December 16, 2019
Sorting Out Worker Misclassification
The increase in gig workers has more companies testing the teeth of worker misclassification rules. They’re about to come under the gun in California, but some construction contractor practices may get a pass.
Tom Zind | Nov 18, 2019
It’s a match made in heaven — at least on paper: workers who increasingly long to be “free agents” and employers who salivate at the prospect of reducing the many costs that come with maintaining traditional employees. That’s the recipe for the possible growth of the “gig economy,” in which more workers move from being employees to independent contractors, ostensibly handing workers the freedom and flexibility many crave while freeing employers from some of the financial burdens of being, well, employers.
Some of the allure of gig work has been abating as workers complain of exploitation — such as Uber drivers — and employers rediscover the management advantages of having full-time, dedicated employees. But independent contractor arrangements continue to be a force in the evolving labor economy — nowhere more so perhaps than in the construction contractor sector, where the practice has a long history.
Broadly, though, it’s drawn the probing, wary eyes of legislators, regulators, and even prosecutors, who are lifting the hood to find loads of trouble in worker’s paradise: namely, that many workers are actually being taken advantage of by companies breaking labor laws, cheating on pay, not paying their fair share of taxes, and fostering an uneven playing field in their industries.
At issue is worker misclassification, describing when workers enter into labor arrangements that bear all the marks of a standard employer-employee relationship but are treated as off-payroll, independent, self-employed contractors. Doing so frees companies from paying the employer’s share of payroll taxes, unemployment and workmen’s compensation insurance premiums, and extending benefits such as health insurance and overtime pay.
Many independent contractor arrangements are legitimate and legal, others exist in a gray area, and others are blatantly illegal — the result of willful violations or ignorance of laws, oversights, or honest misinterpretations. However they’re spawned, it’s the misclassification result that’s under scrutiny, something a 2013 U.S. Treasury Department investigation found was linked to some 15% of employers and 3.4 million workers.
The construction sector has long been a hotbed of activity for misclassification, partly due to the industry’s need for temporary labor and the reliance of some firms on the underground labor market. Many studies have documented construction’s tie; one, the Economic Roundtable’s 2014 “The Growing Informal Economy in California Construction,” concluded that one of every six construction jobs in the state in 2011 existed outside of a traditional employer-employee structure. Furthermore, it estimated that 19% of non-employee construction workers in California were misclassified in 2011.
“High-road contractors, like higher skilled workers, are pushed out of the industry by low-road competitors who don’t report employees and commit payroll fraud to win contracts,” the report stated.
Informal labor arrangements exist within a wide variety of construction sub-sectors and jobs, the report noted. But among those with lowest incidence of misclassification are electricians, estimated at 10%, suggesting, in turn, that electrical contracting is not where the problem lies.
But electrical contractors aren’t immune from getting embroiled in misclassification cases. The attorney general for Washington, D.C., last year brought charges against St. Petersburg, Fla.-based contractor, Power Design, Inc., and two companies it allegedly hired to furnish labor on various jobs in the district for “failing to classify hundreds of its workers as employees and cheating them out of wages and benefits,” according to an Aug. 6, 2018, press release from the AG office announcing the action.
The suit alleges that from 2014 to 2017, actions taken by the three firms resulted in at least 535 workers being misclassified as independent contractors, causing many to be denied minimum wage, overtime pay, and sick leave, and led the companies to not maintain payroll records and to fail to pay into D.C.’s unemployment insurance program on behalf of the misclassified workers. In the AG release, the alleged violations where characterized as an “illegal payroll scheme (that) enabled Power Design to cut business costs and submit low bids to win business over law-abiding competitors.”
Power Design’s general counsel, David Redden, told EC&M that the company is contesting the suit on the assertion that responsibility for any misclassification that may have occurred lies solely with the other two defendants. He says the suit, as it applies to Power Design, appears to turn on the debatable assumption that responsibility for violations of this nature naturally flows up the chain.
“What’s unfortunate about the situation is that this didn’t involve any Power Design employees,” he says. “We hired subcontractors and they misclassified their employees. So, we’re currently in dispute about our liability in the way of responsibility for fines and penalties as a contractor for what our subcontractors did.”
In another electrical contractor case from 2018, the U.S. Department of Labor settled with Ernest P. Breaux Electrical LLC, New Iberia, La., after an agency investigation determined it misclassified employees and failed to pay them for overtime work in violation of the Fair Labor Standards Act. It also failed to maintain accurate payroll records. According to a department release from November 2018, the company agreed to pay $250,000 in back wages for 117 employees and pledged to enact measures to avoid repeat violations.
California Says Enough
While violators are being taken to court or rung up by watchdog agencies, lawmakers are also getting into the action. The latest legislative push is underway in worker-friendly California, where a new law subjecting employers to clearer and more rigid tests — essentially a higher bar — before they can classify workers as independent contractors is set to take effect Jan. 1, 2020.
Assembly Bill 5 (AB 5), signed into law in September, grew out of a 2018 California Supreme Court decision that produced a ruling upending guidelines employer had used for 30 years to determine worker classification. The court’s ruling established a new three-factor test for determining that, one that replaces gray areas of an old multi-factor test that provided more flexibility for hiring entities with one that’s more definitive. Though detailed and comprehensive, that old test hinged largely on whether the hiring party had the right to control the “manner and means of accomplishing the desired result.” Eleven other factors — not all required to be met — make up that test, one that effectively granted employers wide latitude in deciding to designate workers as non-employees.
The new criteria, growing out of the court’s 2018 Dynamex Operations West case, in which it upheld an appeal court’s ruling in favor of courier drivers who contended they were improperly classified as contractors by Dynamex, reside in what’s dubbed the “ABC” test. It tells businesses a worker is assumed to be an employee, not an independent contractor, unless they can demonstrate three things: 1)that the worker “is free from the control and direction of the hiring entity in connection with the performance of the work”; 2)“performs work that is outside the usual course of the hiring entity’s business”; and 3)“is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.” Meet all three, and employers presumably have a green light to designate workers as non-employees.
With AB 5 in force, the test is now codified. That means California employers will be guided by it as they hire, and will be subject to oversight, enforcement actions, fines, penalties, and litigation for non-compliance. Advocates say the new law will help stop illegitimate misclassification practices that have harmed more than 1 million workers in the state and regularly keep billions of dollars in tax money from flowing to state coffers.
Construction Gets a Lifeline
However, exceptions to AB 5 have been granted to employers in a broad range of industries. One beneficiary is construction contractors, whose common practice of formal subcontracting has nuances that can cloud the nature of the relationship between a hiring entity and those hired.
Crafted with the input of Associated General Contractors of California (AGCC) and other industry groups, including California chapters of the National Electrical Contractors Association (NECA), the exception recognizes that the existence of a valid contract is a critical determinant of the relationship.
Consequently, construction contractors who engage a subcontractor pursuant to a contract aren’t subject to the ABC test, AB 5 states, and can instead default to the more flexible framework provided for in the old California rule known as the Borello test. But they must first check seven boxes that can confirm the labor provider is a separate entity, among them that a written contract exists; the provider has a state contracting license and performs work within its scope; maintains a business location separate from that of the contractor; has authority to hire and to fire other persons to provide or assist in providing the services; and is customarily engaged in an independently established business of the same nature as that involved in the work performed.
AGCC, in a written summary of the new law for members, frames that special preliminary test as the legislature’s way of ensuring “that a subcontractor to a prime contractor is a true subcontractor, and not a ‘captured subcontractor.’” But, it cautions, Borello hurdles could still trip up hiring parties. Even if contract paperwork is ironclad, it says, “if challenged, the prime contractor would have a burden to prove enough of the Borello factors to avoid liability.”
There’s enough uncertainty about interpretations of the new law, AGCC says, that contractors and their customers should brace for some potential financial consequences. Until the law is ultimately “litigated, mitigated, or adjudicated,” and is clarified, says Robert Dugan, AGCC vice president of advocacy and public affairs, construction bids could rise.
“The law may open the door to a multitude of new exposure for construction and labor costs on projects,” he says.
Business Services Carve-Out
However, another notable concession to construction interests is tacit acknowledgement that contractors routinely rely on independent labor for certain “business-to-business” services and strong reassurance that they can continue doing so unimpeded. That’s an important win for electrical contractors, says Greg Armstrong, executive director of NECA’s Northern California Chapter.
“Third parties doing testing, certification, and commissioning for lighting systems, for instance, are typically sole proprietors,” he says. “That’s a business-to-business transaction, not someone who’s working directly for a contractor. It would have increased contractor costs if they had to put someone on the payroll to do that work.”
AB 5, with its rigid three-factor test, worried electrical contractors who rely on independents for such services, particularly the requirement that the work performed is outside the contractor’s normal scope, says Eddie Bernacchi, who lobbied on behalf of NECA’s state chapters. Since it’s potentially debatable that a given hiring contractor couldn’t or doesn’t perform that work, the industry worried that many such arrangements as commonly structured might not hold up under scrutiny.
“AB 5’s “B” prong caused us some concern, that without some clarification those service provider arrangements could have caused some disruption for members,” Bernacchi says. “So, we worked hard to make sure we got a fair exemption in the statute, and the sponsors thought it was important contractors could continue to use the subcontractor model.”
AB 5, however, will surely apply to contractors in their hiring of other workers clearly outside the definition of ancillary, self-employed service providers under valid contract or not. Construction contractors have long had to navigate the worker classification minefield because many are faced with supplementing their workforces when demand spikes. That often means temporary workers come into the picture, along with questions about how to classify them. AB 5, AGCC says, doesn’t seem to clear that up much.
“Where the law is vague in when contractors and subcontractors use independent contractors to supplement their workforce on a temporary basis,” says Dugan. “As written, it appears those independent contractors will either need to establish their own licensed businesses, with all the appropriate local and state licenses, or become temporary employees of the contractor.”
While AB 5, even with granted exceptions, is sure to create headaches for California construction contractors, it also promises to flush out those who flout labor laws most others follow. Promising penalties for companies that abuse the independent contractor route, it should help to begin eroding an unfair — and often substantial — competitive advantage that violators enjoy.
Trevor Falk, director of government affairs for NECA, expresses hope that California’s effort to ensure the industry’s workers are treated fairly will spark similar efforts on the state and national level.
“(Misclassification) forces contractors across the country to compete against people who are intentionally undercutting them,” he says. “There have been some fixes proposed over the years, but identifying and penalizing violators has been largely underfunded and overlooked in terms of enforcement. Getting a national misclassification bill through would be a good thing for the industry.”
Zind is a freelance writer based in Lees Summit, Mo. He can be reached at email@example.com.