Four grim faces glared at the audit partner at the opposite end of the table.
“Let me get this straight,” growled the CEO, “You won’t sign-off on our audit until we do something about this contingent liability connected to that anti-trust suit, right?” The auditor nodded. The CEO turned his icy stare on the general counsel and said, “I thought you said this case was nothing more than an overblown nuisance suit.”
The lawyer objected. “It’s not the litigation per se; it has more to do with how we’re litigating.”
“Go on,” replied the CEO, “You’re just a model of clarity.”
“If you’ll remember, the court ordered all five defendants to comply with plaintiff’s discovery requests and not only produce all the paper files but also electronic data, including email from dozens of employees. We needed a small army of attorneys to review not only our documents, but also those of the other defendants.”
The CFO took over the explanation, “Outside counsel offered to bring in extra staff on a contract basis to handle it, but they were going to charge us their regular billing rates. Based on our projections of the time involved, the cost was unbearable. It was cheaper for us to bring on the contract attorneys directly, give them computers and set them up in some excess office space we had on the seventh floor.”
“And because it was such a short-term project,” added the Director of Human Resources, “we decided to keep them off the payroll. It eliminated the need to add them to the company’s benefits plans or pay FICA or unemployment taxes or worker’s comp. We anticipated savings of something in the range of $2 million.”
At this point the general counsel re-joined the conversation, “But that was fifteen months ago, and in the interim, Congress passed EMPA. There are serious questions whether these contract lawyers are really employees not true independent contractors. If they wake up and challenge their classification, the company could be on the hook for tens of thousands of dollars in unpaid health insurance and pension benefits.”
The CEO looked around the table at the others in the room, saying, “I still don’t understand. That certainly can’t be a material amount.”
“But,” said the auditor quietly, “If the retirement plan loses its status as an ERISA plan because you did not include otherwise qualified employees …”
The Impact of EMPA on FLSA
If enacted, the Employee Misclassification Prevention Act (H.R. 5107 and S. 3254, introduced April 22, 2010, collectively “EMPA”) will amend the Fair Labor Standards Act of 1938 (“FLSA”), potentially producing a sea of change in the hiring of “non-employees who perform labor or services for remuneration,” a/k/a “independent contractors.” As with most legislation, some contend this bill is a pre-cursor to the rise of socialism in the United States while others insist it is a necessary evolution of labor law to protect workers with little or no leverage against abuse from their employers. As with most legislation, the reality is somewhere in the middle, but it will nonetheless require a fundamental appraisal of relationships with non-employee workers and coordination among multiple constituencies in many organizations.
Generally, classification of workers is an issue of control. All employer/worker relationships involve an exchange of services for compensation. Where the employer merely defines the outcome of the service, for example hiring an electrician to install a light fixture in a particular location, the worker is purely a service provider and properly classified as an independent contractor. At the other end of the spectrum, when the employer provides all of the necessary tools and supplies to perform the service, determines the specific procedures to be performed and provides training on those procedures, etc., the worker is indisputably an employee. The real issues arise when the degree of service recipient control falls somewhere in the middle.
Failure to properly classify employees has always been unlawful, but until recently, enforcement of the rules was lax. Often businesses would make classification decisions based on rationales having nothing to do with the degree of control over the worker. These reasons could be convenience (a sole proprietor taking on one or two workers who doesn’t want the burden of calculating withholdings and filing payroll tax returns), budget (a department which has expended its payroll budget but has funds available for consulting fees) or the worker’s request (a worker who wants to set money aside in a pension plan working for a company with no retirement benefits). Knowing there was a risk of misclassification issues, businesses would proceed because the prospect of audit, and therefore discovery, was remote and the penalties limited.
Substantially increased risks with EMPA
EMPA does not change the nature of employee classification; rather it raises the stakes of misclassification by approaching the issue from two sides – employer responsibilities and enforcement. As presently drafted, EMPA imposes notice and record-keeping requirements on recipients of services from non-employee workers. EMPA also makes misclassification a prohibited act under the FLSA providing a private right of action to allegedly misclassified workers. Thus, even if the risk of audit from a governmental agency continues to be remote, the prospect of workers pursuing misclassification claims on a class-wide basis looms over any business using independent contractors in any meaningful way.
Under EMPA, the stakes change. The risk will no longer be the odds of being audited combined with the relatively small exposure of unpaid payroll taxes. Under EMPA, the risk is that a dissatisfied independent contractor pursuing a claim on behalf of all independent contractors will seek damages which could conceivably include:
- Unpaid overtime, holiday, vacation or other paid time off in accordance with company policy and procedure;
- The value of health, life or disability insurance which was provided to other employees as part of the company’s standard benefits package;
- The cost of self-paid training, tools or work-related supplies if company-paid for other employees;
- Forgone retirement benefits, including amounts which might have been withheld from compensation for deposit into a qualified retirement plan; or
- The value of stock which would have been available in the form of options or direct grants had there been proper classification.
Entities which operate with a significant level of non-employee worker have two choices address this issue: restructure the positions filled with non-employee workers to reduce control over the manner of performance or convert independent contractors to employees (either of the company or of a separate company which, in turn, leases staff to the entity using the person’s services). Whichever option is chosen, the company will need to coordinate a variety of constituencies to achieve a satisfactory outcome. Finally, a consultant can be useful in assessing exposure which often is the first step in evaluating whether and how to deal with the issue.
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