The perils of permitting an employee to reclassify as an independent contractor
January 2022
Here’s a scenario we see once in a while - a small business in New York has an employee who decides that he/she wants to be an independent contractor (we’ll refer to this individual as the “worker”). This worker and the business agree a monthly fee and/or hourly rate and the newly minted independent contactor (i.e. the worker) issues monthly invoices to the employer instead of being paid a salary. Often this scenario occurs when the worker has “outgrown'“ the business and views themselves as having some entrepreneurial potential. This switch to being an independent contractor permits the worker the flexibility to build a side business, to feel more separate from their employer, and to deduct business expenses. The employer is generally happy as it no longer has to provide employee benefits, make FICA (social security/Medicaid) contributions, or maintain workers compensation insurance for the employee. The worker’s day-to-day role hasn’t actually changed much - she still uses the same company-provided computer she did when an employee, she’s still “online” during the same hours and still holds herself out as working for the company. Furthermore she has the same client accounts and is regarded as being place in the company’s hierarchy. It feels like a win-win for both parties.
Fast forward a year and the relationship has become acrimonious - maybe the worker feels she deserves a higher hourly rate than the one initially negotiated, or she isn’t being given any additional work in spite of the company signing new clients. The relationship ends up suffering and the employer decides to end the relationship with the worker, assuming it to be a clean break.
Feeling hard done by, the worker speaks to a lawyer about her potential options for recourse against the company. That’s when the worker commences a law suit against the employer for misclassification i.e. that she was wrongfully classified as an independent contractor by the employer when she was actually an employee. In a misclassification suit, an employee can claim lost benefits/wages (unpaid overtime, break time, paid time off, pension (401k) contributions, and healthcare coverage. In addition, courts have discretion to assess additional penalties. In some instances a state Dept. of Labor investigation can be triggered.
The employee can allege misclassification even though she asked to be an independent contractor because the courts will look beyond the label either party gives to their relationship and will instead look on the characteristics of the relationship.
The characteristics of an independent contractor relationship are as follows: they use their own tools/equipment, they control the method through which they carry out their work (though not the end product), they are free to work for other clients/companies and they pay their own expenses.
The fact pattern above is similar to an issue a client recently experienced. The worker in question had been a key employee and had been responsible for building strong client relationships for her employer. After a number of years, she had decided to set up her own consulting business, while agreeing to continue working under her former employer’s “umbrella” to service her former client accounts. She continued to use her company-issued computer, maintained a desk in her former employer’s office, and continued notifying the company’s HR manager of days she’d be taking off (though she wasn’t allocated any specific amount of PTO). Her former employer closely supervised her work and while she was not formally required to work any particular hours, she ended up continuing to work a 9am - 6pm schedule, Monday - Friday as she had previously. The relationship worked well for a couple of years until her former employer decided to remove her from a key client account, which resulted in a significant reduction in her income. The relationship soon turned acrimonious and the employer terminated her contract. In retaliation she threatened misclassification.
When dealing with employees in this situation, we always counsel employers to understand the difference between the employment relationship and the independent contractor relationship, to enter into a formal independent contractor agreement with the worker and most importantly, to treat the worker as an independent contractor, not an employee. This requires regular assessment as these relationships have a way of backsliding over time as old patterns are reestablished. If the new relationship is established with clear parameters that are respected by both sides, the new arrangement can be “win-win”. If not, the employer may be subject to significant liability.
