Articles Posted in Independent Contractors

Independent contractor or employee? It’s a hot question these days, for sure. A recent decision from the Delaware Superior Court answers the question in an unusual way–yes and no. In Colon v. Gannet Co., Inc.,
No. N10C-04-007-MMJ (Del. Super. July 26, 2012), the court held that the plaintiff was an independent contractor but that the employer still could be found liable for harm caused to him during the course of his work.

The plaintiff, Jesus Colon, was selling newspapers as a street hawker when he was struck and injured by a motor vehicle. A street hawker, according to the court, is an “independent contractor who purchases and resells copies of the newspaper at predetermined locations.”

The publisher had a contract with Keith Walker, who, in accordance with the contract, purchased papers daily and resold them in a designated territory. Pursuant to the agreement, Walker could contract with other parties to assist in selling the papers. Colon was one such party. The agreement also contained an indemnification provision whereby Walker would indemnify the publisher for any claims against it brought by any of Walker’s agents.

Colon filed suit against the newspaper’s publisher, Gannett Company, Inc., alleging negligence and reckless disregard for his safety. The publisher answered the complaint and filed its own, third-party complaint against Walker and the driver of the vehicle. The publisher later filed a motion for summary judgment on the grounds that Colon’s status as an independent contractor precluded a finding of liability.

The court acknowledged that, generally, an employer will not be liable for the torts of an independent contractor that are committed in the performance of contracted work. However, the court went on to explain, the general rule is subject to three exceptions. First, the employer can be liable for its negligence in selecting, instructing, or supervising the contractor. Second, the employer can be liable when it has delegated non-delegable duties that arise out of some relation to the public or the particular contractor. Third, the employer can be held liable where the work that the contractor was hired to perform was “specially, peculiarly, or ‘inherently’ dangerous.”

The court found that the first two exceptions did not apply before turning to the third. The third exception, the court held, applies not only to inherently dangerous work but also to work that involves a risk of harm is present where the work is performed in the ordinary manner.

The court went on to conclude that, whether a street hawker, who sells newspaper on the street corner and who, in the course of doing so, would enter the roadway many more times a day than the ordinary pedestrian. As a result, the court found that it would be up to the factfinder to determine whether this risk constituted an inherently dangerous risk that would prevent Gannett from avoiding liability with the independent-contractor defense.

Employers in the construction industry should, by now, be painfully aware of the Delaware Workplace Fraud Act, signed into law in 2009. The Act imposes stiff penalties on construction-services employers who misclassify employees as “independent contractors.”
Delaware Misclassification

As a result of amendments signed into law on July 12, 2012 (HB 222.pdf), the General Assembly has added more teeth to the law, in the form of public shame. Now, the name of any employer that has violated the Workplace Fraud Act will be posted on the Department of Labor’s website for a period of 3 years from the date of the final determination.

The DDOL will maintain something akin to a sex offender registry for misclassification–or affix the offending contractor with a Scarlet “M”–to use a more literary analogy. Regardless of how you may feel about this new penalty or its effectiveness as a deterrent, it makes clear that this issue remains a top priority for legislators. So far, Delaware’s attempts to expand this law to other industries have not succeeded but, if Delaware follows the national trend, this won’t last long. All Delaware companies would be well advised to ensure that they are not wrongfully labeling employees as “independent contractors,” in light of the state and national focus on this issue.

All individuals performing work for an employer should be classified as employees or independent contractors. Employees are then further classified under the Fair Labor Standards Act as “exempt” or “non-exempt” for purposes of overtime compensation. Proper classification of employees and independent contractors can be difficult, and misclassification can lead to significant financial liability in the form of back taxes and overtime pay.  Red 3D Figure Raising Hand

In an attempt to address misclassification of independent contractors for tax purposes, the IRS launched the Voluntary Classification Settlement Program (VCSP). The goal of the VCSP is to properly classify workers, while collecting unpaid payroll taxes for employees improperly classified as independent contractors. As the IRS explained, “this new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.” An employer’s voluntary participation in the VCSP removes the burden of interest and penalties that would be assessed if the misclassification were discovered as the result of an IRS audit.

Despite the many benefits offered by the VCSP, many employers were reluctant to participate because it was unclear whether the facts surrounding the employer’s participation would be shared with other government agencies. Of particular concern is the Department of Labor’s Wage and Hour Division, which is responsible for enforcing the Fair Labor Standards Act. Employers’ concerns were legitimized by the earlier announcement that the IRS, the Department of Labor, and several states would be joining forces to identify wage and hour violations and impose significant fines on non-compliant employers.

In an attempt to address employer concerns about the VCSP, the IRS has issued an FAQ sheet. The FAQ resolved three key fears for employers:

  • The IRS states that it will not share information about VCSP applicants with the Department of Labor or state agencies;
  • An employer that applies for but is not accepted into the VCSP will not automatically be subject to an IRS audit; and
  • Participation in the VCSP is not an admission of liability or wrongdoing with respect to employee classification issues.

With these concerns alleviated, we’ll have to wait to see whether employers forward and work with the IRS to address any concerns they may have about whether they have misclassified independent contractors.

See also these previous posts on misclassification of employees:

3d Cir. Rules on Enforceability of Non-Compete Agreements for Independent Contractors

Pennsylvania Passes Misclassification Law

Will “Misclassification Initiatives” Reduce Employers’ Use of Independent Contractors?

The Third Circuit gave employers new reasons to worry about misclassifying their employees in its decision in Figueroa v. Precision Surgical, Inc., (PDF), C.A. No. 10-4449.  A former employee brought suit seeking to invalidate the non-competition provision in his independent-contractor agreement (“ICA”).  The plaintiff alleged that his former employer had materially breached the contract and, therefore, could not enforce it against him. approved-stamp

During the course of his 6-years with the organization, the plaintiff’s relationship became more like that of an independent contractor.  For example, the company required that the plaintiff: (1) devote 100% of his energy to selling the company’s products; (2) report to his supervisors daily and attend monthly meetings; (3) abide by a dress code; and (4) obtain permission from before giving quotes to certain prospective customers.

As the supervision and reporting requirements became more onerous, the plaintiff objected and, eventually, requested a new contract that clarified his status as an independent contractor.  The company refused and stated that it intended to convert all sales positions to employees, eliminating all independent contractor positions.  When he refused to make the conversion to employee status, his contract was terminated. 

The employee brought sought suit seeking declaratory relief invalidating the non-compete provision in the agreement. The company filed a counter-claim alleging breach of the non-compete agreement based on the plaintiff’s new contract position as a sales representative for a competitor.

The District Court denied the employer’s request for a preliminary injunction, finding that the employer had more likely than not breached its obligations under the independent-contractor agreement.  The Third Circuit affirmed, finding that the requirements to which the plaintiff had objected were not consistent with requirements for an independent contractor.  As a result, the court held, the employer breached the agreement by treating the plaintiff as an employee. 

Well-informed employers understand the significance of properly classifying employees for tax and benefits purposes. The Third Circuit’s recent opinion gives employers another reason to avoid misclassifying their employees: failure to properly classify workers as employees or independent contractors may impact their ability to enforce restrictive covenants and non-compete agreements.

Pennsylvania now has a misclassification law that mirrors Delaware’s law. Delaware’s Workplace Fraud Act, enacted in 2009, imposes stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on  business costs and avoid paying appropriate taxes. Sheldon Sandler previously posted about Delaware’s law.caution sign road barrier

Similarly, under Pennsylvania’s Construction Workplace Misclassification Act, an individual who performs services in the construction industry is considered an independent contractor in limited circumstances. The individual: (i) must have a written contract to perform services, (ii) be free from control or director over performance of such services both under the contract of service and in fact, and (iii) with respect to the individual’s services, the individual must be customarily engaged in independently established trade, occupation, profession or business.

In addition to this criteria, Pennsylvania’s law has particular requirements to prove that an individual is “customarily engaged” in an independently established trade, occupation, profession, or business. The law takes effect 120 days from October 13.

Employers’ use of independent contractors instead of traditional employees has been on a steady incline over the past 20 years. Some employers feel that they can save money by using independent contractors instead of full-time employees. The contractors themselves may value the autonomy and economic perks that the status provides. Also, the specific skills and knowledge that independent contractors can bring to a short-term project can be critical and, therefore, worth a premium but not sustainable in the long term. But the use of independent contractors is not as perfect as these mutually beneficial points may seem.

A report prepared by the U.S. Government Accountability Office (GAO) in the Fall of 2009 concluded that employee misclassification is a “significant problem” with “adverse consequences” because it reduces tax revenues flowing to the government. In fact, the misclassification of employees as contractors is estimated to cost the Treasury Department over $7 billion in lost payroll tax revenue over the next ten years.

So the theory goes, since independent contractors are, by definition, self-employed, they are not considered “employees” and thus not covered by various tax withholding laws. Independent contractors also are not subject to most employment laws, so in addition to avoiding taxes, some employers may reclassify employees as independent contractors in order to avoid payment of overtime and benefits, and workers’ compensation liability.

And, thus, the crackdown on the misclassification of employees as independent contractors began. he U.S. Department of Labor (DOL) has made the proper classification of employees and independent contractors one of its “top priorities.” The agency’s 2011 budget includes an additional $25 million for what it calls the “Misclassification Initiative” designed to target misclassification of independent contractors. Approximately 100 additional DOL enforcement personnel will be added to investigate employers.

The Internal Revenue Service (IRS) is in the middle of a similar misclassification crackdown. Beginning in February 2010, the IRS will commence intensive audits of randomly selected employers. One of the focal points of the audits is whether the employers are improperly misclassifying workers as independent contractors to save on taxes and employee benefits.

There’s also new federal legislation on the horizon. Congress is expected to take up legislation that will penalize employers for employee misclassification. One proposed piece of legislation, known as the Independent Contractor Proper Classification Act, was sponsored by President Obama when he was a member of the U.S. Senate.

States are getting into the enforcement act as well. New York and Massachusetts have created task forces to locate employees who are misclassified. Other states such as Maryland and Colorado have enacted new laws that impose harsh penalties on employers who misclassify employees as independent contractors.

Here in Delaware, the General Assembly passed its own law last year imposing stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on business costs and avoid paying appropriate taxes. In addition to penalties of $1,000-$5,000 per misclassified employee, employers who fail to produce requested records can be issued a stop-work order by the Delaware Department of Labor and fined up to $500 per day for each day during which the requested records are not produced.

Compliance, though, presents its own difficulties. The tests used to determine whether someone is an independent contractor or an employee are fact intensive and differ among government agencies. In addition, each state may have its own unique test to determine a worker’s proper status.

Still, the penalties for non-compliance make this a treacherous area for the unwary employer. In addition to federal and state governments seeking unpaid payroll taxes and associated penalties, employment lawsuits in this area are becoming increasingly common. Claims from misclassified workers range from those seeking unpaid wages and overtime, to multi-million dollar class actions lawsuits. Misclassified employees have also successfully recovered retirement benefits, medical coverage for injuries they sustained on the company’s property, and rights to employee stock options and bonuses.

Given the increased attention to this area, the time to act is now. An internal review and audit of worker classifications should be a crucial component for any company that currently employs independent contractors.

President Obama’s administration will seek more funding for the U.S. Department of Labor (DOL), including more funds to enforce wage and hour laws and pursue employers who misclassify employees as independent contractors. In a press release yesterday, Secretary of Labor Hilda L. Solis outlined the president’s fiscal year (FY) 2011 budget request for the DOL, which is built around the vision of “good jobs for everyone.”

The FY 2011 budget requests $117 billion, with the majority to be used for unemployment insurance benefits for displaced workers and federal workers’ compensation. The DOL’s discretionary request of $14.0 billion overall includes $1.7 billion for worker protection programs, a four percent increase over the prior year’s budget.

According to Secretary Solis, “[t]he FY 2011 budget will help to make the vision of good jobs for everyone a reality for America’s workers. This budget invests in innovation and reform that will play a critically important role in building long-term economic security for workers. At the same time, the budget reflects our commitment to fiscal responsibility, investing in what works and carefully evaluating our programs to make sure that we obtain results that produce good jobs.”

The DOL seeks to hire more than 350 new employees, including 177 investigators and other enforcement staff, many of whom will be bilingual to better communicate with employees. The 2011 budget builds on the 2010 budget policy of returning worker protection programs to FY 2001 staffing levels, after years of decline. The Wage and Hour Division of the DOL will receive $244 million, an increase of almost $20 million from the prior year, including funding to hire 90 new investigators.

One particular area that will be the target of enforcement is the use of independent contractors by employers. When workers are misclassified as “independent contractors,” they are deprived of benefits and protections to which they are legally entitled,” said the DOL. For example, independent contractors do not receive overtime and are ineligible to receive unemployment benefits. The FY 2011 budget includes an additional $25 million for a Misclassification Initiative to target misclassification with 100 additional enforcement personnel and competitive grants to boost states’ incentives and capacity to address this problem. (This $25 million includes the nearly $20 million increase for the Wage and Hour Division discussed above.)

Independent contractors, by definition, are self-employed and because they are not “employees” are not covered by employment, labor, and various tax withholding laws. In some instances employers reclassify employees as independent contractors in order to avoid taxes, payment of overtime and benefits, and workers’ compensation liability. However, whether or not a worker is covered by a particular employment, labor, or tax law hinges on the definition of an “employee.”

The IRS uses a 20-factor, right-to-control test to assess an employers’ tax liability. The DOL often relies on the so-called “economic realities test” or a hybrid of the right-to-control and economic realities test to determine independent contractor status. Some believe the economic realities test makes it harder to classify an employee as an independent contractor, since, in addition to considering the degree of control the employer exercises, it takes into account the degree to which the workers are economically dependent on the business.

The DOL’s efforts to crack down on the use of independent contractors is just the latest in a series of federal initiatives and state laws that have made this issue come under increasing scrutiny. For instance, in December 2009 legislation was introduced in the U.S. Senate that would make it more difficult for employers to classify workers as independent contractors for employment tax purposes. In October of last year, Maryland passed the Workplace Fraud Act, which made it a violation of law to fail to properly classify workers as employees and imposed penalties on those employers who knowingly misclassify their workers.

In July 2009, Delaware passed its own law imposing stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on business costs and avoid paying appropriate taxes.

Delaware has become the latest state to impose stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on business costs and avoid paying appropriate taxes.

On July 31, 2009, Delaware Governor Jack Markell signed into law House Substitute No. 1 for House Bill No. 230, which imposes significant monetary and other penalties on “construction services” employers who willfully misclassify employees as “independent contractors.”

The Delaware action follows similar recent enactments in Maryland and Colorado. Other states that have similar statutes include Illinois, Indiana, Minnesota, New Hampshire, New Jersey, Rhode Island, and Washington. 3d man holding up roof of house

The Delaware Department of Labor is responsible for accepting and investigating complaints under the new law and for its enforcement. The Act directs the DDOL to adopt regulations to “further explain” and provide examples of the prohibited conduct. The law presumes that an employer-employee relationship exists when work is performed for remuneration, and places the burden on the employer to convince the DDOL that the person is an independent contractor or otherwise exempt. If the DDOL initially determines that a violation has occurred, the employer has a right to an administrative appeal.

In addition to penalties of $1,000-$5,000 per misclassified employee, employers who fail to produce requested records can be issued a stop-work order by the DDOL and fined up to $500 per day for each day during which the requested records are not produced. An employer that retaliates against a person who made a complaint or provided information to the DDOL is subject to a penalty of no less than $5,000 up to $10,000 for each violation.

Also, persons who create or assist in creating legal entities to avoid detection of violations are subject to fines of up to $20,000. Employers found to have violated the Act twice in two years are subject to debarment from public contracts for up to five years and may be assessed an administrative penalty of $20,000 per improperly classified employee.

If the DDOL is notified of an alleged violation and has not taken action either by investigating or filing a lawsuit in 90 days, the “person alleging a violation” may file suit for declaratory relief and “actual damages,” which is defined to include “treble damages for lost wages or benefits” as well as attorney’s fees and costs. The law also requires employers to keep certain records pertaining to both employees and independent contractors and to retain those records for three years.

 

See these posts for information about similar proposals affecting employment laws and independent contractors:

Delaware General Assembly Piles on Construction Industry
Employee Misclassification Prevention Act Update
R.I.P: Several Bills Affecting Delaware Employers Killed by the Legislature
Construction-Industry Employers Are Targeted in Several States

Independent Contractor Update: A bill targeting the construction industry has been introduced   in the Delaware General Assembly. “The Construction Industry Independent Contractor 3d construction man with hard hat and blueprintAct,” HB129,   which is similar to one that failed to pass during the last legislative session, creates a presumption that an individual performing a service “in the making of improvements to real property” is an  employee rather than an independent contractor.  To overcome that heavy burden, an employer must prove that the individual is free from control or direction over the performance of that service, the service is outside the usual course of the employer’s business or performed outside of all of the employer’s places of business [seemingly impossible to prove in the context of a construction employer, who travels from place to place], and the individual is customarily engaged in “an independently established trade, occupation, profession or business.”

And woe to the employer who misclassifies, either unwittingly or knowingly.  The law not only contains criminal fines and imprisonment penalties, it also authorizes civil suits, including class actions, and allows attorney’s fee awards to prevailing plaintiffs. An employer who knowingly misclassifies an individual can also be debarred from working on public projects. The law also makes the Secretary of Labor the judge, jury and executioner, authorizing administrative monetary penalties if he or she decides that there has been a violation, subject only to a hearing that can be requested after the initial decision has been made.

Since the Act only applies  to individuals, employers wishing to engage legitimate independent contractors may wish to require them to incorporate or form limited liability companies before entering into an agreement for construction-related services.  As an alternative, the cautious employer may want to rely heavily on temporary job services, with the individual remaining an employee of the service company, which would be responsible for taxes, withholdings and other legal requirements.  Of course these approaches will cost more money, and one wonders why, in the midst of an economic crisis, the Delaware General Assembly would want to create additional financial burdens for companies. The only message that can be inferred from this one-sided legislation is that Delaware is less friendly to business than it used to be.

See prior posts about Independent Contractors: Employee Misclassification Prevention Act Update, Construction-Industry Employers Should Be Aware of Proposed Legislation, Pennsylvania House Passes Construction Industry Independent Contractor Act, Delaware Legislation Proposes to Criminalize Employment Law

Independent Contractor Update:  Earlier this year, legislation was introduced that would prevent employers from improperly classifying employees as “independent contractors” in order to avoid paying them overtime and benefits. The Employee Misclassification Prevention Act (H.R. 6111) hasn’t seen any activity since June, when it was referred to the House Ways and Means’ Subcommittee on Income Security and Family Support. (Readers may recall that this was the same time that the Delaware and Pennsylvania state legislatures were reviewing similar legislation). 

In light of the impending change in the White House and the pro-union legislative efforts that are sure to follow, it may be time to take a second look at the Employee Misclassification Prevention Act. (Especially since President-elect Barrack Obama was one of two Senators to introduce S. 2044, called the “Independent Contractor Proper Classification Act of 2007,” which would repeal section 530 safe harbor for classifying workers as independent contractors.)

Aside from clarifying that misclassifications are a prohibited act under the FLSA, the proposed bill would also increase penalties under appropriate circumstances and require the U.S. Department of Labor (DOL), and the states to work together to better detect misclassification. In addition, the bill would: (1) require employers to designate on their employee’s records whether they are an “employee” or “independent contractor;” (2) require employers to notify workers of that classification and their right to challenge it; and (3) require state unemployment insurance agencies to audit employers to identify employers who are misclassifying employees.

The DOL and Internal Revenue Service (IRS) would also be required to share information on cases where employers misclassify workers. In addition, the proposed bill would mandate that the DOL perform targeted audits focusing on employers in industries that frequently misclassify employees. Presumably, the construction industry would be a prime target, in light of the fact that the industry was the focus of both Delaware and Pennsylvania’s proposed laws, both of which shared the same name, the Construction Industry Independent Contractor Act.

According to the latest comprehensive study by the IRS, 15% of employers in the U.S. were misclassifying employees as independent contractors. 3.4 million employees were affected. The IRS’s findings are similar to those of the May 8, 2007, report by the Government Accountability Office. The report, titled “Employee Misclassification — Improved Outreach Could Help Ensure Proper Worker Classification,” concludes that there were 10.3 million independent contractors in 2005. That number grew from 6.7% of the total workforce in 1995 to 7.4% in 2005.

And what’s so bad about misclassification? For one, misclassification costs the Treasury billions in lost revenue. Additionally, improper misclassification artificially lowers costs for those businesses that engage in the practice. In turn, the businesses that follow the rules are put at a competitive disadvantage. But the real focus of the proponents of the legislation has been the potential harm to the employees who do not have access to the benefits and protections to which they are entitled under the law.

Misclassification violates the Fair Labor Standards Act (FLSA), because it enables employers to avoid meeting the mandatory minimum wage and overtime requirements. And, just as they are exempted from the requirements of the FLSA, independent contractors also are not protected by worker’s compensation and discrimination laws and are not entitled to unemployment insurance.

The employers’ perspective is equally compelling. For a variety of reasons, such as fluctuating work demands and seasonality, many businesses cannot afford to maintain a workforce comprised exclusively of year-round employees. Independent contractors provide a solution to the demand for personnel with specialized skills and knowledge that may be required for short-term projects. Additionally, the ability to set one’s own schedule is seen by many as an attractive benefit.

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