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Labor: 4 steps to identifying and handling high-risk independent contractors

Reducing wage and hour liability in 2012

The misclassification of independent contractors will likely be one of the hottest wage and hour issues of 2012. The processes discussed below will assist in-house counsel in identifying potential high-risk contractors and reducing overall liability.

1. Identify Independent Contractors When the government conducts a misclassification audit, the Department of Labor (DOL) requests all 1099 tax forms and cash ledgers for the past three years. In-house counsel should review these documents for high risk contracts, paying particular attention to:

  • All payments to individuals
  • All payments to any company or entity that does not have an employee identification number (EIN)
  • All recurring payments to the same entity

2. Obtain Contracts Employers need to obtain contracts for each of the entities identified above, as a written agreement is the first line of defense against misclassification claims. If no written agreement exists, then the company should determine who entered into the agreement on the company’s behalf and the agreement’s original terms. After determining whether any liability exists, it is strongly recommended that the parties immediately enter into a written agreement.

3. Review Contracts Contracts should not only provide a clear description of the relationship between the parties, but should also guarantee that the contractor is in compliance with all employment and immigration laws. It is recommended that contracts contain a provision that allows the company to randomly audit the contractor for compliance. The audit provision should create an explicit duty on the contractor to correct any issues revealed during the third-party audit.

The contract should also include an indemnification and duty to defend clause for any matter related to compliance with employment laws. This clause should include a duty to cooperate, stipulations that could serve as the basis for an injunction, recovery rights for lost profits and good will, a duty to pay for public relation firms when necessary, and a duty to produce all copies of records provided to a government agency. Finally, it is recommended that the contractor agree to arbitrate all employment related matters and obtain arbitration agreements from each of their employees who will perform work on the contract.

4. Examine Work Environment Even if the contract looks great, it is still important to get a sense of how work is actually performed. Some companies develop contractor surveys but, as surveys may result in the creation of evidence that could be used against the company, I recommend onsite visits.

During the visit, the company’s attorney should observe the following:

  • Do the contractors’ employees punch a company time clock or are they listed on a schedule?
  • Who assigns the contractor or its employees tasks or work?
  • Does the contractor or its employees have control over how the work is performed and where it is performed?
  • Is the contractor or its employees interchangeable with the company’s employees – do they work side by side?
  • Who supervises the contractor or its employees?
  • When the contractor makes a mistake, are they disciplined or told that they are in breach of contract?
  • Does the contractor or its employees participate in company meetings or training or follow company procedures?
  • Who pays the contractors’ expenses?
  • Who owns the tools and equipment used to perform the work?

A simple test is to approach a contractor working for your company and ask: “What are you working on? Who told you to work on this? How do you know how to perform this task? If something goes wrong who do you go to? Who determines if you are doing a good job? Who do you tell if you need to leave early or will be out sick?”

If the answers to any of these questions indicate someone at the company instead of the contractor, there may be a misclassification issue.

High-risk Areas: Red Flags

The following are areas in which there are reoccurring misclassification issues:

  • Temporary Employment Agencies: Often companies will retain the services of temporary employment agencies to avoid misclassification issues. However, a common technique used by the DOL is to target a temp agency and investigate its clients. If an agency is improperly paying its employees then the DOL will pursue the matter against its clients as joint employers.
  • Former Employee Consultants: This violation often occurs when companies try to assist a former employee. The most common example is the retiree or former employee who is hired as a consultant to perform the same work he did while employed, but on a part-time basis.
  • Seconded Consultants: Most of the time, these consultants are skilled professionals who come from large companies. Often these consultants are brought in for a specific project but are so well-liked that they are integrated into the workforce. Typically, such consultants work only for one company and are present during business hours. These consultants, even if they are skilled professionals, such as nurses, lawyers, accountants and industrial psychologists, are probably misclassified contractors.
  • Sales Representatives: Sales representatives in various industries are considered and paid as independent contractors. These employees tend to have flexible schedules and little supervision; however, these factors alone are not sufficient to overcome a misclassification claim.
  • Installers and Delivery/Couriers: Generally, these employees do not report to a set location. Rather, they receive assignments at home and report to various locations to perform work. Examples include cable installers, HVAC professionals, fire alarms installers, computer repair, route drivers, distributors, marketing representatives and product demonstrators.

Unfortunately, there is no easy checklist to determine whether a contractor is misclassified. The best approach is to set parameters for entering into contracts that will identify high-risk contracts within the company. Educating your business partners to notify legal prior to hiring a high-risk contractor is the best way to prevent misclassification liability.

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