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Microsoft needs no introduction to the average American. Its near-monopoly of the computer operating system market and the vast wealth obtained by its founders and many of its employees through its stock option plans are well-known to the layperson. However, far fewer are aware of an actively litigated suit against Microsoft that is of great significance to employment lawyers — the class action suit in Seattle in which several thousand of its “permatemp” or long-term temporary employees are claiming the benefits enjoyed by Microsoft’s regular employees. [FOOTNOTE 1]This litigation has important implications for the increasing numbers of independent contractors and other temporary employees employed in the modern workplace. MICROSOFT’S WORKPLACE CASTE SYSTEM During the 1980s and early 1990s, Microsoft maintained a two-tiered workforce. Many of its workers were its regular employees, who were eligible to participate in the full spectrum of its benefits packages, including pension and stock option plans. A significant number of Microsoft’s workers, however, were the so-called “permatemp” employees — those who worked for a number of years but were denied the opportunity to participate in Microsoft’s fringe benefits. These permatemp employees were not hired or employed through a staffing agency but were hired directly by Microsoft to provide what the company called “contract services.” Microsoft set up a subtle caste system to distinguish between permatemps and its regular employees: permatemps had a differently-colored identification badge, were not invited to holiday and social events, could not participate in employee clubs, and could not purchase Microsoft goods in the company store. More importantly, Microsoft created very different compensation packages for the two groups: in exchange for a salary rate that was supposedly slightly higher, the permatemps were denied the opportunity to participate in any of the company’s benefit plans. Nonetheless, the workplace similarities between the groups at Microsoft were greater than the differences: the permatemps (1) had offices and email addresses at Microsoft, (2) spent months to years working on various projects, (3) were supervised and evaluated by Microsoft managers, and (4) some permatemps themselves supervised regular employees. THE PERMATEMPS ARE COMMON-LAW EMPLOYEES OF MICROSOFT The starting point of this litigation was an IRS letter ruling that held that the permatemps “were not independent contractors but [were] employees for withholding and employment tax purposes.” [FOOTNOTE 2]There are a number of common-law factors that determine whether a worker is an employee or an independent contractor. [FOOTNOTE 3]The Supreme Court, in Nationwide Mutual Ins. Co. v. Darden, adopted a non-exhaustive listing of twelve such factors in considering whether “the hiring party’s right to control the manner and means by which the product is accomplished” made a worker an employee, rather than an independent contractor. [FOOTNOTE 4] These factors are: (1) the skill required; (2) the source of the instrumentalities and tools; (3) the location of the work; (4) the duration of the relationship between the parties; (5) whether the hiring party has the right to assign additional projects to the hired party; (6) the extent of the hired party’s discretion over when and how long to work; (7) the method of payment; (8) the hired party’s role in hiring and paying assistants; (9) whether the work is part of the regular business of the hiring party; (10) whether the hiring party is in business; (11) the provision of employee benefits; and (12) the tax treatment of the hired party. [FOOTNOTE 5] For Microsoft, it was the fact that it directly controlled the terms and conditions of the permatemps’ employment that led to the IRS letter ruling. [FOOTNOTE 6]In an attempt to make it appear that it did not control the permatemps’ employment, Microsoft “converted” all of its permatemps into either: (1) regular employees; or (2) employees who worked for “a new temporary employment agency” that would act as the ostensible employer of the former permatemps. [FOOTNOTE 7] Despite those changes, the second category of former permatemps “noticed little change in the terms or conditions of their employment; they continued working the same hours on the same projects and under the same supervisors.” [FOOTNOTE 8]Further, these workers still received none of Microsoft’s fringe benefits. Notwithstanding these “changes,” about a third of Microsoft’s current workforce remain temporary employees. Several former permatemps who found themselves in the latter category, as well as some who refused to accept this change in their status and were terminated, filed a class action in Seattle alleging that the denial of their right to participate in Microsoft’s fringe benefits package, especially its pension plan and its Employee Stock Purchase Plan (“ESPP”) violated the Employee Retirement Income and Security Act (ERISA) and the federal tax code, respectively. This litigation is still pending before the federal district court on remand — after not one but three appeals by Microsoft to the 9th U.S. Circuit Court of Appeals, all of which the 9th Circuit rejected, and the Supreme Court twice denied certiorari. Despite the attempts by Microsoft to run its permatemp employees through outside staffing agencies, the 9th Circuit continued to find that they were common-law employees of Microsoft, entitled to participate in its stock option and pension plans. This litigation has led to several major changes regarding the treatment of permatemp employees by Microsoft and will inevitably lead to similar changes by other large employers. PERMATEMPS AND ERISA PENSION PLANS Microsoft’s pension plan (Savings Plus Plan, “SPP”) was a Section 401k deferred compensation plan that allowed Microsoft employees to set aside up to 15 percent of their income, with Microsoft matching the contributions up to a certain level. The permatemps alleged that the denial of their participation in the SPP violated Section 502(a) of ERISA, 29 U.S.C. � 1132(a). The 9th Circuit found that there was such a violation, but on grounds that may not be applicable to all employers. Microsoft’s pension plan stated that it was open to “any common-law employee who receives remuneration for personal services rendered to the employer and who is on the United States payroll of the employer.” [FOOTNOTE 9]Thus, because Microsoft’s SPP was by definition open to all such common-law employees, the judicial determination that the permatemps were common-law employees of Microsoft made the permatemps eligible to participate in the SPP. In analogous litigation, the Department of Labor recently sued Time-Warner, claiming that Time-Warner breached its fiduciary duty to its employees on the ground that numerous common-law employees were erroneously classified as freelancers or independent contractors, and thus, were wrongfully denied participation in Time-Warner’s benefits plans. [FOOTNOTE 10] This statutory remedy may not be open to permatemps if other employers have adopted narrower definitions of “eligibility” to participate in pension plans. If an employer’s pension plan expressly defines “employee” to exclude leased or temporary employees, then such persons cannot invoke ERISA to claim a right to participate in the pension plan. For example, the 11th Circuit recently held that leased employees of Coca-Cola could not participate in its pension plans for that very reason. [FOOTNOTE 11] PERMATEMPS AND EMPLOYEE STOCK PURCHASE PLANS Microsoft’s stock option plan (ESPP) is governed by Section 423 of the Internal Revenue Code, 26 U.S.C. � 423 (“Employee Stock Purchase Plans”), which requires that such plans be extended to “all employees.” As for the ERISA claims, the 9th Circuit held that definition of employee under the tax code was based on the aforementioned common-law factors set forth in Dardenregarding the right of the employer to control the employee. [FOOTNOTE 12]Thus, the 9th Circuit’s finding that the Microsoft permatemps were common-law employees of Microsoft made the permatemps eligible to participate in the company’s ESPP. There exist safe harbors for the employer under which permatemps can be excluded from participation in the ESPP. The tax code, 26 U.S.C. � 423(b)(4)(A), “allows an employer to exclude all short-term employees — those “who have been employed less than 2 years” — from the ESPP. Microsoft invoked this statutory safe harbor by requiring that, as of July 1, 2000, contract employees can work at Microsoft for at most one year, upon which they must take at least 100 days “off” before returning to Microsoft.” [FOOTNOTE 13]Microsoft will be spinning its contract employees through the 100-day revolving door in order to avoid any future statutory obligation to include such employees in its ESPP. Even though Microsoft could have allowed those employees to work just short of two years, Microsoft, smarting from successive litigation losses, decided to play it safe by cutting the employees’ employment off after one year. PERMATEMPS: THE OUTLOOK The Microsoftpermatemp litigation has shown how employers may redefine their pension plans and restructure their use of permatemps in order to exclude these employees from their pension and stock option plans. Even where plaintiffs’ attorneys are able to obtain favorable judicial determinations, the practical consequence is that the remedy may not extend into the future. Although such steps may benefit Microsoft in the short run, one can only wonder whether independent contractors will want to work for Microsoft in the future given these new limitations on the duration of their contracts with Microsoft. Highly skilled permatemps may choose to “vote with their feet” and avoid Microsoft in favor of other, more enlightened employers. After all, the purpose of giving stock options to employees is to ensure their long-time service to the employer, even when they are receiving lower wages. Thus, employees will see little reason to stay for long at companies with poor wages if they are ineligible for “long-term” benefits such as stock options. Marketplace economics may take over where the law stops, giving companies an incentive to provide highly skilled permatemps with better benefits to keep them working for the long term and without interruption. This article is excerpted with permission from CCH’s Journal of Employment Discrimination Law, Summer 2000 Edition. Lynne Bernabei is a partner at the Washington, D.C. law firm, Bernabei & Katz PLLC. She represents plaintiffs in employment discrimination, civil rights, and whistleblower cases. She has published widely in the area of employment discrimination and is a frequent commentator for national news programs. Alan R. Kabat, an associate with Bernabei & Katz, assisted with the research for this column. FOOTNOTES: FN1This litigation has a protracted history. See Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1996); Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997) (en banc), cert. denied 522 U.S. 1098 (1998); In re Vizcaino, 173 F.3d 713 (9th Cir. 1999), cert. denied, 120 S. Ct. 844 (2000). FN2 Vizcaino I, 97 F.3d at 1190. FN3See, e.g., RESTATEMENT (SECOND) OF AGENCY, � 227 (1958); Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318, 323-24 (1992); “Employment Status under Section 530(d) of the Revenue Act of 1978,” Rev. Rul. 87-41, 1987-1 INTERNAL REVENUE CUMULATIVE BULLETIN296(setting forth twenty-factor control test). FN4 Darden, 503 U.S. at 323 (quoting Community for Creative Non-Violence v. Reid, 490 U.S. 730, 751 (1989)). FN5Id. at 323-24 (quoting Reid, 490 U.S. at 751-52) (bracketed numbering added). FN6 Vizcaino III, 173 F.3d at 723-24. FN7 Vizcaino I, 97 F.3d at 1191. FN8Id. FN9 Vizcaino I, 97 F.3d at 1192. FN10 Herman v. Time-Warner Inc., 56 F. Supp. 2d 411 (S.D.N.Y. 1999) (denying defendants’ motion to dismiss). FN11 Wolf v. Coca-Cola Co., 200 F.3d 1337, 1340-42 (11th Cir. 2000). FN12 Vizcaino III, 173 F.3d at 723-24. These factors are set forth in note 5, supra. FN13See Microsoft Policy Statement: Length of Assignment Time for Agency Temporaries, http://washtech.org/roundup/contract/031300_msbreak.html . See generally J. Cook, Microsoft Limits Amount of Time Temps Can Work; New Policy Could End Its ‘Permatemp’ Problem, SEATTLE POST-INTELLIGENCER, Feb. 19, 2000; Microsoft to Limit Term of Temporary Workers, WASH. POST, Feb. 21, 2000, at A15. � 2000, CCH INCORPORATED. All Rights Reserved.

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