As global competition and technological change progressively require more worker specialization and just-in-time delivery of highly specialized talent, the pressure on businesses to engage consultants on an independent or “gig” basis continues to grow, especially for high-end, knowledge-based consultants. And while some independent contractors would prefer to be employees, surveys suggest independents are the most satisfied worker group in the United States.
Yet numerous stakeholders — including government taxation bodies, workers’ rights advocates and social commentators — bemoan the drive toward flexible, independent and gig engagements. While advocates tend to focus on lower-end, low-wage independent workers, the rules that apply to them apply to high-end knowledge workers and consultants as well. This has led to a clash, and there appears to be no end in sight.
The economy, the drive for efficiency, technological innovation, and the entrepreneurial spirit of individual workers themselves continue to force independent engagement, and some stakeholders consider this to be a disaster. Given this seemingly unavoidable conflict, it is important to periodically take stock of issues affecting IC engagement. Here are five such areas.
State tests and Dynamex. In Dynamex Operations West Inc. v. Superior Court of Los Angeles, the California Supreme Court adopted a new test for employee status in California, which presumes that workers are employees, unless the “employer” proves:
- The worker is free from control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- That the worker performs work that is outside the usual course of the hiring entity’s business; and
- That the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
Unlike federal tests and tests applied by most other states, an employer must prove all three elements in order for a worker to qualify as an independent contractor in California. The “A” and “C” elements are not new. These are elements that businesses would have been ready and able to prove before Dynamex.
The fly in the ointment is the “B” element of the test. The work must be “outside the usual course of” the hiring entity’s business. There are two problems with the B test. First, in some cases, businesses are engaging independent contractors to perform work that is part of the usual course of their business. This is done either to supplement the existing workforce, or to provide specific expertise in a particular area. Under existing state and federal law, this is normally not a problem.
An accounting firm can hire an extra accountant as an independent contractor; a construction company can hire an extra architect, etc. But, under the new Dynamex test, this is prohibited. The construction company that hires an extra architect must treat the architect as an employee, because the architect will fail the “B” test. This is true even if the architect has her own office, hundreds of her own clients, other employees, etc., and even if the architect would clearly and unequivocally “pass” as an independent contractor under the IRS test and other tests. Dynamex will move many bonafide ICs to employee status or move the work out of California.
The second major problem with the “B” test is determining what it means to perform tasks that are “outside” of the usual course of the hiring entity’s business. Businesses will have to wait to see how California interprets this concept. Assessments that may seem like common sense to businesses that a worker is performing functions outside of the entity’s “usual course of business” may not be so common sense to California Department of Labor staff, plaintiffs’ lawyers and courts.
If independent work can be performed anywhere other than California, businesses are incentivized to move the work. If the work must be performed in California, many businesses are taking a cautious “wait and see” approach to Dynamex, and defensively classifying all or virtually all workers in California as employees for the immediate future until the dust settles on how Dynamex is interpreted.
As difficult as Dynamex is, it is also emblematic of the bigger problem — a developing patchwork-quilt of local laws pushing businesses to engage workers as employees. Perhaps the greatest IC compliance challenge today is keeping up with the proliferation of new and changing tests for employee status.
Benefits. For the most part, the Employee Retirement Income Security Act of 1974, or ERISA — the main federal law governing employee benefit plans — permits businesses to exclude contingent workers and workers classified as independent contractors from participation in employee benefit plans, even if the workers are misclassified. In addition, a company’s interpretation of any language excluding ICs is likely to be accepted by a reviewing court. ERISA permits the very deferential “arbitrary and capricious” standard of review. In other words, a reviewing court does not determine whether the worker was misclassified. Rather, the reviewing court determines whether the plan administrator was “arbitrary and capricious” in interpreting the exclusion language in an ERISA plan, which is much more difficult to prove for a plaintiff than proving misclassification.
Even when workers are excluded from receiving benefits under an ERISA plan, it is usually necessary to confirm that such exclusions do not violate the rules that govern nondiscrimination. Many benefit plans must be tested to ensure that the benefits and coverage do not disproportionately favor highly compensated employees. To further complicate those matters, certain workers known as “leased employees” need to be included in the testing even though they are not common law employees. Employers often miss counting the leased employees in the nondiscrimination numbers, which can have an unexpected and sometimes problematic impact on the nondiscrimination testing. In short, the nondiscrimination testing area is a potential landmine for any employer with a large contingent workforce.
The best course is to simply review benefit plans and assure that proper worker exclusion and standard of review language is present. Most businesses have already done this. In any case, businesses should periodically review their benefit plans. This is the best defense to unanticipated benefits liability for potentially misclassified workers.
Arbitration. Following the United States Supreme Court decision in Epic Systems, businesses can, in most cases, effectively bar class litigation for employees and putative independent contractors. Arbitration has many shortcomings. Businesses that believe they will get a better result in arbitration, or who believe that arbitration will be more predictable or less expensive than court litigation, are usually wrong. With that said, there is a potential significant advantage in avoiding class litigation. Businesses that have not already done so should consider adopting arbitration agreements with class waivers.
Expenses. Perhaps the easiest thing businesses can do to mitigate the risk of independent contractor misclassification is to discipline themselves to stop reimbursing expenses. This is perhaps the most common IC classification mistake businesses make, and one of the easiest to fix. Independent contractors have opportunity for profit and risk of loss. That is one of the main features of IC status under many tests. In many cases, businesses want to insulate highly sought-after talent from the ups and downs of business.
Reimbursing expenses is one way to do this. In doing so, however, the businesses insulate the workers from some of the very facts that make them independent contractors in the first place. If businesses want to make sure they get the talent they really want, they can increase the pay rate for that talent. Businesses should stop reimbursing expenses for anyone they are serious about treating as independent contractors. There are exceptions to this rule, but the exceptions should be exceptions.
Contract forms and insurance. A contract with an independent contractor is a business-to-business contract, and should borrow from vendor contracts, not employee contracts. One of the ways businesses self-create problems is by beginning IC engagements with employment template documents. Businesses engaging an independent contractor should start with vendor template documents, thus avoiding employment-looking language.
At the same time, however, businesses using vendor contracts as templates will very often run into the problem of standardized terms for required insurance. Independent contractors have expenses. Especially for knowledge workers, who in many cases do not need any equipment or resources to perform a job, coming up with expenses for a putative independent contractor can be difficult; in some cases, they do not have many, if any, expenses, whether they would be classified as employees or independent contractors. Insurance is a legitimate business requirement which can show fixed and recurring expenses for independent contractors.
Waiving insurance requirements can be a mistake. Businesses should be careful not to waive insurance requirements for putative independent contractors without thinking through the consequences of this waiver, especially as applied to the underlying independent contractor status of the workers.
Meanwhile, some insurance requirements make no sense and can chase away talent. In many cases, someone, at some time, spent a lot of time deciding what insurance types and what policy limits to require from vendors. Taking these insurance requirements “off the shelf” can make sense in some cases; but, if it makes sense, this is usually just “luck.” The insurance requirements in a standard template document will often not make any sense as applied to an individual contractor/consultant. A good best practice is to periodically have an insurance broker review insurance requirements for vendors to ensure that the engaging entity is actually asking for insurance coverage, and policy limits, that make sense as applied to work the contractor is doing.