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broker – Hollrah LLC

Recent Developments Affecting Brokers/Referral Agencies that Contract with Independent Contractors to Provide Services to Third-Party Clients

Two recent developments would directly affect companies that contract with independent service contractors to provide services to third-party clients.

Two recent developments would directly affect companies that contract with independent service contractors to provide services to third-party clients. One involves recent legislation enacted in New Jersey that dramatically increases the financial consequences of worker misclassification, generally. The other is a court decision that provides helpful insight into how a broker/referral agency can bolster the defensibility of its independent-contractor relationships and thereby reduce the risk of worker misclassification. Each is discussed below.

  1. New Jersey Escalates the Financial Consequences of Misclassification

Three recently enacted bills in New Jersey escalate the remedies available to the government if it determines a company has misclassified an individual as an independent contractor. A company doing business with independent contractors in New Jersey should carefully review its independent-contractor relationships to ensure that the relationships are defensible under New Jersey’s “ABC” test.[1]

AB 5890 provides that if the New Jersey Commissioner of Labor and Workforce Development determines that an employer has violated any state wage, benefit and tax law, the Commissioner shall (i) notify the employer of the determination, and (ii) conduct an audit of the employer within 12 months of the determination.

The bill also authorizes the Commissioner to bring an enforcement action for a violation of any state wage, benefit and tax law – by either (i) bringing an administrative action, or (ii) filing a lawsuit in Superior Court. The Commissioner is empowered to bring a lawsuit in the form of a class action.  It can seek any fines, penalties or administrative assessments authorized by law. And, if a prevailing plaintiff, the Commissioner can recover all remedies available on behalf of the individuals deemed to have been misclassified and “shall” be awarded attorney’s fees and litigation and investigation costs. If appropriate, the Commissioner can ask a court to issue an injunction prohibiting a company from continuing to misclassify individuals as independent contractors for purposes of state laws. 

While the Commissioner already possessed the right to issue a “stop work” order against a company determined to have misclassified individuals as independent contractors, the bill clarifies that if a company requests a hearing on such an order, the request does not automatically stay the effect of the order. And if a stop-work order becomes final, the affected company would be required to pay any “employee” who loses work on account of the work stoppage 10 days of lost earnings.  An employer that violates a stop-work order can be assessed a civil penalty of $5,000 per day. A.B. 5890 was signed into law on July 8, 2021. It became effective immediately.

A.B. 5892 created a new type of violation resulting from worker misclassification. The new violation occurs when a person purposely or knowingly (i)  makes a false or misleading statement, representation, or submission, including failing to properly classify employees, in violation of state wage, benefit and tax laws for the purpose of evading the full payment of insurance benefits or premiums, or (ii) coerces, solicits, or encourages any individual to make a false or misleading statement, representation or submission concerning any fact that is material to a claim for insurance benefits, or the payment of insurance benefits or insurance premiums, for the purpose of wrongfully obtaining the benefits or of evading the full payment of the insurance benefits or insurance premiums (or employs, contracts, or otherwise conspires with a person to coerce, solicit, or encourage a person to do so).

The penalty for violating this provision “shall be” $5,000 for the first violation, $10,000 for the second violation and $15,000 for each subsequent violation.  A.B. 5892 was signed into law on July 8, 2021. It will become effective on the first day of the sixth month next following the date of enactment.

A.B. 5891 created a new Office of Strategic Enforcement and Compliance in New Jersey’s Department of Labor and Workforce Development (with a $1 million appropriation to fund the office). The new office is charged with overseeing and coordinating the strategic enforcement of state wage, benefit and tax laws. A.B. 5891 also was signed into law on July 8, 2021. It became effective immediately.

The foregoing new laws appear intended to send a clear message that New Jersey is a high-risk jurisdiction for doing business with independent contractors. 

  1. Court Decision Reveals How a Broker/Referral Service Can Avoid Being Deemed the ‘Employer’ of Contractors Who Perform Projects for Third-Party Clients

A court decision involving a company that contracts with independent service providers to perform projects for third-party clients offers helpful insight into how such a company can avoid being deemed the “employer” of the service providers. Practice Pointers are inserted, where appropriate, to emphasize practical implications of the court’s analysis.

The decision in Vendor Surveillance Corporation v. Henning, 62 Cal.App.5th 59 (2021), involves an appeal by a company (“Company”), from an unemployment insurance tax assessment by California’s Employment Development Department (“EDD”). The issue is whether certain “project specialists” contracted by Company between January 1, 2011 and December 31, 2013 (the audit years) were employees or independent contractors.  

The California appeals court held that the common-law test established by S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 769 P.2d 399 (1989), continues to govern unemployment insurance taxes assessed for work performed before January 1, 2020, rather than California’s recently enacted “ABC” test.[2]

Practice Pointers:

  • While this court decision applies to the pre-AB-5[3] era, it nonetheless remains relevant in California, as it offers helpful guidance on satisfying the “A” factor of California’s “ABC” test, which is the factor representing a common-law test. In addition, many of the statutory carve-outs from California’s “ABC” test created by the enactment of AB 2257[4] still require that a relationship satisfy the Borello test. 
  • The court decision also is relevant in other jurisdictions, and for purposes of certain federal laws, where an individual’s status, as an employee or independent contractor, is determined by a common-law test.

According to the court’s findings in Vendor Surveillance Corporation, Company maintains a database of “project specialists” who are qualified to perform “source inspections.” Company is a wholly owned subsidiary of a parent company (“Parent”). Parent provides management services, including source inspections, to aerospace and defense manufacturers. Aerospace manufacturers use component parts made by third-party suppliers that must be fabricated to exacting specifications. To identify potentially defective parts, the manufacturer inspects (or contracts with a vendor to inspect) the parts at the supplier’s facility. The industry calls this “source inspection.” 

When a Parent customer requests a source inspection, Parent negotiates the services to be performed and the corresponding fee. If the customer requires part-time, project-based, on-demand source inspections, Parent subcontracts with Company to provide a qualified “project specialists.” Company classifies project specialists as independent contractors. Parent also has a staffing subsidiary, (“Staffing Affiliate”).  If a Parent customer needs full time work (including but not limited to source inspection) in one location exceeding three months, Parent subcontracts with Staffing Affiliate to provide qualified personnel. Staffing Affiliate classifies its personnel as employees.

For a project subcontracted to Company, Company identifies qualified project specialists from its database and informs them about the project. A project specialist is free to decline work with impunity. Company submits the resumes of project specialists who express interest in a project to Parent, which forwards them to its customer to choose from.

Applying the common-law Borello test to determine the status of source inspectors under contract with Company, the court of appeal affirmed a superior court’s judgment that the source inspectors were employees of Company and not independent contractors.  The following outlines the court’s rationale for its decision.

a. Company had the right to control and exercised actual control

The court observed that under the Borello test the most important factor in distinguishing employees from independent contractors is the putative employer’s right to control the manner and means of accomplishing a desired result. The appeals court affirmed the trial court’s determination that Company had the requisite right of control for this factor to weigh in favor of employment.

The court rejected Company’s claim that it only connected project specialists with suppliers and primary contractors, based principally on findings that:

  • Company determined the manner and means of reporting source inspection results;
  • Company provided supervision and advice upon a project specialist’s request;
  • customers expected supervision by Company; and
  • Company’s agreement with source inspectors authorizes Company to terminate a project specialist without cause.

The court contrasted the foregoing findings with the facts in Varisco v. Gateway Science & Engineering, 83 Cal.Rptr.3d 393 (2008), which involved a company that provided quality assurance services that hired an inspector to check construction undertaken by a school district. The court determined the inspector to be an independent contractor. In that case:

  • the company paid the inspector by the hour and sent him to the job site, but that is all it did;
  • the company did not train the inspector;
  • if questions arose, the inspector addressed them to the school district, not to the company;
  • the inspector reported results to the school district on its forms, not the company’s; and
  • the inspector supplied his own tools and equipment.

The court in Vendor Surveillance Corporation reasoned that the project specialists under contract with Company differ from the Varisco inspector in the following significant respects:

  • Company provided a customer orientation to project specialists;
  • a Parent program leader instructed project specialists on how to use suppliers’ reporting systems;
  • using Parent educational materials, Company mandated that project specialists pass an ethics test based on Company’s code of ethics;
  • Company required that project specialists pass a safety test based on educational materials used by both Parent and Company;
  • Company arranged work-related travel for project specialists;
  • Company provided project specialists with Company branded business cards;
  • Company trained project specialists on certain international regulations;
  • customers expected Parent to supervise, oversee, and manage project specialists; and
  • Company provided software for project specialists to record time and upload the results of the source inspection. 

Company also could terminate a project specialist without cause by providing 30 day’s advance notice. Rejecting Company’s argument that this right does not evidence control because of the 30-day notice period, the court reasoned that, even with a 30-day notice period, a right to discharge without cause would reasonably be expected to compel a project specialist desiring future assignments to obey Company’s directives.

Practice Pointers:

  • Any training or orientation of an independent contractor should be provided by a third party, e.g., an industry association or a client, but not by the company that contracts with an independent contractor to perform a project.
  • The company that contracts with an independent contractor should not supervise or monitor the independent contractor’s work.
  • Contracts with clients should not contemplate any supervision or training of independent contractors.
  • The company that contracts with an independent contractor should not have the contractual right to terminate the independent contractor.
  • If the company that contracts with an independent contractor is owned by a parent company, the company should operate with complete autonomy relative to the parent company; the parent company should not have any direct interaction with the independent contractors, and the independent contractors should not be given any parent-company-developed training or testing materials or project-related information.
  • The company that contracts with an independent contractor should not provide an independent contractor with any logo-wear, badge, business cards, or similar item that identifies the company or that is in any way suggestive of the independent contractor working on behalf of or for the benefit of the company.

b. Project Specialists are not engaged in a distinct business

The appeals court affirmed the trial court’s conclusion that this factor slightly favors employment, reasoning that though some project specialists had created their own business entities, others did not, and even those who did worked predominantly for Company. The court reasoned that its determination is supported by the following findings:

  • one project specialist had a business entity but no website, no e-mail address, no business cards, and no employees except himself;
  • another project specialist had a business entity but no other employees, no clients besides Company, no website, no advertising, and no business cards; and
  • other project specialists had not created separate entities.

Practice Pointers:

  • An independent contractor’s creation of an entity can be of little value if the independent contractor does not also take other actions consistent with operating a separate business.
  • A best practice is for an independent contractor to complete a document in which the independent contractor makes affirmative representations to the contracting company concerning the specific actions the independent contractor has taken that are consistent with operating a separate and distinct business.

c. No evidence on whether the work is usually done in the locale without supervision

The court affirmed the trial court’s determination that EDD prevails on this issue because the evidence on this factor favored neither side – and Company bore the burden of proof. The trial court noted that neither side offered any expert testimony on whether, in the relevant locale, source inspection is typically done using the business model used by Company, or rather done by employees of prime contractors.

While Company argued that the only evidence offered on this point is that project specialists were not supervised while conducting inspections, the court explained that this argument misses the point, because the factor focuses on how the work is usually done in a given locale, not on how the work actually was done in this particular case.

Practice Pointers:

  • The court’s analysis of this factor emphasizes the importance of carefully reading and understanding the meaning of each factor of a test for independent contractor status.
  • The requisite expert testimony that was missing in this case could have been provided a trade association representative of other individual who is knowledgeable about the industry practice at issue.

d. Project specialists are highly skilled

The court affirmed the trial court’s determination that this factor weighs in favor of independent-contractor status, based on findings that many project specialists had years if not decades of experience.

e. Neither Company nor project specialists supplied the tools and instruments

The court rejected the trial court’s determination that this factor “slightly favored EDD,” based on findings that measuring instruments used in a source inspection are supplied by neither Company nor the project specialists, but instead by the supplier.

The appeals court reasoned that ownership of tools is probative because ownership implies a right to control their use. But since neither Company nor the project specialists own the instruments, nor as a practical matter could they, this factor does not apply.

Practice Pointers:

  • The court’s analysis of this factor is helpful, as it indicates that in an industry that does not require an independent contractor to provide very much in the way of tools or equipment, this factor would not necessarily weigh in favor of employment, so long as the company that engages an independent contractor can demonstrate that it does not provide any such items.

f. The work is continuous

The court affirmed the trial court’s determination that this factor supports employment, based on findings that many project specialists had ongoing long-term relationships with Company (some had worked exclusively for Company for 11, 18, 20, and 28 years) and several worked near full time 40-hour weeks. The appeals court determined that these findings outweighed countervailing findings that (i) the Agreement provides that continuity of relationship is not contemplated; (ii) project specialists could (and did) decline work without negative repercussions; and (iii) some project specialists choose to work only part time.

Practice Pointers:

  • Any independent contractor who works 40-hour weeks for one company for an extended period of time is inherently a high-risk independent contractor.
  • For project-based engagements, it is advisable for the agreement with an independent contractor to emphasize that each project constitutes a separate contractual relationship and that upon the independent contractor’s completion of a project, the independent contractor has no obligation to perform another offered project.

g. Project specialists are paid by the hour, not by the job

Based on findings that Company paid project specialists by the hour, which was determined to be the industry standard, the court affirmed the trial court’s determination that this factor favors an employee relationship.

While acknowledging Company’s counterargument that in the modern economy, there is no logical connection between hourly pay and distinctions between employee and independent contractor, the appeals court nonetheless reasoned that common experience teaches that a worker who receives hourly wages is likely (but not necessarily) an employee, and a worker who receives payment by the task is likely (but not necessarily) an independent contractor.

Practice Pointers:

  • For project-based engagements, it is advisable for independent contractors to be paid a fixed project fee and not an hourly rate.

h. Source inspection is a part of Company’s regular business

Rejecting Company’s assertion that its business is maintaining a database of highly skilled self-employed project specialists, and does not include the performance of source inspections, the appeals court affirmed the trial court’s determination that source inspections work is at the core of what the Parent group of companies provides to its aerospace customers. This was based principally on findings that Company’s only client is Parent and Parent’s clients are the aerospace and defense contractors who benefit from the labor provided by project specialists. The court reasoned that Company is not just a database manager; rather, it is part of a unitary business providing staffing solutions to its aerospace clients.

The appeals court reasoned that Company’s business is similar to the business examined in People v. Uber Technologies, 56 Cal.App.5th 266 (2020), which concluded that the drivers performed services in the regular course of Uber’s business. The court explained that the analysis in Uber supports its conclusion that this factor weighs in favor of employment, based on the following similarities:

  • Uber offers a mobile phone application that matches those in need of a ride to drivers available to give them rides using their own vehicles.
    • Similarly, Company offers a database to match those in need of a source inspection with a project specialist available to perform the work.
  • Uber drivers need not accept any minimum number of rides, are free to work for competitors and to decline work. Uber monitors its drivers and may use low ratings to deactivate them.
    • Similarly, project specialists are free to decline offered work, Company monitors a project specialist’s performance and, in response to customer complaints, can terminate a project specialist and remove the person from its database.
  • Uber asserted that it was not in the business of providing rides, but instead merely provides a platform to connect drivers and riders.
    • Company similarly claimed that it is not in the business of providing project specialists, but instead is merely a database to connect project specialists with customers. Also, Company earns all of its revenue from providing project specialists to Parent.

Practice Pointers:

  • The decision also reveals the risk that an affiliated group of companies can be viewed as one unified business, which would be problematic for purposes of this factor – and for the “B” factor of an “ABC” test.[5] To mitigate this risk:
    • the subsidiary companies should enter into contract with at least some clients directly, to demonstrate independence from the affiliated entities;
    • the subsidiary companies should maintain their own websites and market their services directly to end-user clients;
    • each subsidiary should operate with complete and absolute autonomy relative to the affiliates; and
    • the parent company’s website should not suggest that the subsidiary companies are part of the parent company’s business but instead should identify them, if at all, as affiliated but separate businesses.
  • The court’s analysis reveals the difficulty of a company successfully arguing that the services an independent contractor provides are outside the usual course of the company’s business if the company monitors the independent contractor’s performance and can terminate the contractor for not meeting performance metrics that the company, itself, establishes.

i. The parties believed they were creating an independent contractor relationship

While the court affirmed the trial court’s determination that this factor “easily favored” an independent-contractor relationship, the court accorded it diminished weight, reasoning that courts ignore the parties’ characterization if their actual conduct establishes a different relationship.

j. Company operates as a business, not an individual

The court recounted that Company acknowledged that it operates as a business and accordingly determined this factor to “lean” towards establishing an employer-employee relationship.

  1. Conclusion

The developments in New Jersey reflect a philosophical shift that has manifested itself throughout the country toward increased skepticism of independent-contractor relationships. Any company doing business with independent contractors should be mindful of this shift and ensure that its independent-contractor relationships are defensible. The decision in Vendor Surveillance Corporation offers helpful guidance for improving the defensibility of such relationships.

*     *     *

If you have any questions or comments concerning the foregoing, please let me know.

The foregoing is intended solely as general information and may not be considered tax or legal advice; nor can it be used or relied upon for the purpose of (i) avoiding penalties under any taxing statute or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. You should not take any action based upon any information contained herein without first consulting legal counsel familiar with your particular circumstances.

[1] N.J. Stat. Ann. § 43:21-19 provides that services performed by an individual for remuneration shall be deemed to be employment for purposes of New Jersey unemployment unless and until it is shown to the satisfaction of the division that:

(A) Such individual has been and will continue to be free from control or direction over the performance of such service, both under his contract of service and in fact; and

(B) Such service is either outside the usual course of the business for which such service is performed, or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and

(C) Such individual is customarily engaged in an independently established trade, occupation, profession or business.

The New Jersey Supreme Court held that the same test should be used to determine the nature of an employment relationship under both the New Jersey Wage Payment Law and the New Jersey Wage and Hour Law. Hargrove v. Sleepy’s, LLC, 220 N.J. 289, 106 A.3d 449 (2015)

[2] California’s “ABC” test provides that a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all three of the following conditions are satisfied:

(A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

(B) The person performs work that is outside the usual course of the hiring entity’s business.

(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

[3] AB 5 refers to the first law California enacted to statutorily adopt an “ABC” test for determining worker status.

[4] AB 2257 refers to a law California enacted that in some respects supersedes AB 5 and created numerous carve-outs from the “ABC” test that AB-5 enacted.

[5] See above note 2.