Using Leased, Contracted and Temporary Workers

I. Introduction

During the 1990s, the composition of the nation's work force has changed dramatically creating many new employment issues. Just ten years ago, with the exception of an occasional temporary administrative employee, employers typically employed all of the workers in their work force. Now, there is a vast array of relationships within the work force, 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 work force, estimated to have doubled during this decade.

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.

II. DEFINING THE WORK RELATIONSHIP

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 them. For purposes of our discussions, 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 work force. 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.

III. 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:

1. The degree of control exercised over the worker;
2. The permanency of the relationship;
3. The skill required of the worker;
4. The investment in the facilities for work; and
5. 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).

A. 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:

1. The parties should enter into a written contract that addresses each of the issues in steps 2 through 9 below.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. The independent contractor's "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.
8. 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.
9. 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. B. Temporary and Leased Employees

1. 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).

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 has 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 employer 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 principal 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).

2. 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, 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 and the conclusion of the leave. Id.

C. 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.


IV. TAX CONSIDERATIONS A. Independent Contractors

The tax code defines an employee as "an individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee . . .." 26 U.S.C. &#sect; 3121(e). The common law rules, however, are the product of decades of development and vary from state to state. To ensure uniform application of these standards, the IRS issued a ruling in 1987 that sets forth twenty factors for determining whether a worker is an employee or an independent contractor. Rev. Ruling 87-41. The relevant factors considered by the IRS are:

1. Is the individual providing services required to comply with instructions concerning when, where, and how the work is to be done?
2. Is the individual provided with training to enable him or her to perform a job in a particular manner or method?
3. Does the business hire, supervise, or pay assistants to help the individual performing services under contract?
4. Is the relationship between the individual and the party for whom he or she performs services a continuing one?
5. Who sets the hours of work?
6. Is the individual required to work full time for the party for whom he or she performs services?
7. Does the individual perform work on another's business premises?
8. Who directs the order and sequence in which the work must be done?
9. Are regular oral or written reports required?
10. What is the method of payment - hourly, weekly, commission, or by the job?
11. Are business or traveling expenses reimbursed?
12. Who furnishes the tools and materials necessary for the provision of services?
13. Does the individual performing services have a significant investment in the facilities used to perform services?
14. Can the individual providing services realize both a profit or loss?
15. Can the individual providing services work for a number of firms at the same time?
16. Does the individual make his or her services available to the general public?
17. Is the individual providing services subject to dismissal for reasons other than non-performance of contract specifications?
18. Can the individual providing services terminate his or her relationship at any time without incurring a liability for failure to complete the job? / As with the economic realities test discussed above, the IRS test involves a detailed and fact-specific analysis of the independent contractor relationship. The key issue in this analysis is whether the employer has control over how the independent contractor performs his or her assigned projects. Employers, however, should carefully analyze each of the factors identified by the IRS to ensure that their independent contractors qualify as bona fide independent contractors. Each of the steps discussed above under the economic realities test should be considered in entering into an independent contractor relationship.

B. Temporary Workers

As a general rule, as long as the temporary agency has control over the payment of the worker's wages, it will be viewed as the sole employer for employment tax purposes. See, e.g., General Motors Corp. v. United States, 91-1 U.S. Tax Cas. (CCH) 50,032 (E.D. Mich. 1990); In re Critical Care Support Servs., Inc., 138 Bankr. 378 (E.D.N.Y. 1992). This general rule applies regardless of whether the employer controls the worker's activities at the employer's work site. Moreover, even if the temporary agency violates its obligation to withhold, the IRS generally will not look to the employer for the payment of federal taxes.

C. Leased Employees

In contrast to the temporary employee situation discussed above, it is not clear whether a leasing company is the sole employer for purposes of federal income taxes. At least one court has held that the employer that directs the work of leased employees also had control over the payment of ages and consequently is an "employer" for purposes of federal employment taxes. In re Earthmovers, Inc., 199 Bankr. 62 (M.D. Fla. 1996).

D. Outsourced Workers

As discussed above, because, in a true outsourcing relationship, the employer does not have control over the work of outsourced workers, the employer is not responsible for withholding taxes for the workers, even if the outsourcing vendor fails to withhold them.

V. ERISA/EMPLOYEE BENEFITS

A. Independent Contractors

Properly characterizing independent contractors also has important consequences under ERISA. ERISA defines an employee as "an individual employed by an employer." 29 U.S.C. &#sect; 1002(b). In Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 319 (1992), the Supreme Court adopted a common law test for determining whether a worker is an "employee" under this standard. As with the IRS test and the economic realities test discussed above, the most critical factor under this test is whether the employer has the right to control the manner and means by which the product of employment is accomplished. The court also ruled in Darden that a number of other factors, many of which are substantially identical to the control test factors discussed above, are applicable in determining whether a worker is an "employee" under ERISA.

If a worker is determined to be an employee under this test, the company must make its ERISA benefits available to that worker on the same basis as other employees. In addition, the employee will be counted in determining whether the employer has satisfied the minimum percentage requirements for tax-qualified retirement plans and welfare plans. On the other hand, if a worker qualifies as an independent contractor, he or she cannot be covered by an employee benefit plan. Retirement plans can lose their tax qualification if they cover non-employees. See Professional & Executive Leasing, Inc. v. Commissioner, 89 T.C. 225 (1987), aff'd, 862 F.2d 751 (9th Cir. 1988).

The Ninth Circuit's recent decision in Vizcaino v. Microsoft, 97 F.3d 1187 (9th Cir. 1996), vividly demonstrates the consequences of mischaracterizing workers as "independent contractors." In that case, Microsoft contracted with a group of workers that it characterized as "freelancers." The contracts signed by the freelancers specified that they were not employees and were not entitled to employee benefits. Each plaintiff conceded that he or she was never promised benefits. A group of the freelancers filed a lawsuit against Microsoft, claiming that they were nevertheless entitled to benefits under the company's 401(k) and stock option plans. / In a split decision, a Ninth Circuit panel concluded that the freelancers fell within the definition of "employee" and thus were entitled to retroactive benefits under the retirement and stock option plans. The court based its ruling on the fact that (1) Microsoft had conceded that the employees were "common law" employees; and (2) the ambiguous definition of who was eligible to participate in the company's benefits plans could be read to include common law employees.

Employers, however, should be able to avoid the situation faced by Microsoft. As long as the company satisfies the threshold standards for non-highly compensated employees (generally 70 percent), there is no prohibition on excluding certain classes of employees from coverage. / Thus, as long as the classification to which the worker belongs (e.g., freelancers or workers deemed by the company to be independent contractors) is clearly excluded, the worker should not be eligible under the benefit plans. See Clark v. E.I. Dupont De Nemours & Co., 105 F.3d 646 (Table), 1997 WL 6958 (4th Cir. Jan 9, 1997), cert denied, 117 S. Ct. 2425 (June 2, 1997); see also Trombetta v. Cragin Fed'l Bank, 102 F.3d 1435 (7th Cir. 1996); Abraham v. Exxon Corp., 85 F.3d 1126 (5th Cir. 1996).

B. Temporary and Leased Employees

Because temporary employees receive benefits from their temporary agency, temporary employees do not raise similar ERISA issues. However, that is not the case with leased employees. Although leased employees also receive benefits from the leasing company, section 414(n) of the Internal Revenue Code ("IRC") imposes special obligations on employers with respect to their leased employees. Under section 414(n), clients of leasing firms must include "leased employees" in their employee head count to determine if their benefit plans qualify for favorable tax treatment under the IRC's coverage and non-discrimination tests. Section 414(n) defines a "leased employee" as an employee who:

1. Performs services under an agreement between the client-employer and the leasing organization/staffing firm;
2. Performs services under the primary direction or control of the client; and
3. Performs services for the client on a full-time basis (i.e., 1500 hours) for a 12-month period. In addition, there are record keeping, de minimus and "safe harbor" exceptions to section 414(n) that may allow clients to avoid counting certain leased workers.

C. Outsourced Employees

Outsourcing arrangements can also present difficult benefits issues. For example, an employer that outsources its employees may not be permitted to distribute the employees' 401(d) plan moneys because there has been no separation from service. IRS Priv. Ltr. Ruling No. 9652025. Moreover, in Inter-Modal Rail Employees Ass'n v. Atchison, Topeka & Santa Fe Ry. Co., 117 S. Ct. 1513 (1997), the Supreme Court held that employees stated a claim under section 510 of ERISA where their employer outsourced them to another company that did not provide equal health and pension benefits.

VI. OTHER APPLICABLE LAWS

A. Workers' Compensation

Under the laws of most jurisdictions, workers' compensation benefits are the exclusive remedy for employees who are injured in the workplace. The economic realities test is generally applied in determining whether a worker is an "employee" for purposes of the workers' compensation liability shield. Thus, if a worker who is labeled as an "independent contractor" is determined to be an "employee" of the employer under the economic realities test, the employer will be shielded from liability under these statutes. Similarly, in situations involving temporary, leased and outsourced workers, the employer will be shielded by the workers' compensation laws if it controls the work of the worker. See, e.g., Thompson v. Grumman Aerospace Corp., 78 N.Y.2d 553, 578 (1995).

Mackall v. Zayer, 443 A.2d 98 (Md. 1982), addresses the application of the joint employer doctrine to outsourced employees. The plaintiff, Mackall, was the manager of the wig department at a Zayre department store. The operations of the wig department were outsourced to Alden Millinery and Mackall was employed by Alden. Mackall, however, was subject to the same supervision as Zayre employees who worked in other departments. Both Alden and Zayre had the authority to terminate Mackall. Mackall injured herself in the store and sued Zayre for negligence. Zayre argued that it was a joint employer of Mackall and that it was only liable for workers' compensation benefits. After reviewing the conditions of Mackall's employment, the court concluded that Mackall was jointly employed by Zayre and Alden because Zayre controlled the work performed by Mackall. See also Whitehead v. Safway Steel Prods., 497 A.2d 803, 808-09 (Md. 1985).

In Mackall, it was clear that Zayre had control over Mackall's work and was therefore her joint employer. In other situations, however, the determination of whether an employer has control over the work of the leased or outsourced employee will not be as clear. This potential problem can be addressed through a comprehensive agreement that describes the respective responsibilities of the parties and imposes an indemnification obligation on the leasing or outsourcing company.

B. OSHA

The federal Occupational Safety and Health Act ("OSHA") and state law require employers to maintain a safe and healthy workplace. When temporary or other leased employees are used, the party in direct control over the workplace and the actions of the employee are cited under OSHA for safety violations in the workplace and are required to maintain records of illnesses and injuries. The temporary or leasing agency will only be cited if it fails to inquire as to conditions at the work site or fails to take adequate steps to ensure that its employees are protected from work site hazards.

C. I-9 Verification

Under the Immigration Reform and Control Act, employers are required to complete I-9 forms attesting that they have verified employees' authorization to work in the United States. Customers using contract services do not have an obligation to verify the employment status of workers that they retain from temporary or leasing firms.

D. EEO-1 and Affirmative Action Requirements

All private employers with 100 or more employees are required to file an annual EEO-1 Report that identifies employees by job category, race, gender and ethnicity. Moreover, federal contractors with 50 or more employees and $50,000 or more in federal government contracts or grants are required to prepare an Affirmative Action Plan ("AAP"). Both the EEOC and the Department of Labor generally exclude temporary employees and workers referred through an employee contractor or employment agency from the 50- and 100-employee thresholds for the EEO-1 report and AAP requirements.

VII. CONCLUSION

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 chose those that best suit their needs.