Treating contractors as employees may pose risks for the organization. When planning the annual company picnic, keep the party to the family.

by William B. Bierce

HR directors face a daily struggle to match internal and external resources to meet the tasks and fulfill the mission of their organizations. To meet needs, they call on independent contractors to augment staff. Companies that provide both personnel and payroll services create legal risks of co-employment. Such risks could seriously prejudice the enterprise’s HR operations, impacting morale, performance, financial condition, and income statements and shareholder value.

Co-employment arises when a worker has two supervisors who exercise real or potential control over the worker’s manner of performance and workplace activities. Usually this involves a supervisor dictating the sequence of projects and how the work is to be performed (beyond defining acceptable work). The workplace supervisor might provide input on interim work product and requesting changes.

Three basic tests exist for co-employment. The IRS applies a 20-factor test to determine employee or independent contractor status. These criteria are potentially inconsistent and do not offer much assurance. The Department of Labor’s test under the FLSA considers “economic realities” such as degree of economic integration, the permanency of the relationship, the worker’s investment in tools and equipment, and assumption of profit risks. Under a common law test, the question is whether the workplace employer has the right to control the manner and means by which the contract worker performs the assigned tasks.

None of these tests is conclusive, making it practically impossible to eliminate co-employment risk in any staff augmentation relationship. Further, all three tests (and hybrids according to state laws) also need to be satisfied.

Co-employment creates the risk of vicarious liability of one co-employer for the misdeeds of the other. Such liability might involve a hostile work environment or mistreatment of a contractor that might violate civil rights or employment discrimination laws.

Indeed, the scope of co-employment liability can cover the entire waterfront of laws that protect the employment relation. These include civil rights, Title IX, EEO reporting and affirmative action, OSHA, Americans with Disabilities Act, Age Discrimination in Employment Act, the right to unionize, I-9 hiring compliance, and many others.

For companies that have a stock option plan or are going public so that options have a higher value, co-employment is an immediate danger. Microsoft learned this from having thousands of contractors performing software development work at its facilities. It reportedly paid $97 million in settlement costs to avoid giving contractors rights to its plan. If the contractors had been treated as co-employees of Microsoft, trustees of Microsoft’s ERISA plans might have been found out of compliance, and the plan might have been invalidated for full-time employees.

Similarly, co-employment creates the risk of unforeseen vicarious legal rights for the worker who purports to be an “independent contractor.” Such rights might include stock option eligibility, social security rights, FMLA time-off for family needs, the right to sue for an unsafe, hazardous, or hostile office environment, and civil rights violations.

Vicarious legal rights and liabilities occur regardless of whether the contractor is paid directly by the enterprise on a Form 1099 basis or indirectly through a staffing company that pays on a Form W-2 basis.

Co-employment can be managed with these options.

• Use a staffing company with deep pockets and an internal employment compliance program that actually treats workers as its employees for all purposes. This path still has risk.

• Outsource services provided by a managed service provider (MSP) that manages and controls its own employees directly. Insulation from the enterprise is provided by the outsourcer’s on-site supervisor.

Achieving insulation through outsourcing demands a high degree of process management by the MSP. The key is the governance relationship, in which the HR director assigns tasks to the outsourcer’s personnel director. The HR director has to be willing to lose direct control and regain it by indirect means such as work orders, statements of work, change control procedures, and the outsourcer’s liaison.

HRO works well in defined roles such as recruitment process outsourcing (RPO). It encounters more difficult challenges where the roles of the workplace workers change rapidly. Contracting with MSPs can mitigate or even eliminate co-employment risks.

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