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Contracts With Independent Contractors

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in Compensation and Benefits,Employee Benefits Program,Human Resources

Your contract with an independent contractor establishes payment rates and methods, the nature of the work to be completed, the deadline for completing the job and performance standards.

No matter how casual the relationship or how well you know the contractor, you should always have a signed contract describing the work to be done. Here's why:

  • It helps establish that your intent was to hire the individual as a contractor, not an employee. The contract won’t prove a bona fide contractor relationship existed, but the lack of a contract makes it extremely difficult to prove such a relationship existed.
  • It offers you protection should the contractor’s work be unacceptable in some way. If a disgruntled contractor sues you and there’s nothing in writing, it’s up to the court to decide whether the terms of the contract were met.
  • Most reliable contractors will insist on a contract. After all, the contract represents the freelancer’s best protection as well.

Remember: Although the contract affirms your intent to hire the individual as a contractor and not as an employee, an IRS inquiry would focus on how the contractor performed his work. Thus, the safest course is to ensure that your company’s supervisors understand that they must produce a quality end product with only minimum involvement with contractors.

Courts may overlook the contract

Even if you draft a contract that classifies workers as independent contractors and they sign it, you’re not home free. If the workers challenge their status, a court may care less about the contract they signed and more about the actual terms of the work relationship.

FedEx is finding this out the hard way. In 2005, a California trial court ruled that FedEx’s delivery drivers were employees because the company exercised “close to absolute actual control” over the drivers. In fact, the court described FedEx’s operating agreement, the basis of the company’s defense, as “a brilliantly drafted contract creating the constraints of an employment relationship with [the drivers] in the guise of an independent contractor model.” The court awarded $5 million in damages.

A Superior Court affirmed, ruling, “The drivers look like FedEx employees, act like FedEx employees, are paid like FedEx employees and receive many employee benefits.” The judge added: “If it looks like a duck, walks like a duck, swims like a duck, and quacks like a duck, it is a duck.” To date, the courts have awarded more than $14 million in damages in that case.

But that was just the tip of the iceberg for FedEx. More than 27,000 drivers in 19 states have been certified in further class action lawsuits over the company’s driver classification. Worse, the IRS independently decided that all the company’s drivers were employees, regardless of the lawsuits, and tallied a potential back tax bill of $319 million plus interest for the year 2002 alone. Estrada v. FedEx Ground Package System, Inc., 154 Cal.App.4th 1, 10-11, 64 Cal.Rptr.3d 327 (2007)

In another high-profile case, hundreds of Microsoft Corp. programmers who had signed a document saying they were independent contractors later sued the company for inclusion in its 401(k) plan and claimed they were really employees. The programmers had worked full time for 18 months in Microsoft’s offices, side by side with full-timers doing similar work, so it was hard to tell the difference. The 9th Circuit judges ruled that because the difference between these workers and Microsoft’s regular employees was not very clear, the independent contractors qualified as common-law employees eligible for benefits. The software giant’s argument that its freelancers signed contracts agreeing to independent-contractor status was ruled invalid. Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1996), cert. denied, 522 U.S. 1098 (1998)

Note that in the Microsoft case the contractors won the right to participate in the company’s 401(k) plan because the benefit was made available to all employees. But in a later, similar case the DuPont Co. was able to escape a similar fate because DuPont’s benefits plan explicitly excluded contractors. Clark v. E.I. DuPont, 105 F.3d 646 (4th Cir. 1997)

Recommendation: You can avoid similar problems with contingent workers by carefully wording the language in your benefits plans to exclude contract workers.

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