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Independent Contractor Agreements: Are They Worth the Risk??

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Jeffrey B. Oberman

Oberman Thompson & Segal, LLC

One Financial Plaza

120 South Sixth Street, Suite 850

Minneapolis, MN  55402

Telephone: 612-217-6441

joberman@obermanthompson.com

 

 

BUSINESS LAW INSTITUTE

Minnesota State Bar AssociationContinuing Legal Education

May 5-6, 2011

 

 

These materials are provided for educational and informational purposes only.They are not intended to constitute legal advice in any particular situation.

TABLE OF CONTENTS

Page

I.          Introduction …………………………………………………………………………………………… 1

II.        Why Businesses Prefer Independent Contractor Status……………………………… 1

A.        Taxes……………………………………………………………………………………………… 1

B…….. Benefit Plans…………………………………………………………………………………… 1

C…….. Workers’ Compensation…………………………………………………………………… 1

D…….. Unemployment Benefits…………………………………………………………………… 1

E……… FLSA Overtime Wages……………………………………………………………………. 1

F……… Liabilities……………………………………………………………………………………….. 1

G…….. Indemnification………………………………………………………………………………. 2

III.       The Government Has Noticed; Is Taking Actions; and Is Sharing Information……….. 2

A.        Federal Agencies…………………………………………………………………………….. 2

B.        Pending Federal Legislation……………………………………………………………… 3

C.        Minnesota Agencies…………………………………………………………………………. 4

D.        Minnesota Legislation………………………………………………………………………. 4

IV.       The High Risks of Being Wrong………………………………………………………………… 5

A.        Despite Well Drafted Agreements, Labels May Not Count………………….. 5

B.        “Domino Effect” of Legal Challenges to Worker Classification……………. 5

C.        Statutory Obligations and Penalties…………………………………………………… 5

D.        Litigation……………………………………………………………………………………….. 7

V.        Factors to Determine Employee v. Independent Contractor……………………….. 8

A.        IRS………………………………………………………………………………………………… 6

B.        Economic Realties Test and the Fair Labor Standards Act……………………. 9

C.        Federal Common Law Right to Control Test and

National Labor Relations Act……………………………………………………………. 9

D.        Minnesota Common Law…………………………………………………………………. 9

E.         Minnesota Regulations…………………………………………………………………… 10

VI.       Drafting Tips………………………………………………………………………………………….. 10

VII.     Conclusion……………………………………………………………………………………………… 12

VIII.    Appendix A………………………………………………………………………13


  1. I. Introduction

 

This article provides an overview of statutory, common law and contractual issues relating to the classification – or misclassification – of workers as independent contractors rather than employees.

 

  1. II. WHY BUSINESSES PREFER Independent Contractor status

 

In the modern workplace, the use of independent contractor relationships has flourished.  If businesses retain independent contractors, rather than hire employees, the businesses can often avoid social security and unemployment insurance taxes, payroll tax withholding obligations, insurance and retirement benefits, workers’ compensation obligations, overtime pay and other legal obligations to the person – as well as the obligation to defend and indemnify the person for actions done within the course and scope of the job.

 

  1. A. Taxes. Independent contractors are responsible for payment of their own taxes.  A principal of an independent contractor, unlike an employer of an employee, is relieved of the obligation to pay social security and unemployment insurance taxes, and need not withhold payroll taxes from payments made to the independent contractor.  See, e.g. I.R.C. §3509.

 

  1. B. Benefit Plans. Generally, independent contractors are not eligible for benefits under the principal’s employee benefit plans.  Employee benefits typically cost employers between fifteen to thirty percent of the base pay to their employees.
  2. C. Workers’ Compensation. Under the Minnesota Workers’ Compensation Act, only employees are eligible to collect compensation for work-related injuries.  Minn. Stat. § 176.021.  Employee is defined as “any person who performs services for another for hire.”  Minn. Stat. § 176.011, subd. 9.  Minn. Stat. § 176.041 lists numerous exceptions to the definition of “employee,” including an independent contractor.
  3. D. Unemployment Benefits. Minnesota’s unemployment insurance program is only applicable to individuals who meet the common law definition of the employer-employee relationship.  Minn. Stat. § 268.035. Employment includes service performed by “an individual who is considered an employee under the common law of employer-employee and not considered an independent contractor.” Minn. Stat. § 268.035, subd. 15 (1).
  4. E. FLSA Overtime Wages. Independent contractors, unlike employees, are not subject to the requirements of the Fair Labor Standards Act, including overtime.  See 29 U.S.C. §§ 206, 207.  Similarly, for purposes of the Minnesota statutes, employee is defined as “any individual employed by an employer.”  Minn. Stat. § 177.23 (7).  Workers who are properly classified as independent contractors are not employees, and therefore are not entitled to overtime pay.  Minn. Stat. § 177.25. 
  5. F. Liabilities.  In general, an employer is vicariously liable for acts committed by an employee that are within the scope of the employee’s employment.  See Laurie v. Mueller, 78 N.W.2d 434 (Minn. 1965).  This can include torts, negligence, and acts in furtherance of the employment.  See Stephen F. Befort, Employment Law & Practice 2d, 17 Minnesota Practice Series §8.2 (2003).  Conversely, a principal is not liable for the actions of an independent contractor in most situations, because independent contractors are “not subject to any control or right of control with respect to their physical conduct in carrying out the undertaking.” Urban ex rel. Urban v. American Legion Post 184, 695 N.W.2d 153, 160 (Minn. Ct. App. 2005) (quoting Frankle v. Twedt, 47 N.W.2d 482, 487 (1951)).  Therefore, “principals are generally not vicariously liable for the acts of independent contractors.” Id.[1]
  6. G. Indemnification. Minn. Stat. § 181.790 generally requires an employer to indemnify its employees in certain situations.[2] In addition, there are several other statutes that provide for the indemnification of certain types of employees.[3] Some employees are specifically excluded from indemnification, but typically they are indemnified from individual liability through another means, such as government employees, and employees who are governed by a separate agreement concerning indemnification.  Minn. Stat. § 181.790.  However, an independent contractor is not an employee and is therefore not indemnified by statute for actions performed, even within the scope of the individual’s duties under the independent contractor agreement.  An independent contractor cannot use an individual liability defense for actions performed in furtherance of the employment relationship or otherwise.
  7. III. THE GOVERNMENT HAS NOTICED; IS TAKING ACTIONS; AND IS SHARING INFORMATION

 

For the same reasons that businesses like independent contractor status, governmental agencies have concerns about it.  Businesses that improperly classify workers as independent contractors contribute to the tax gap, deprive the workers of federal, state and local employment-related protections, which in turn lead to more governmental financial assistance to those workers, and puts businesses that properly classify workers as employees at a competitive disadvantage. Several governmental agencies have shown increased interests in this issue and/or have taken actions to enhance enforcement.  Among others, for example:

  1. A. Federal Agencies.
  2. The federal Government Accountability Office (GAO) HAS estimated that the government loses more than 2.7 billion dollars each year in unpaid social security, unemployment, and income taxes as a result of independent contractor misclassification. (GAO Report 07-859 (May 8, 2007)).
  3. Beginning in November 2009, the Internal Revenue Service began conducting random audits of companies, with a special focus on independent contractor misclassification. (IRS Headline Volume 280 (Nov. 9, 2009)).
  4. According to a study commissioned by the federal Department of Labor, up to 30% of companies in the US misclassify workers as independent contractors. (GAO Report 09-717 at 11-13).
  5. In 2010, Congress increased spending for the Department of Labor by more than 600 million dollars, in order to increase enforcement.  The Department of Labor’s wage and hour division has already added over 250 investigators to focus on wage and hour compliance issues, and the Department of Labor has proposed a 2011 budget which includes a 25 million dollar program called the “Misclassification Initiative”. (Budget of the U.S. Government, Fiscal Year 2011, at 100).
  6. B. Pending Federal Legislation. Various bills have been introduced in Congress or proposed by the Obama administration to enhance enforcement powers for classification in various federal agencies, to make it more difficult for businesses to defend against misclassification claims, and to increase penalties.
  7. The Fair Playing Field Act of 2010, S. 3786, H.R. 6128 (111th Congress), would repeal the safe harbor of Section 530 of the Revenue Act of 1978, which allows companies to treat workers as independent contractors, so long as such treatment has a reasonable basis and has been consistent over time; and require businesses who use independent contractors on a regular and ongoing basis to furnish a written statement that informs the contractors of their federal tax obligations and of various employment law protections that do not apply to them.
  8. The Employee Misclassification Prevention Act of 2010, S. 3254, H.R. 5107 (111th Congress), would require employers to keep records that accurately reflect each worker’s status as employee or independent contractor and to notify workers classified as independent contractors of their status; clarify that misclassification constitutes an FLSA violation and increase penalties on employers where misclassification leads to overtime and/or minimum wage violations; and  set  penalties at $1,100 per employee for  the first violation and up to $5,000 per employee for subsequent or willful violations.
  9. President Obama’s 2011 budget proposes legislation, which would shift the burden of proof to the employer to demonstrate that workers are properly classified; eliminate the “safe harbor” provision of Section 530 of the Revenue Act of 1978 for employers who, based on industry standards, have a “reasonable basis” for classifying workers as independent contractors; and make it clear that misclassification of an employee as an independent contractor will be a violation of the FLSA.

 

  1. C. Minnesota Agencies.
  2. In late 2006, the Minnesota Department of Revenue’s withholding division implemented a new audit program that targeted worker classification.  Out of the first 37 audits that it completed, 24 (65%) resulted in reclassification of at least one worker from independent contractor status to employee status.  Among the 24 audited employers that misclassified workers, the amount of taxable payroll associated with the reclassified employees (10 million dollars) was nearly twice the payroll originally reported to the Department of Revenue (5.7 million). (Office of the Legislative Auditor. “Misclassification of Employees as Independent Contractors.” Evaluation Report Nov. 2007 at 16).
  3. In November 2007, the Minnesota office of the legislative auditor reported an estimated 14% of employers subject to Minnesota unemployment insurance taxes – 1 in 7 – misclassified at least one worker in 2005, which it estimated to be 17,500 employers who were out of compliance.  Moreover, the legislative auditor indicated that this estimate was likely quite low, since it did not account for businesses that do not treat any workers as employees. (Office of the Legislative Auditor. “Misclassification of Employees as Independent Contractors.” Evaluation Report Nov. 2007 at 15).
  4. The legislative auditor recommended that the Minnesota Department of Employment and Economic Development, the Minnesota Department of Labor and Industry and the Minnesota Revenue Department work together to coordinate definitions, legislation, audits, and investigation relating to worker classification, and to increase litigation options and various penalties. Further, it recommended that the three departments establish procedures to routinely share information about identified instances of misclassification and work together and with the legislature to address them. (Office of the Legislative Auditor. “Misclassification of Employees as Independent Contractors.” Evaluation Report Nov. 2007 at 33-36).
  5. D. Minnesota Legislation.
  6. In 2005, the Minnesota Legislature enacted a law forbidding misrepresentation by an employer of the employment relationship.  Minn. Stat. § 181.722 (2005).  The law prohibits an employer (1) from misrepresenting the nature of the relationship to any government unit or to its employees and (2) from requesting or requiring an employee to enter into an agreement that results in misclassification.  The statute provides that the nature of the employment relationship is determined by the tests used under applicable workers’ compensation and unemployment insurance laws. Upon violation of this statute, the court shall submit its findings of fact to the commissioner of labor and industry, who will then report the violation to any and all applicable agencies.
  7. In 2010, the Minnesota Legislature enacted amendments to Minn. Stat. § 268.035, Subd. 23a (g) and Minn. Stat. § 268.085, Subd. 16 (d), which deal with staffing services.  In at least one (pending) case that this author is aware of, the Minnesota Department of Employment and Economic Development has essentially argued that workers for staffing services are, by definition, independent contractors.

 

 

  1. IV. THE HIGH RISKS OF BEING WRONG

 

Even under current laws and regulations, which appear likely to become more harsh and more vigorously enforced in the future, the misclassification of employees as independent contractors can lead to serious consequences such as (often uninsured) liability, penalties, and even criminal offenses.

 

  1. A. Despite Well Drafted Agreements, Labels May Not Count. If the parties identify, in a contract or otherwise, an individual as an independent contractor, this designation may not survive a challenge if the relationship is actually an employer-employee relationship.  “The labels that the parties give themselves is not determinative; the relationship is determined by the law, not the parties.” Moore Associates, LLC. v. Commissioner of Economic Security, 545 N.W.2d 389, 393 (Minn. App. 1996); Speaks, Inc. v. Jensen, 243 N.W.2d 142,145 (1976).

 

  1. B. “Domino Effect” of Legal Challenges to Worker Classification. An employer’s classification of an employee as an independent contractor rather than an employee may be disputed in a number of contexts: audits from tax agencies; claims by workers for workers’ compensation or unemployment benefits; third-party lawsuits where the actions of the worker are sought to be attributed to the putative employee; actions from labor organizations; or audits from pension authorities; and individual or class action law suits.  See Robert W. Wood, Defining Employees and Independent Contractors: Don’t Try This at Home!, Business Law Today, at 46 (May/June 2008).  A challenge to a classification in one context may lead to retroactive reclassification by any number of agencies or groups. [4]

 

  1. C. Statutory Obligations and Penalties. A false declaration that a person is an independent contractor can create a “perfect storm” of expenses, insurance, liability, penalties, and even criminal sanctions.  For example:
  2. Fair Labor Standards Act.  The Fair Labor Standards Act (“FLSA”) and similar state statutes require employers to pay “employees” certain minimum wages and require overtime to be paid to non-exempt employees under specified circumstances.
  3. Unpaid minimum wage. Federal law requires employers to pay employees at least $7.25 for all “hours worked.” 29 U.S.C. § 207. Minnesota state law requires employees of “large employers” to receive $6.15 for all “hours worked.” Minn. Stat. § 177.24.
  4. Unpaid overtime compensation. Federal law requires 1.5 times  the “regular rate of pay” for all hours in excess of 40 hours per week 29 U.S.C. § 207. Minnesota law requires 1.5 times the “regular rate of pay” for all hours in excess of 48 hours per week.  Minnesota law, Minn. Stat. § 177.25.
  5. “Liquidated” (Punitive) Damages) to Employees. Employers who violate the federal FLSA or Minnesota FLSA are liable to the employee(s) for double damages. 29 U.S.C. 216(b); Minn. Stat. § 177.27. An employer can avoid paying liquidated damages only if it proves that it acted in good faith and that it had a reasonable basis to believe its practices complied with the law.
  6. Civil penalties. Under Minn. Stat. § 177.27: “Any employer who is found . . . to have repeatedly or willfully violated [minimum wage or overtime requirements] shall be subject to a civil penalty of up to $1,000 for each violation for each employee.  In determining the amount of a civil penalty under this subdivision, the appropriateness of such penalty to the size of the employer’s business and the gravity of the violation shall be considered.” Also, under Minn. Stat. § 177.32 (Minnesota record-keeping requirement): “The commissioner may fine an employer up to $1,000 for each failure to maintain records ….”
  7. Attorneys Fees to Employees.  The employee may seek other damages and other appropriate relief, including attorney’s fees. E.g., Minn. Stat. § 177.27.
  8. Anti-Retaliation. An employer cannot wrongfully terminate an employee who makes a complaint that the employer is not complying with the Fair Labor Standards Act. For example, under Minn. Stat. §177.32, an employer will be assessed a fine of $700.00 to $3,000.00 if it is convicted of either wrongfully terminating or otherwise discriminating against an employee.[5] In addition, an employer who does not comply with Minn. Stat. §177.25—including failure to pay overtime to an employee who deserves payment—is guilty of a misdemeanor.  Minn. Stat. § 177.32
    1. Tax.  If the IRS finds that an employer has misclassified an employee as an independent contractor, the employer will be obligated to pay back taxes, as well as interest and potential penalties.  IR-2004-47, April 5, 2004. Also, the person that “blew the whistle” may be entitled to be paid a whistleblower fee of up to 30 percent of the amount of tax, interest, and penalties ultimately collected by the IRS. (Tax Relief and Health Care Act of 2006 (P.L. 109-432).
    2. Benefit Plans.  If, as a result of being misclassified as an independent contractor, an individual is not eligible to receive these benefits, the employer risks the disqualification of its benefit plans. This is a potentially catastrophic risk, as it affects all employees and not merely the employee who was misclassified.
    3. Workers’ Compensation.  Failure to provide workers’ compensation insurance coverage where required by law can result in substantial financial penalties, including the assessment of $1,000.00 per week of non-compliance for each uninsured employee.  Minn. Stat. §176.181, subd. 3.  In addition, an employer that willfully and intentionally fails to provide such coverage is guilty of a gross misdemeanor.  Minn. Stat. § 176.181, subd. 5.
    4. Deliberate Misrepresentation. Minn. Stat. § 181.722 (2005) prohibits an employer from misrepresenting the nature of the relationship to any government unit or to its employees and from requesting or requiring an employee to enter into an agreement that results in misclassification.
    5. Unemployment. If an employer makes a false statement knowing it to be false or without a good faith belief as to its correctness in order to prevent or reduce the amount of unemployment coverage to an individual or the payment required by the employer (such as the classification of an employee as an independent contractor to reduce payments), the employer will be subject to a $500 penalty or 50 percent of the reduced unemployment benefits or payment required, whichever is greater.  Minn. Stat. § 268.184.
    6. Insurance. It should be noted that insurance companies are likely to deny an employer’s coverage (e.g. workers’ compensation, employment practices liability, other liability) relating to an “independent contractor” who was not disclosed as an “employee” at the time of the insurance application; and are even more likely to decline to pay for penalties resulting from improper classification.
    7. D. Litigation. In light of the many investigations, audits, and whistleblowers – and the huge potential damages, penalties, fines and fees – it should come as no surprise that litigation has followed.  For examples:

 

  1. Vizcaino v. Microsoft Corporation. Microsoft classified a group of workers, labeled “freelancers,” as independent contractors.  After an IRS audit that determined they were, in fact, employees, the workers filed a class-action lawsuit to seek participation in two of the company’s benefit plans.  Microsoft was ordered to retroactively fund the workers’ benefits.  Following several appeals, the parties ultimately settled out of court for $96.885 million, including $27.129 million in attorney fees and costs.  Vizcaino v. Microsoft Corp., 142 F.Supp. 2d 1299 (W.D. Wash. 2001), aff’d, 290 F.3d 1043 (9th Cir. 2002).

 

  1. Estrada v. FedEx Ground, 154 Cal. App. 4th 1 (2007).  The court found that   FedEx drivers were employees and not independent contractors. In 2007, FedEx settled a California class action for $26.8 million. FedEx later disclosed in a 10Q that there had been an IRS audit for 2002, 2004 and 2006, focused on classification of owner-operators at FedEx Ground: “The IRS has tentatively concluded, subject to further discussion with us, that FedEx Ground’s pick-up-and ­delivery owner-operators should be reclassified as employees for federal employment tax purposes. The IRS has indicated that it anticipates assessing tax and penalties of $319 million plus interest for 2002. Similar issues are under audit by the IRS for calendar years 2004 through 2006.”

 

  1. Labrie v. UPS Supply Chain Solutions, Inc., No. 08-3182 (ND. Cal. 2009). This was a class litigation alleging denial of minimum and overtime wages, in violation of California Jaw and the FLSA, because of misclassification of delivery drivers as independent contractors. The parties agreed to a $12.8 million settlement in January 2010.

 

  1. In re FedEx Ground Package System, Inc., Employment Practices Litigation (N.D. Ind. 3:05-MD-527 11.1v1, and state-court actions).  In these cases, several classes have been certified around the country, alleging misclassification of drivers as independent contractors. Some have been settled and others are still pending.  Not all of them are getting resolved in plaintiffs’ favor. E.g., see Anfinson FedEx Ground Package Sys., Inc., No. 04-2-39981-5SEA (King County Super. Ct.); In re FedEx Ground Package Sys., Inc., Employment Practices Litigation, No. 3:05-MD-527, slip. op. (N.D. Ind. Aug. 11, 2010); In re FedEx GroundPackage Sys., Inc., Employment Practices Litigation, No.3:05-MD-527, slip. op. (N.D. Ind. May 28, 2010).

 

  1. Lint v. Northwestern Mutual Life Insurance Co., 09-1373 (S.D. Cal. 2009). This is a class action alleging denial of minimum and overtime wages, in violation of the Fair Labor Standards Act (FLSA) and California law, because of misclassification of insurance agents as independent contractors.

 

  1. Bamgbose v. Delta-T Group Inc., No. 09-667 (E.D. Pa. 2009). This is a collective action against a temporary staffing agency, alleging that home health care workers were misclassified as independent contractors. See also Bamgbose v. Delta-T Group Inc., 2010 WL 2649925 (E.D. Pa. June 30, 2010).  Norris-Wilson v, Delta-T Group Inc., No. 09-906 (S.D. Cal. 2009); Norris-Wilson v. Delta-T Group Inc., 2010 WL 3834886 (S.D. Cal. Sept. 30, 2010), which involve the same employer.

 

  1. Edwards v. Multiband Corp., No. 10-02826 (D. Minn. 2010).  A satellite television installer filed a collective action in July 2010, alleging that Multiband misclassified him and similarly situated installers as independent contractors and, consequently, failed to pay them overtime wages to which they were entitled.

 

  1. St. Croix Sensory Inc. v. Dept of Employment and Econ. Dev., No, A09-1627 (Minn. Ct. App. 2010). St. Croix Sensory hires “sensory assessors” as independent contractors to participate in olfactory testing sessions for third parties’ products. Following a routine audit, the Minnesota Department of Employment and Economic Development found that the assessors were, in fact, employees and ordered St. Croix Sensory to pay unemployment taxes with respect to them. In July 2010, the Minnesota Court of Appeals reversed the Department’s determination, holding that the assessors had properly been classified as independent contractors.

 

  1. V. Factors to Determine Employee v. Independent Contractor

 

There are seemingly endless different statutory, regulatory and common law definitions of Independent contractors and tests to determine who is an employee who is an independent contractor. While there are efforts to coordinate them better, that has not happened yet. When analyzing an issue, it is critical to make sure you carefully review and are operating under the right set of guidelines.   For Example:

 

A.        IRS. The IRS has historically applied a twenty-factor analysis to be used as a guide to determine the status of a worker.[6] It considers: instructions and control; training; integration; personal services; hiring, supervising, and payment of assistants; continuing relationship; set hours of work; full-time required ; work on the company’s premises; order or sequence set ; oral or written reports; payment by the hour, week or month; payment of business and/or travel expenses; furnishing of tools and materials; significant investment; realization of profit or loss ; working for more than one firm at a time; making services available to the general public; right to discharge; and right to terminate the relationship.  IRS Rev. Rul. 87-41 (IRS 1987).  The degree of importance of each factor varied depending on the occupation and the factual context in which the services are performed.  The most important aspect of the relationship is the degree of control exercised by the principal over the individual worker.  The twenty factors are intended to indicate whether the principal has a sufficient degree of control over the worker such that an employer-employee relationship exits.  In general, the greater the control exercised by the principal, the more likely the worker will be found to be an employee.  Id.

  1. B. Economic Realties Test and the Fair Labor Standards Act. Courts analyzing the employment status of an individual in an FLSA action have created and utilized the “economic realities test.”  The factors initially established in United States v. Silk. 331 U.S. 704 (1947) (“the courts will find that degrees of control, opportunities for profit or loss, investment in facilities, permanency of relation and skill required in the claimed independent operation are important for decision”) have evolved to a review  of at least five factors: the degree of control exercised by the business;  the extent of the relative investments of the worker  and the business; the degree to which the worker’s  opportunity for profit or loss is determined by the business; the skill and initiative required in performing the job; and the permanency of the relationship. Brock v. Mr. W Fireworks, 814 .2d 1042 (5th Cir.), cert. denied, 484 U.S. 924 (1987). Some jurisdictions add a sixth factor to the inquiry: whether the service rendered by the worker is an integral part of the alleged employer’s business. See Brock v. Superior Care, 840 F.2d 1054 (2d Circ. 1988); Donovan v. DialAmerica Mktg., 757 F.2d 1376 (3d. Cir.), cert denied, 474 U.S. 919 (1985); Secretary of Labor, U.S. Dept. of Labor v. Lauritzen, 835 F.2d 1529 (7th Cir. 1987); Donovan v. Sureway Cleaners, 656 F.2d 1368 (9th Cir. 1981); Dole v. Snell, 875 F.2d 802 (10th Cir. 1989).
  2. C. Federal Common Law Right to Control Test and National Labor Relations Act. Federal courts have generally applied the common law agency or “right to control” test. Community for Creative Non-Violence v. Reid, 490 U.S. 730 (1989); Nationwide Mut. ins. Co. v. Darden, 503 U.S. 318 (1992), which considers several factors: the alleged employer’s right to control the manner and means by which the individual’s work is accomplished; the skill required to perform the individual’s duties; the source of tools and instrumentalities needed to perform the duties; the location where work is performed; the duration of parties’ relationship; the businesses’ right (or lack thereof) to assign additional projects; the  individual’s discretion over when and how long to work; the method of payment; the  individual’s role in hiring and paying assistants; whether  the work is part of alleged employer’s regular business; whether “employee benefits” are provided; and the  tax treatment of the individual.

Since the 1947 Taft-Hartley amendments to the NLRA, which contained provisions excluding independent contractors from its coverage, the NLRB has applied the common law “right of control” test to determine whether particular classes of individuals are employees or independent contractors for purposes of NLRA coverage.

  1. D. Minnesota Common Law. Minnesota courts will consider: who has the right to control the means and manner of performance; the mode of payment; who furnishes the material or tools; who controls the premises where the work is done; and the businesses right to discharge.  Goodnature v. Mower County, 558 N.W.2d 19, 21 (Minn. Ct. App. 1997).  The right to control the means and manner of performance generally carries the greatest weight in a determination of the worker’s status.  Id.; see also Speaks, Inc. v. Jensen, 243 N.W.2d 142, 144 (Minn. 1976) (observing that an employee “undertakes to achieve a given result under an arrangement with another who has authoritative control over the manner and means in which and by which the result shall be accomplished” while an independent contractor “agrees to achieve a given result but is not subject to the orders of another as to the method or means to be used.” (internal quotation omitted) (emphasis added)).
  2. E. Minnesota Regulations

Minnesota has several different regulations, factors and definitions, depending on the departmental agency that is involved: Minnesota Rule 3315.0555 – Minnesota Department of Employment and Economic Development; Minnesota Rule 5224.0210; 5224.0320; 5224.0330; 5224.0340 Minnesota Department of Labor (including workers’ compensation).  Generally, Minnesota agencies have adopted the economic realities tests as a means to determine whether an individual is an independent contractor or an employee.  Pursuant to Minnesota Rule 5200.0221, “all factors must be weighed to determine whether the worker is economically dependent upon the business to which the worker provides services.”(Emphasis added).  See also Minnesota Rule 5224.0340 (listing other factors to determine independent contractor status); Minnesota Rule 5224.0330 (discussing the issue of the control of an individual’s performance).

 

The Minnesota Court of Appeals recently summarized Minnesota common law and Minnesota Rule 3315.0555, as follows:

Traditionally, five factors are used to determine whether a worker is an employee or an independent contractor: “(1) The right to control the means and manner of performance; (2) the mode of payment; (3) the furnishing of material or tools; (4) the control of the premises where the work is done; and (5) the right of the employer to discharge.” Guhlke v. Roberts Truck Lines, 268 Minn. 141, 143, 128 N.W.2d 324, 326 (1964). Of these five factors, the two most important are “the right or the lack of the right to control the means and manner of performance,” and the right or the lack of the right “to discharge the worker without incurring liability.” Minn. R. 3315.0555, subp. 1 (2009).

The Minnesota Rules also provide additional factors to be considered when determining whether an employment relationship exists, including: (1) whether the individual makes services available to the public; (2) whether the individual is compensated on a job basis or by the hour; (3) whether the individual is in a position to realize a profit or loss as a result of the services offered; (4) whether the individual may end the relationship without incurring liability; (5) whether the individual made a substantial investment in the facilities used to perform the services; (6) whether the individual works simultaneously for multiple firms; (7) whether the individual is accountable for his or her own actions while working; and (8) whether the services performed by the individual are in the course of the employer’s organization, trade or business. Minn. R. 3315.0555, subp. 2 (2009).  St. Croix Sensory Inc. v. Dept of Employment and Econ. Dev., No, A09-1627 (Minn. Ct. App. 2010).

  1. VI. drafting tips

 

Again, a written independent contractor agreement is not necessarily a binding determination that an independent contractor relationship exists, particularly with respect to various state or federal agencies.  Nevertheless, careful drafting of an independent contractor agreement, along with clear discussions of expectations, can help avoid problems, or at least minimize the risks.

  1. A. Define Relationship. Clearly state that the intention of the parties is to have an independent contracting relationship, and not an employer-employee relationship.  Stress, in language appropriate for the circumstances, that the hiring entity not have control or responsibility with respect to the daily expectations of the independent contractor and his/her/its employees, but rather, is only interested in the end result.  Have the contractor use its own tools and equipment, and schedule the work times.
  2. B. Wages and Withholding. State, up front, that wages will not be paid and withheld on a W-2 basis, and will be paid on a gross-1099 basis.  Confirm that the independent contractor has complete and total responsibility to withhold, administer and pay all applicable federal, state and local employment and income taxes.  Moreover, it is better to pay by the project than by the hour.
  3. C. Employee Benefits. State clearly that the independent contractor has full responsibility to maintain and administer any and all benefit plans for him/her/it and the independent contractor’s employees.
  4. D. Workers’ Compensation. Expressly state that the independent contractor, and not the employer, is obligated to provide workers’ compensation insurance, and to comply with all applicable workers’ compensation laws and regulations.
  5. E. Compliance with COBRA. Similarly, make it clear that the independent contractor, and not the employer, is fully responsible for any COBRA obligations.
  6. F. Maintenance and Retention of Payroll and Benefit Records. The contract should include language requiring the independent contractor to maintain and complete records as legally required with respect to wages, benefits and personnel actions, and to comply with all applicable federal, state and local laws regarding such records.
  7. G. Other Legal Compliance. The contract should expressly state that the independent contractor, and not the hiring entity, has full responsibility for other legal obligations, such as licensing obligations, permit obligations, compliance with state or federal environmental, import or other rules and regulations, employment laws, etc.
  8. H. Insurance. The contract should clearly state that the independent contractor is obligated to obtain and provide all required insurance, which relates in any way to the services which he/she/it is rendering.  Also consider adding the hiring entity as an additional insured, and/or requiring certificates of insurance.
  9. I. Warranties, Representations and Indemnification. Although each situation may vary, it is always important to clarify, up front, who is responsible, legally and otherwise, for what.  Often, it is appropriate to have the hiring entity defend and indemnify the independent contractor for certain risks, while the independent contractor defends and indemnifies the hiring entity for others.
  10. J. Supervision, Direction and Control. At the risk of repetition, it is critically important for the agreement to state clearly that the independent contractor is responsible for and the employer of any of its employees and/or subcontractors.  It, and not the hiring entity, should retain and exercise supervisory responsibilities and obligations with respect to its employees and subcontractors, including day-to-day control and direction, performance reviews, evaluations, and promotions, and any termination decisions.
  11. K. Avoid “AtWill” Language. This implies an employment relationship.
  12. VII. Conclusion.

 

Independent contractor agreements, however innocently entered into, can create the “perfect storm” for any business that uses them to misclassify an employee as an independent contractor. Great care and caution must be taken before entering into such an agreement, when preparing such an agreement and when implementing one. The risks of being wrong seem to be endless, both in terms legal exposure, financial exposure and the amount of time that may be needed to defend against several agencies and plaintiffs.


[1] However, if an agency relationship has been formed, the principal will likely be liable for the individual’s actions, even if the individual is an independent contractor.  Pastor v. Florey, No. C9-99-1743, 2000 WL 388062 *4 (Minn. App. April 18, 2000) (“an independent contractor may be an agent of the hirer for purposes of vicarious liability if there is a fiduciary relationship, and continuous subjection to the will of the principal.”)

 

[2]The employer is obligated to “defend and indemnify its employees for civil damages, penalties, or fines claimed or levied against the employee, when the employee was acting in the performance of the duties of the employee’s position; was not guilty of intentional misconduct, willful neglect of the duties of the employee’s position, or bad faith; and has not been indemnified by another person for the same damages, penalties, or fines.”  Minn. Stat. § 181.790.

 

[3]For example, under Minn. Stat. §302A.521, employees (including directors and officers) of corporations are indemnified in certain situations.  Minn. Stat. §317.521 provides for the indemnification of directors, officers, and employees of non-profit corporations in similar language as listed above.  Minn. Stat. §322B.699 similarly indemnifies directors, officers, and employees of Minnesota Limited Liability Companies.

[4] For example, in Vizcaino v. Microsoft, 97 F.3d 1187 (9th Cir. 1996), a group of freelance programmers who had been hired on the understanding that they were independent contractors sought and received employment benefits from their employer after an IRS examination of the employer’s records concluded that the programmers were employees, not independent contractors.  This case clearly demonstrates that interactions between tax agencies and other worker status inquiries are practically inevitable.  “Vizcaino was a civil suit brought by workers.  Yet, the IRS really started Vizcaino.”  Wood, supra, at 48.

[5]An employer will be fined under this statute for terminating or discriminating against an employee if “(1) employee complained to employer that wages were not paid under § 177.21 –.435; (2) employee started a proceeding under or related to § 177.21-.435; or (3) employee testifies in any proceeding.  Minn. Stat. § 177.32 subd. 2.

 

[6] See Appendix A, IRS Publication 15-A, 2011 Edition, pages 4-9, for current IRS guidelines.

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