually to the president, treasurer, and any other officer having management of the company. 

A recent series of cases sharing the name Awuah v. Coverall North America, Inc., demonstrated how misclassification as an independent contractor triggers many potential areas of liability and exposure to substantial damages.  Coverall North America, Inc., a national commercial cleaning franchise, had classified the individuals to whom it sold a franchise as independent contractor franchisees.  Unfortunately, the putative franchisees later claimed to be employees who were misclassified as independent contractors.  Over the course of 9 years of litigation in 6 different forums, beginning with a former franchisee’s request for unemployment benefits because Coverall purportedly terminated her franchise, it became evident that Coverall directed and controlled the franchisee’s work and Coverall – not the franchisee – contracted with, invoiced and collected payments directly from the franchisee’s customers.  As a result, at least in Massachusetts, Coverall had misclassified their franchisees as independent contractors.

For many companies, the Coverall situation may seem a remote possibility.  More common is the use of a limited number of independent contractors to boost a workforce during a busy time or for a special project.  It is in those instances, however, that the line between independent contractor and employee is grayest and where a careful review upfront could save significant time and money later. 

The first stop in reviewing the status of an independent contractor is the contract itself, if there is one.  Any of the following types of provisions in an independent contractor agreement are likely to be viewed as favoring classification as an employee, notwithstanding any statement that the individual is an independent contractor:

  • Having a title within the company.
  • Requiring the worker to perform services that are regularly performed by an employee of the company.
  • Requiring the worker to follow instructions of a supervisor employed by the company.
  • Reimbursing the worker for regular business expenses incurred in the course of providing services.
  • Restricting the worker’s ability to provide similar services to a competitor after the engagement ends.
  • Restricting the worker’s ability to provide similar services to a non-competitor during the engagement.
  • Retaining any control or direction over the manner or means by which the worker provides services.
  • Payment of the worker on a payroll schedule.

Review of proper classification should also focus on what the worker is actually doing and how the worker is providing the services on a day-to-day basis.  Factors such as:

  • Coming to the company offices every day at the same time as an employee;
  • Working next to or near employees and performing the same or similar work as employees;
  • Interacting with employees and taking instruction from managers in the same manner as other employees;
  • Having an email account with the hiring company’s email address; and
  • Having business cards showing only the hiring company as the business with which the worker is associated

will all be considered to favor classification as an employee; and not as an independent contractor.

While there is no panacea for avoiding misclassification, proactively reviewing independent contractor arrangements and making re-classification efforts can greatly reduce a company’s risk.