Independant Contractor or Employee? Misclassification can Be Costly

One of the hottest topics in employment law is worker misclassification; that is calling certain workers independent contractors when they should be classified as employees. The cost of misclassifying workers can be brutal. FedEx recently settled a misclassification suit involving FedEx Ground drivers for $228 million. Uber, the darling of the on-demand service industry, is actively defending a massive misclassification class action lawsuit and suffered several procedural set-backs in recent months. If Uber loses, its entire business model may crash, along with its multi-billion dollar valuation.

“But,” you say, “I am just a small business, it can’t happen to me.” Well, yes and no. Yes, you won’t be subject to ten figure damage awards or settlements. But no, a misclassification action could still put you out of business. The potential damages for misclassification come in two, independent forms: (1) back pay and benefits owed to employees and (2) back tax withholding, worker’s compensation premiums, and unemployment insurance payments owed to the state. A single misclassified independent contractor could cost you tens of thousands of dollars in damages and fines, plus legal fees.

Resolution of the independent contractor vs. employee question is tricky because the analysis is very fact specific. By some counts there are as many as 48 factors to consider when determining if a worker is an independent contractor or an employee. The burden of proof is always on the employer, the business, to prove a person is an independent contractor. Finally, the government has a bias to finding an employee relationship.

In some cases, workers may bring an action against an employer under state wage laws alleging they were improperly classified as contractors when they should have been employees. In other cases, the issue arises when the State wants to collect back worker’s compensation or unemployment insurance premiums. In Maryland, courts often look at the following five factor test: (1) whether the employer selected or hired the worker, (2) whether wages were paid to the worker, (3) whether the employer had the ability to discharge the worker, (4) whether the employer has the ability to control the worker’s conduct, and (5) whether the worker’s work is part of the employer’s regular business. Of the five, Maryland courts say factor 4, the control test, is most important. However, courts are beginning to look more closely at the fifth factor, the degree of similarity between the worker’s work and the employer’s business.

Of course, control does matter greatly, but in the fifth factor may carry more weight within the advertising and creative industry. One challenge is the lack of industry knowledge among the government investigators. Advertising services can take so many overlapping forms, it may be difficult to parse the distinction between a company’s business and the work a contractor is doing. For example, few investigators could describe the differences between a web design company that provides content for clients and a content marketing contractor, or between an SEO company and an a Google Adwords specialist.

Companies can increase their protection, and contractors can help their clients, by actively documenting the relationship. Of course, having a state of the art independent contractor agreement is a good start, but it is no longer enough. Some documentation beyond a contract can help:

  • Ask for current, active client references, then actually calling and documenting the references.
  • Determine if the contractor has employees of its own.
  • Ask for the contractor’s advertising or promotional materials, indicating the contractor is actively soliciting other business.
  • Ask for an EIN and a copy of an operating agreement or corporate bylaws.
  • These documentation efforts can go a long way to helping demonstrate independent contractor status.

To close, companies that use independent contractors should keep three factors in mind:

  1. The government is biased toward finding employee relationships over independent contractor relationships and the business has to prove independent contractor status.
  2. The closer the contractor’s work is to the employer’s business, the greater the risk of stepping over the line into employee status and all its attendant obligations.
  3. The facts of each situation or each contractor engagement are different and a separate analysis and documentation effort should be undertaken.
  4. If you would like assistance in analyzing your independent contractor relationships or to assist you in preparing a documentation checklist, please contact an attorney.

About Matt Johnston
Matt Johnston operates his own law firm in Frederick with a focus on small business counseling, copyright and trademark law, and dispute resolution. Many of Matt’s clients are in the creative industries whose concerns overlap Matt’s practice areas. Matt focuses on providing practical legal advice to prevent legal questions from becoming legal problems. Matt has been described as an approachable lawyer and is always willing to listen and address client concerns tailored to the client’s way of doing business.

DISCLAIMER - The preceding article is intended for educational and informational purposes only. The article should not be construed as legal advice applicable in all situations. No attorney-client relationship is created through this article. If you need confidential legal advice, Matt is available for confidential and privileged consultations by calling 240-351-9944 or emailing matt@johnston-legal.com