Alert October 05, 2009

Massachusetts High Court Decision Highlights Perils of Misclassifying Workers as Independent Contractors

The Massachusetts Supreme Judicial Court’s recent decision in Somers v. Converged Access, Inc. highlights the perils of misclassifying workers as independent contractors. Converged Access hired the plaintiff, Robert Somers, to perform electrical engineering work at its Billerica, Massachusetts facility as an independent contractor. Because he was not classified as a regular employee, he was ineligible for fringe benefits and did not receive overtime premiums for hours worked in excess of 40 in a workweek. However, he was paid a higher hourly rate than he would have received had he been classified as a regular employee, and his  monetary compensation exceeded the combined value of wages (including overtime premiums) and benefits received by employees performing similar work. After the company cancelled funding for his position and his contract ended, Somers brought suit for, among other things, unpaid overtime compensation and other benefits he would have received had he been considered an employee.

The employer in Somers raised a defense against liability on the basis that Somers had not suffered any damage as a result of the misclassification since he would have received less had he been properly classified. The SJC rejected this defense and held that, for damages calculation purposes, his wage rate was the hourly rate at which he was hired – not what Converged Access claimed it would have paid him had he been properly classified. In remanding the case to the Superior Court for trial, the SJC also indicated that the company could be liable to Somers for unpaid vacation pay, holiday pay and other benefits received by regular employees. In addition, the plaintiff’s damages for unpaid overtime, vacation and holiday pay would be trebled under the provisions of the Massachusetts wage payment law, and the company would be liable for the plaintiff’s attorneys’ fees.

Recent legislative, judicial and regulatory activity at both the federal and state levels have increased concern and enhanced employers’ potential liability for misclassification of workers, especially in Massachusetts. While standards and definitions differ based on legal context, at the federal level the applicable test generally is whether the contracting entity retains the right to control the manner in which work is performed. In Massachusetts, the applicable test is more stringent.

The Massachusetts Independent Contractor Law

The Massachusetts General Laws, c. 149, Section 148B creates a “presumption” that a person hired to perform services is an employee unless a company can establish each of the following: (i) that the individual is free from the company’s control and direction; (ii) that the service performed is outside of the usual course of the business of the company; and (iii) that the individual is customarily engaged in an independently established trade or profession of the same nature as the service being performed. The second factor creates the most difficult burden for employers seeking to justify classification of a worker as an independent contractor. There is not a significant amount of judicial guidance available to apply the “outside the usual course of business” test. In a 2008 Advisory, the Office of the Massachusetts Attorney General indicated that, in its enforcement actions, it will consider whether the work performed by the individual is “merely incidental” to the work regularly undertaken by the employer and, therefore, satisfies the second prong, or, alternatively, if the work is “an essential part of the employer’s business” rendering an independent contractor classification inappropriate.

A misclassification of individuals as nonemployees does not itself establish a violation of Section 148B. Rather, Section 148B(d) provides that a violation occurs only where an employer misclassifies a worker “and in so doing fails to comply, in any respect,” with any of several other specified employment statutes, such as: any other provision of Chapter 149 (including the state personnel records law); the minimum wage and overtime provisions of Chapter 151; the workers’ compensation insurance requirement of Chapter 152; or the state tax withholding provision of Chapter 62B. Therefore, there must be a so-called “secondary violation” for an employer to be liable. A violation of Section 148B can subject an employer to civil and criminal penalties. Further, private litigants may file a civil action seeking mandatory treble damages plus attorneys’ fees.

In light of this significant potential liability, employers should make sure that workers classified as independent contractors are timely paid, receive at least the minimum wage, receive one and one-half times their regular rate for hours worked over 40 (unless they are paid a fixed salary and are performing work that is exempt from federal and state overtime requirements) and receive meal breaks to which employees are entitled. Also, since vacation and holiday pay are deemed wages under Chapter 149, Section 148, unless workers designated as independent contractors are clearly excluded from eligibility for such benefits, regardless of whether such designation is correct (e.g., by excluding temporary workers), failure to provide a misclassified worker with paid vacation or holiday pay could be a secondary violation triggering liability.

Scope of Impact on Workers’ Compensation and Tax Withholding

In addition, employers should consider the potential applicability of workers’ compensation and the state tax withholding laws to persons who are otherwise treated as independent contractors. Each of the workers’ compensation law and the state tax withholding law has its own definition of “employee.”  The standard under the state tax withholding law is clearly narrower than the Section 148B standard. The state tax withholding law specifically refers to the definition of “employee” in the Internal Revenue Code (a multi-factor test designed to measure the degree of independence a worker actually possesses). Since the independent contractor law did not amend the workers’ compensation law or the state tax withholding law, the definitions did not change for that purpose. However, Section 148B creates additional adverse consequences for employers that do not provide workers’ compensation coverage for persons who are employees for both Section 148B and workers’ compensation law purposes.

Potential Implications for Employee Welfare Benefit and Retirement Plans

While the Massachusetts independent contractor law may, in some cases, have an impact on employee benefit plans, that impact will in any case be indirect and will depend upon a number of factors. By its terms, the law does not purport to require employers to extend benefit plan coverage to workers who do not satisfy the three-part test (and are therefore considered to be employees for purposes of Chapter 149, Section 148B). Indeed, it is likely that any such direct attempt to require benefit plan coverage through a state statute would be preempted by a federal law in the case of pension plans or other self-insured benefit plans covered by the federal Employee Retirement Income Security Act. However, adjustments to employment practices that employers make in response to the independent contractor law conceivably could have a collateral effect on benefit plan coverage depending on the wording of the relevant plan documents. For example, an employer’s plan document may provide that it covers only “employees” who satisfy certain criteria, and may define “employee” for this purpose as any individual who is identified as an employee on the employer’s records. In this case, if the changes to the independent contractor law resulted in the employer identifying as “employees” on its records additional individuals who would not be considered to be employees under the traditional IRS test, those additional “employees” would become eligible for benefits under the terms of the plan document. It therefore is important for employers to review the terms of their plan documents to ensure that the plan language will not result in the unintended extension of benefit coverage to these individuals. If employers do not wish to provide benefits to such workers, it may be necessary for them to amend their plans. It also typically would be helpful in this regard to have any agreement with a person classified as an independent contractor contain an express waiver of any right to be covered by any benefit plans of the employer.

Conclusion

Employers should be extremely thoughtful about whether  to classify workers as independent contractors. While still appropriate in a narrow set of circumstances, recent legislative, judicial and regulatory activity at both the federal and state levels have increased concerns and enhanced employers’ potential liability for misclassification of workers. Massachusetts companies must be particularly vigilant in light of Chapter 149, Section 148B’s more stringent test, the potential for a relaxed standard for establishing a secondary violation, and the mandatory trebling of damages.    

The Massachusetts law should not have any impact on contract workers employed through staffing agencies, so long as the staffing agency complies with workers’ compensation, wage/hour withholding and wage payment laws. Companies using these firms to supply workers should insist on evidence of compliance and indemnification for any liability arising out of a failure to comply with such laws.