October 1998

Workplace Labor Update - Independent Contractors and Temporary, Leased and OutsourcedEmployees: Borrowing Trouble? – October 1998

11 min

The composition of the nation's workforce has changed dramatically. Just ten years ago, with the exception of an occasional temporary administrative employee, employers typically employed all of the workers in their workforce. Now, there is a vast array of relationships within the workforce, including independent contractors, temporary employees, leased employees and outsourced employees. These categories of employees - commonly referred to as "contingent" workers - are now believed to be the fastest growing of the nation's workforce. The retention of contingent workers appears, at least on the surface, to offer many advantages to employers. The employer, by avoiding the payment of taxes and other administrative burdens, achieves cost savings and increased efficiency and flexibility. However, there are substantial risks associated with utilizing independent contractors and temporary, leased and outsourced workers. There are many traps for the unwary, that could result in substantial exposure to employers. Consequently, employers should not enter into an alternative employment relationship without first undertaking a thorough analysis of the parties' respective legal obligations. With care, an employer may retain the advantages of contingent workers, without borrowing trouble. Types of Alternative Work Relationships There are a number of titles and labels assigned to these alternative work relationships. However, in assessing an employer's potential liability, it is important to understand and to be able to distinguish between the different types of relationships. For purposes of our discussion, we will divide them into four generally-accepted categories: Independent Contractors - Independent contractors are self-employed individuals who are retained by the employer on a contract basis to perform specified tasks. They are usually compensated on a contract or fee for service basis, issued Form 1099s, and are free to render services to other companies while they also work for you. Traditional Temporary Employees - A temporary employee is a worker who is recruited, hired, employed and paid by a temporary staffing agency. The agency assigns the worker to temporary assignments with its clients, generally to supplement the client's own workforce. During the period that the temporary worker is assigned to the client, the temporary worker works under the supervision of the client. Leased employee - A staffing arrangement whereby all or substantially all of a company's employees (or those of a discrete category, facility or site) are transferred to the payroll of an employee leasing firm. The leasing firm leases the workers back to the employer and administers the payroll, provides benefits, maintains payroll records, and is responsible for most of the administrative functions normally performed by a human resources department. Outsourced employees - Outsourced employees are workers who work for an independent vendor or company to which the employer has "outsourced" functions (e.g., accounting, human resources). Although these labels are helpful, they are only the starting point for assessing the nature of the relationship and determining the employer's obligations under state and federal law. The fundamental issue with respect to each of these categories of workers is whether the worker will be deemed an "employee" of the employer. In the sections below, each of the four categories of workers and the standards that are applied in determining an employer's potential obligations under federal employment laws are discussed. Keep in mind that each of these standards involve a highly fact-specific inquiry. Consequently, it is critical that employers use the utmost care to ensure that they are protected to the maximum extent possible. Federal Employment Laws Almost all of the federal employment statutes provide particular protections to "employees." Federal courts generally apply an "economic realities" test in determining whether a worker is an employee under these statutes. See, e.g., Knight v. United Farm Bureau Mut. Ins. Co., 950 F.2d 377, 380 (7th Cir. 1991). The economic realities test examines five factors:
  • The degree of control exercised over the worker;
  • The permanency of the relationship;
  • The skill required of the worker;
  • The investment in the facilities for work; and
  • The potential for profit or loss by the worker.
The determination of whether an independent contractor or temporary or leased worker is an "employee" has two distinct consequences under many of the federal employment laws. First, because only "employees" count toward the numerical thresholds for the application of certain of the statutes, the determination impacts whether the employer is subject to such laws as the Americans with Disabilities Act (ADA), the Age Discrimination in Employment Act (ADEA), and Title VII of the Civil Rights Act of 1964, as amended (Title VII). See Martin v. United Way of Erie County, 829 F.2d 445 (3d Cir. 1987). Second, because most statutes protect "employees" in a specified way, the determination of whether a worker is an "employee" will control whether he is entitled to pursue particular remedies available under the statutes. See Mallare v. St. Luke's Hospital, 699 F. Supp. 1127 (E.D. Pa. 1988). Independent Contractors The critical factor in determining whether a worker is an independent contractor or an employee under the economic realities test generally is the level of control that the employer has over the work performed by the worker. If the employer controls the hours of work, the selection of work, and the manner in which the work is to be performed, it is highly likely that a court will conclude that the worker is an employee. The fact that the worker is labeled as an "independent contractor" and acknowledges in an agreement that he or she is not an "employee" for purposes of federal employment statutes or federal or state taxes has no bearing on this determination. To maximize the probability that a worker's independent contractor status is established and retained throughout the relationship, the employer should take the following steps:
  • The parties should enter into a written contract that addresses each of the issues in steps 2 through 9 below.
  • The independent contractor should be assigned an independent, discrete task or project that does not relate to the employer's core business functions. For instance, it would be appropriate to assign to an independent contractor the task of performing a study of food quality and delivery times at the employer's restaurants in Division IV. On the other hand, a task such as managing the restaurants in Division IV of the employer generally would suggest the individual is an "employee" rather than an independent contractor.
  • The employer should not provide any training or instruction to the independent contractor with respect to the skills that are necessary to perform the assigned project or task.
  • The employer should not provide any instructions to the independent contractor concerning how the tasks or projects should be performed. The independent contractor should have the discretion to determine when, where, and how the work should be performed and to set his or her hours of work.
  • The employer should not hire and pay any assistants for the independent contractor. The employer should also avoid furnishing the tools and equipment necessary for the independent contractor to perform his or her assigned tasks or projects.
  • A true "independent contractor" is an individual who makes his or her services available to the public. Consequently, the employer should not restrict the independent contractor from working for other employers during the period of the contract. Although, in practice, the projects assigned to the independent contractor may require him or her to devote his or her full time to them, the employer should not become the sole client of the independent contractor for more than a short period of time.
  • The independent contractors "base office" should be located off of the employer's premises. For certain projects, it is likely that the independent contractor will need to be on the employer's premises. The independent contractor, however, should not take up long-term or permanent residence at the employer's premises and should maintain his or her independent base office during the period of the contract.
  • The employer should not pay the independent contractor compensation that resembles a salary. The independent contractor should either be paid a flat fee or on a schedule that calls for large intervals between payments. An hourly fee is permissible if the other factors support the conclusion that the worker is an independent contractor.
  • The independent contractor agreement should not be subject to termination for any reason other than non-performance of the contract specifications. Conversely, the independent contractor should not be able to abandon further work without incurring liability for breach of contract. Temporary and Leased Employees General Standards
    The determination of whether temporary and leased workers are "employees" for purposes of most federal employment statutes is not as difficult as with independent contractors. The reality with most temporary and leased workers is that, although they are hired and paid by the temporary employment agency or leasing firm, they are under the employer's direction and control and, consequently, are "employees." In that situation, the employment agency or leasing firm and the employer are deemed "joint employers." Reynolds v. CSX Transportation, 115 F.3d 860 (11th Cir. 1997); Virgo v. Riviera Beach Assoc., Ltd., 30 F.3d 1350 (11th Cir. 1994); Amarnare v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 611 F. Supp. 344, 347-48 (S.D.N.Y. 1984), aff'd, 770 F.2d 157 (2d Cir. 1988).1 The joint employer doctrine can result in liability for the temporary or staffing firm, the employer or both. If the firm discriminates against a worker and the client does not have knowledge of or participate in the discrimination, only the firm is liable. If the employer discriminates against a worker and it is deemed an "employer" under the economic realities test, the employer will be liable as a "joint" employer. The agency will also be held liable if it participated in the discrimination or harassment or knew or should have known of it and failed to take prompt corrective measures. Amarnare, 611 F. Supp. at 347-48; see also Zarnoski v. Hearst Bus. Comm., Inc., 69 FEP Cas. 1514 (3d Cir. 1996); Magnuson v. Peak Technical Serv., Inc., 808 F. Supp. 500 (E.D. Va. 1992). Moreover, in situations where an employee seeks an accommodation under the ADA or Title VII, the temporary or leasing firm and the client have an obligation to work together to provide the accommodation. Poff v. Prudential Ins. Co., 882 F. Supp. 1534 (E.D. Pa. 1995). The EEOC recently issued an Enforcement Guidance to employers that clarifies employers' liability for temporary and leased workers under the statutes administered by that agency (i.e., Title VII, the ADEA, the ADA, the Equal Pay Act). The Guidance specifies that both the agency or firm and the employer may be liable as joint employers under those statutes for discrimination against or the harassment of temporary workers. The Guidance clarifies that (1) agencies must hire and make job assignments in a non-discriminatory manner; (2) the employer must treat workers assigned to them by agencies in a non-discriminatory manner; and (3) the agency must take immediate and appropriate corrective action if it learns that an employer has discriminated against one of its workers. The Guidance also addresses the allocation of remedies between agencies and clients when the EEOC determines that they have both engaged in unlawful discrimination. The principle benefit of a temporary or leasing arrangement is that, at least theoretically, it frees the employer from the burdens of payroll and benefits functions. For smaller employers, it may allow the workers to participate in larger and potentially better and lower-cost benefits plans. However, given the employer's potential liability under federal and state employment laws, it should undertake a number of steps to reduce its potential liability. First, the employer should only retain experienced and reputable temporary and leasing firms. Second, the agreement between the employer and the temporary or leasing firm should clearly identify the parties' respective responsibilities. Third, the agreement should require the temporary or leasing firm to indemnify the employer for any liability under the federal labor and employment laws arising out of any function performed by the temporary or leasing firm. For instance, with respect to the parties' obligations to pay overtime under the Fair Labor Standards Act (FLSA), the contract should specify that the parties have an obligation to ensure that employees record and report all hours worked and that the firm has the responsibility to pay overtime on those reported hours consistent with state and federal overtime provisions. Both parties should, ideally, sign off on the classification of any employee as "exempt" under the FLSA. The employer should monitor the activities of the firm to ensure that it properly categorizes employees and pays non-exempt employees overtime for all hours worked over 40 during a workweek. The agreement should provide that, if the firm fails to undertake these obligations and violates the FLSA, it is responsible for indemnifying the employer for any liability (including attorney's fees). Additional Issues Raised by the FMLA
    Regulations have been adopted under the Family Medical Leave Act (FMLA) that allocate responsibilities for FMLA compliance between temporary and leasing firms, the "primary" employer,2 and the employer, the "secondary" employer. 29 C.F.R. &#sect; 825.106. The leasing company has the responsibility for (1) giving the required notices to employees; (2) approving the required leave; (3) maintaining health benefits during the leave; and (4) restoring the employee to the same or equivalent position upon returning from leave. Id. The employer, on the other hand, may not interfere with an employee's exercise of his or her rights under the FMLA or retaliate against the employee for opposing an unlawful act under the FMLA, and generally must allow the temporary employee to return to work at that client at the conclusion of the leave. Id. Outsourced Employees
    In a true outsourcing relationship, the employer should not be liable under federal employment discrimination statutes to employees of the outsourcing company because it does not have control over their work. However, if the employer and the outsourcing company share control over the work of employees of the outsourcing company, the employer will be liable as a "joint employer" for claims under state and federal employment laws. As maintaining a competitive edge demands the increasing use of contingent workers, employers must understand the different types of alternative work relationships, the corresponding legal obligations, and purposely choose those that best suit their needs. 2The regulations provide that the "primary" employer is the employer that has the authority or responsibility to hire, fire, assign or place the employee and to pay and provide benefits to the employee. 29 C.F.R. &#sect; 825.106(c). Generally, the leasing company is deemed to be the "primary" employer.