Delaware Business Lawyer Blog

As a Delaware business attorney, I’m always interested in protecting my clients from lawsuits, and so it’s important that I learn as much as possible about my clients and how they do things. In this regard, I find it interesting whenever a huge company gets caught trying to cheat its employees by trying to save a few bucks.

Have you heard about Federal Express being sued by 25,000 drivers who claim that by improperly classifying them as independent contractors as opposed to employees, FedEx has cheated them out of overtime pay, employee benefits, and the right to file claims for workers comp and unemployment insurance. The IRS has also gone after FedEx on this same issue. In December 2007, after determining that FedEx's Ground independent contractors should be reclassified as employees for tax purposes, the IRS ordered FedEx to pay more than $319 million in back taxes and penalties for the year 2002.

FedEx is not the only big company that has paid a huge price because it misclassified employees as independent contractors. In 2000, Time-Warner settled a case that was brought against it by the Department of Labor because Time-Warner had failed to give employee benefits to certain workers by calling them independent contractors. The amount of the settlement? It was $5.5 million.

And in 1997, a federal court ruled that Microsoft improperly classified thousands of its workers as independent contractors in order to deprive them of stock option benefits that were available to Microsoft's employees. The company even went so far as to have these workers sign contracts in which they agreed that they were independent contractors, and acknowledged that they weren’t entitled to any company benefits. Microsoft is believed to have paid close to $100 million to settle that case.

In previous articles, I discussed the difference between an employee and an independent contractor, and the IRS's position on this distinction. This article talks about the factors to be considered when deciding whether an individual is an employee or an independent contractor.

As a Delaware business lawyer, I’ve seen a lot of contracts entitled “Independent Contractor Agreement.” But the fact that a contract calls someone an independent contractor doesn’t make him one. It’s therefore important to have a Delaware business attorney prepare your written agreement in a way that accurately describes in detail your relationship with the worker. It’s also important for you to discuss with your attorney how the contract needs to be carried out by you so your conduct does not turn someone you consider an independent contractor into an employee.

An awful lot has been written about how the courts decide whether a worker is your employee or an independent contractor. In Delaware, although there are numerous factors taken into consideration, the most significant factor has to do with control by the business owner.

Let’s compare two different kinds of control. If a business owner controls how the work is performed, the courts view that as evidence of an employer-employee relationship. On the other hand, if the owner’s concern is the final result and not how that result will be achieved, then the court views that as evidence of an independent contractor relationship.

One of the most recent views expressed by a Delaware court boils it down to a “time, manner and method” rule. If the owner maintains control over the time, manner and method of performing the work, as opposed to just requiring that the results are in compliance with the terms of the contract, then an employer-employee relationship is found to exist.

If the individual in question is your employee instead of an independent contractor, it means:
(1) He can a claim for unemployment insurance
(2) He can file a claim for workers comp disability benefits
(3) He can file a claim under Delaware's Wage Payment and Collection Act
(4) Taxes have to be withheld
(5) As his employer, you will be vicariously liable for any injuries he causes to others while he's in the course and scope of his employment.

In my last article entitled "Employees and Independent Contractors - What's the Difference?" I pointed out that one important reason for a business owner to know whether a worker is an employee or an independent contractor is that an employer is legally responsible for the negligence of his employees, but he's not responsible for the negligence of an independent contractor. Here's what the IRS has to say about the difference between employees and independant contractors from a taxation point of view.

It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.

Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be (1) An independent contractor (2) An employee (common-law employee) (3) A statutory employee or (4) A statutory non-employee.

In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

Facts that provide evidence of the degree of control and independence fall into three categories:

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that the employer has the right to control the details of how the services are performed. Such details include:
When and where to do the work
What tools or equipment to use
What workers to hire or to assist with the work
Where to purchase supplies and services
What work must be performed by a specified individual
What order or sequence to follow

Financial: Are the business aspects of the worker’s job controlled by the payer? Are there unreimbursed expenses that the worker has to bear themselves? Are the worker’s services available to the public? What is the method of payment; do they get paid whether the work is done or not or do they get paid only if they finish the job? Independent contractors can realize a profit or loss on a job. Can the worker make business decisions that affect his bottom line?

Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue indefinitely or only for a specific project or period. Also, does the worker have his own business, which he markets to others?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Small business owners sometimes consult with a Delaware business attorney to discuss the pros and cons of hiring someone as an independent contractor rather than making that person your employee. As with anything, there are factors to consider that way in favor of and against each choice. Let’s suppose you make the decision to engage the services of an independent contractor. You may be surprised to learn that in the eyes of the IRS and the courts, the person you consider to be an independent contractor is actually your employee. And that kind of determination has consequences you may not have wanted.

Here in Delaware, I’ve handled cases where somebody negligently injures my client, and I sue that individual as well as the company he was working for. The reason for suing the company is that an employer is responsible for the negligence of an employee if he was acting within the scope of his employment at the time of the injury. That’s because of a well recognized doctrine called “respondeat superior,” or “vicarious liability.” In some of these cases, the company claims that the negligent worker is an independent contractor rather than an employee. This is important to figure out, because vicarious liability doesn’t apply to independent contractors.

So, if the worker is in fact an independent contractor, there’s no case against the company. On the other hand, if the worker is an employee, the company is liable for his acts of negligence.

It may seem like an easy matter to figure out, but as we’ll see below, it’s not always easy to make this distinction. One thing is clear - it doesn’t make a difference what you call the worker. The courts and the IRS will go beyond any contract that says somebody is or is not an independent contractor, and they will focus instead on the specific facts.

My next article will go into this in more detail, starting with the IRS's position. For now, consider the following quote from a Delaware court:

“It would be a hopeless task for any Court to lay down a rule whereby the standing of men laboring and contracting together could be definitely construed in all cases as employees or independent contractors. Each particular case must, out of necessity, depend on its own facts, and ordinarily no one characteristic of the relation is decisive. All of the characteristics must be considered. Consequently, in a majority of the cases the question becomes one of fact.”