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The days when the traditional employer-employee relationship had a monopoly on the American workplace are long behind us. Today, an extensive array of other options are available to the savvy employer, including temporary help, leased workers, independent contractors, master vendors and outsourcing. Startup and established technology companies alike, from the Alley to the Valley, see these contingent workers as a quick panacea for the host of complexities inherent in hiring and retaining a full-time staff of employees. To the extent that this mindset reflects the fact that a contingent workforce offers a flexibility and ease of implementation that more traditional workforces lack, the perception is often correct. Too often, however, these very virtues blind managers to the potential pitfalls of contingent workers, and the fact that their misuse can cause severe and sometimes crippling economic damages to companies. The most significant legal problems companies face in this area generally arise from misclassification or mistreatment of workers. Misclassification problems most commonly occur when a company labels a worker — usually in good faith — as an independent contractor only to be told later by a court or government agency that the worker is really an employee. Mistreatment problems occur when a company treats a true contingent worker in such a way as to become a “joint employer” of that worker. This article provides an overview of the typical liabilities a company may face when it uses — or misuses — contingent workers. It also suggests steps a company should take to avoid contingent worker misclassification and mistreatment problems that can lead to liability. MISCLASSIFICATION RISKS Just because management does not think that a given set of workers are “employees” in the traditional sense, and just because the written agreement between the worker and the company labels the worker as an “independent contractor” or other type of contingent worker, does not mean that the courts or the IRS will concur in that judgment. This is problematic because misclassification errors may not be discovered until years into a relationship in which the company has been operating under the erroneous belief that the worker was not an employee. A subsequent finding that an employer-employee relationship exists will impose a panoply of duties and obligations on a company that will be considered to have been running to the worker and the government since the onset of the relationship. In such instances, by the time the issue is finally adjudicated before a judge or administrative agency the company may be exposed to judgments that can, in extreme cases, threaten its continuing existence. Identifying misclassification situations would be relatively easy if there were a concise, invariably accurate definition that could be used in every situation to determine whether or not the worker in question is an independent contractor. Unfortunately, however, there is no such definition, and the courts and agencies employ a highly fact-sensitive, case-by-case analysis. Generally, most fact finders rely in one form or another on the common law, 20-factor test developed by the IRS for determining whether a worker is truly an employee. [FOOTNOTE 1]In essence, these 20 factors seek to determine who is controlling the means and methods of a worker’s performance, i.e., “who controls the when, where and how” of the work. If the company retains the right to control the means and methods of performance, the worker will be considered an employee. In contrast, if the company simply defines the objective and sets a deadline for completion, leaving to the worker the control over how the objective is accomplished, the worker will be considered an independent contractor. Perhaps the most ominous liability a company faces when it misclassifies a worker as an independent contractor rather than an employee is employment tax liability. Some experts have estimated that Silicon Valley employers have already paid more than $50 million in back taxes and fines for misclassifying its workers. As a general matter, businesses are under no duty to deduct employment taxes — such as those for income, Medicare, Social Security, and unemployment — from the payments made to independent contractors. However, where a company fails to withhold from an employee, the IRS can require the company to pay the full amount of payroll taxes owed by both the company and the employee, and it can also impose other penalties and fines on top of those back taxes for failure to file accurate reports and returns. [FOOTNOTE 2]Given the potential exposure, it is easy to envision how a judicial determination that a company’s groups of “independent contractors” are in actuality “employees” could be fiscally devastating. Misclassifying workers as independent contractors can also result in significant liabilities under ERISA. As a general matter, a benefit plan is only regulated by ERISA if the plan contains at least one common law employee as a participant. [FOOTNOTE 3]As soon as this one employee test is met, however, ERISA will govern the plan as to all participants in the plan, regardless of their employment status. Thus, a determination that a company misclassified its workers as independent contractors rather than employees can result in the statute’s affecting and governing a plan that would otherwise be free of its constraints. Although ERISA does not require that a company offer a benefit plan at all — or even mandate that all employees be entitled to participate in a plan a company chooses to offer — �510 of ERISA does make it illegal to discriminate against a covered employee so as to interfere “with the attainment of any right to which such participant may become entitled under the plan.” [FOOTNOTE 4]Recent cases have suggested that classifying an employee as an independent contractor in order to render the worker ineligible for employee benefits under the company’s plan may violate �510. [FOOTNOTE 5] The language of a company’s benefit plans may also contain an enormous latent misclassification liability. As Microsoft Corp. learned, workers who are classified by the company as independent contractors and who are thereby excluded from the benefit plans because of that classification may later sue the company under the theory that they are in reality employees who are entitled to participate retroactively in the company’s benefit plans. [FOOTNOTE 6]In the Microsoft case, a group of workers filed a class action lawsuit against Microsoft asking the court to award them retroactive coverage under the company’s 401(k) and stock purchase plans. Those workers, called freelancers by Microsoft, had all signed agreements stipulating that they were independent contractors and they were paid through Microsoft’s accounts payable department, not its payroll department. During an employment tax audit, Microsoft settled with the IRS and conceded that the freelancers were, in fact, common-law employees after it became apparent that Microsoft had exerted control over how these freelancers functioned day to day at the company. After the settlement with the IRS, Microsoft gave some of the freelancers the chance to convert to regular employees. The remaining freelancers were told that if they wished to continue working for the company, they would have to do so through an employee leasing agency. In response, the freelancers sued, alleging that by barring them from participating in Microsoft’s employee stock purchase plan and its 401(k) plan by virtue of their classification as independent contractors, Microsoft had violated the law and its own benefit plans. The contract terms of Microsoft’s stock purchase plan stated that the plan covered “all employees.” Based on this provision, and in light of the IRS settlement in which Microsoft conceded the freelancers’ status as common law employees, the court ruled that the workers were wrongfully excluded from participating in the stock purchase plan. The 401(k) plan posed a thornier issue because that plan covered “any common-law employee” who was on the domestic “payroll of the employer.” Because the freelancers were paid through the accounts payable department and thus were not technically on Microsoft’s payroll, the court sent this aspect of the case to the plan’s administrator for a determination. The court stressed that in the context of temporary help, the burden of demonstrating the contingent status of the workers rests on the employer. ARE YOU A JOINT EMPLOYER? In addition to the misclassification risks discussed above, liabilities can also arise under the joint employment (or co-employment) doctrine. This doctrine describes the legal relationship between two or more employers in which each has actual or potential legal rights and duties with respect to the same employee or group of employees. With contingent workers, the joint employment doctrine suggests that the fact that a worker is provided by a third-party staffing firm and is considered an employee of that staffing firm does not mean that the customer company for which the work is being performed will not also qualify as the worker’s employer. The factors used to determine joint employment status differ somewhat depending upon which statute or law is being analyzed. In general, however, courts look at the totality of the circumstances and focus on the “economic realities” of the work relationship. The most recurring factors relied upon are the customer company’s power to hire and fire the worker and the degree of supervision and control of the work schedule and other conditions of employment the customer company can exert. Where companies need to exercise control over their workers, including their contingent workers, a joint employer relationship may exist. In the event that a company is found to be a joint employer with a staffing firm, liability can arise in every area of the law that concerns an employer’s rights, duties, and obligations with respect to an employee or with respect to the government or a third party. Areas of particular concern include: � Wage and Hour Laws. The Department of Labor (DOL) has held that joint employers can be individually liable for minimum wage, overtime, and equal pay requirements. � Workers’ Compensation. In most arrangements, the staffing firm provides Workers’ Compensation insurance for the contingent worker. This will generally relieve the customer company from providing coverage, so the company should ensure such coverage is in place. � Anti-Discrimination Laws. The Equal Employment Opportunity Commission Policy Guidance on Contingent Workers states that where the customer company exercises control over the worker such that a joint employer relationship exists, the contingent worker is protected by and the company can be liable under the various anti-discrimination laws. � Family and Medical Leave Act (FMLA). DOL regulations provide that if a joint employer relationship is found between the staffing firm and the customer company, both entities must count the contingent worker in determining coverage under the FMLA, and the customer company cannot interfere with the worker’s exercise of his FMLA rights. � Traditional Labor Relations. Under the National Labor Relations Act, a customer company found to be a joint employer can be liable for unfair labor practices. The National Labor Relations Board has also made clear that it will hold union elections for proposed bargaining units that consist of regular employees and contingent “joint employees” where there is a community of interest between these groups. LIMITING YOUR RISKS All companies, especially those which are in the initial stages of developing their workforce, can best solve these problems by ensuring that they never occur in the first place. This not only requires the company to set forth the parameters of the relationship at the outset, but also requires being disciplined in managing the work relationship throughout the applicable work period. You must be constantly vigilant to ensure that the parameters you set at the beginning of the relationship do not erode over time. Before entering into an agreement for the services of any type of contingent worker, it is important to determine what your company is trying to accomplish through the use of a contingent worker or workers. Because there are so many different types of contingent worker arrangements, understanding the objectives will assist you in making the right decision on what type of arrangement, if any, best fits your company’s needs. For example, if cost savings is one of the objectives, it is important to chart the actual or estimated costs of having a traditional employee perform the same functions that you intend the contingent worker to perform. Assuming that an employee already performs those functions, this can be done by researching the actual costs associated with that employee. If it is a new position, you should attempt to estimate to the best of your ability the costs associated with filling the position with a traditional employee. Once you have determined your objectives, it is important to carefully research what options are available that will meet your needs. For example, if your main objective is to merely relieve the company of some of its personnel and payroll duties, selecting a payrolling arrangement will likely prove the best option. This will allow the company to retain control over the hiring, firing, and disciplining functions while shifting the administrative payroll functions to an outside agency. If the company hopes to accomplish several objectives, there will likely be several different alternatives available that will meet its needs. In choosing an arrangement that best fits your objectives, one of the most important aspects is understanding the respective responsibilities of your company and the agency with which you will contract. As explained above, entering into a relationship with a staffing firm or individual without understanding your legal obligations can prove costly. You should carefully select a reputable and financially stable agency, and verify its performance with others who have used it or who know its reputation. (There are several outstanding firms here in New York City with impeccable reputations in the high-tech industry.) You should monitor the agency to ensure that the payroll is being properly paid, including overtime and taxes, and you should ensure not only that the staffing firm provides workers’ compensation coverage, but also that it identifies the name of the carrier and agrees not to change that carrier without your consent. You will likely want your company to be covered under the policy so that your company has the protection of workers’ compensation exclusivity. In addition, you should review the firm’s equal employment opportunities and non-discrimination policies and you should obtain indemnification protection for certain employment-related claims. You should also review and revise your benefit plans to accurately reflect the exclusion or inclusion of contingent workers. As noted above, imprecise drafting in your benefit plans can lead to liability. If your company has an Employment Practices Liability Insurance policy, be sure to determine whether contingent workers are covered under that policy. Finally, you need to educate your managers and supervisors on the constraints inherent in a contingent worker relationship. They must be told that when contracting for the services of contingent workers, merely placing labels on the relationship in an effort to shift responsibility or liability to the other party will not prove successful. Indeed, courts routinely ignore the label when the day-to-day realities of the work relationship contradict it. To maintain the contingent worker status, the company must exercise restraint and cannot direct or control the contingent workers like it does its employees. Contingent workers are valuable options that should be considered by all companies. Outsourcing certain functions, however, will not “outsource” potential liability, and with many of the contingent worker arrangements, avoiding liability on the grounds that the worker is not the company’s “employee” will be an uphill battle. To reap the benefits of contingent workers you must structure your relationship with the agency or individual in a manner that will increase the likelihood that the contingent worker will not be considered the company’s “employee” and you must treat the worker in a manner such that the company will not be found a joint employer with the staffing agency. In the end, understanding the rules, and your potential for liability should a problem arise, is the only way to truly assess whether engaging the services of a contingent worker is the right decision for your company. Kenneth J. Turnbull is a partner in the labor and employment law department of O’Melveny & Myers LLP, and a member of the firm’s emerging companies/venture capital practice group. ::::FOOTNOTES:::: FN1 SeeIRS Rev. Rul. 87-41, 1987-1 C.B. 296. FN2 See, e.g.Internal Revenue Code �� 3102(b), 6672, 6721, 6722, 7501. FN329 C.F.R. � 2510.3-3(b). FN429 U.S.C. � 1140. FN5 See, e.g., Gitlitz v. Compagnie Air France, 129 F.3d 554 (11th Cir. 1997); Burditt v. Kerr-McGee Chemical Corp., 982 F. Supp. 404 (N.D. Miss. 1997). FN6 Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997) (en banc), cert. denied, 118 S.Ct. 899 (1998), opinion after remand at Vizcaino v. United States District Court, 1999 WL 300731 (9th Cir. May 12, 1999).

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