The use of independent contractors has seen a steady rise in America over the decades. Nowhere is this more apparent than in the construction industry that revolves around independent contractor relationships between owner, general contractor, and sub-contractors. This is not to say that employees are shut out of the industry, rather their use is compartmentalized amongst and between general contractors and subcontractors. A single entity, employee driven construction project is a rarity and contractual independent contractor relationships are the norm.
What is an Independent Contractor?
An independent contractor is generally defined as someone who is entrusted to undertake a specific project by a hiring party but who is left free to do the assigned work and to choose the method for accomplishing it. On the other hand, if that “someone” is in the service of another person under an express or implied contract of hire, under which the employer has the right to control the details of work performance then he is an employee. As such, the primary hallmarks of an independent contractor are little to no control over the means a person utilizes to achieve results. General contractors are usually independent contractors of the owner and subcontractors are the independent contractors of the general contractor.
On September 22, 2020, the U.S. Department of Labor (DOL) announced a proposed rule clarifying the definition of an employee under the Fair Labor Standards Act (FLSA) as it relates to independent contractors. The DOL’s purpose in making these rule changes is to bring clarity and consistency to the determination of who’s an independent contractor under the FLSA. The DOL desires to reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility for independent contractors and those who employee them. In this regard, DOL will adopt an “economic reality” test to determine a worker’s status as an FLSA employee or an independent contractor. The test considers whether a worker is in business for himself or herself (independent contractor) or is economically dependent on a putative employer for work (employee). The test further identifies and explains two “core factors,” specifically (1) the nature and degree of the worker’s control over the work, and (3) the worker’s opportunity for profit or loss based on initiative and/or investment. Drilling down further into the independent contractor analysis, the DOL identifies three other factors that may serve as additional guideposts in the analysis: (1) the amount of skill required for the work; (2) the degree of permanence of the working relationship between the worker and the potential employer; and (3) whether the work is part of an integrated unit of production. The DOL’s proposed rule change expands beyond the traditional analysis of the nature of the control that is exercised over the independent contractor and focuses more on the actual practices that underly the relationship between the hiring and independent contractor parties. Notwithstanding the foregoing, the DOL’s proposed rule changes are simply “proposed” and have no current effect of law. As such, the traditional tests of what independent contractors are remain in effect; below we explore some of the pros and cons of the use of independent contractors.
Benefits of Using Independent Contractors
There are several major advantages to using independent contractors rather than employees. In the context of construction contracts, an independent contract relationship can limit the liability of hiring parties. With the exception of ultra-hazardous activities which can impose liability on the hiring parties, they are generally immune from liability for injuries sustained by the independent contractor’s employees in performing their work. However, hiring parties can lose this immunity if they actively participate in or interfere with the job to the extent that they directly influence the manner in which the work is performed. This does not mean that hiring parties cannot order the work stopped or resumed, inspect the progress or receive reports, make suggestions or recommendations which need not necessarily be followed, or prescribe alterations and deviations.
Another advantage of hiring an independent contractor is that hiring parties are not exposed to the legal responsibilities an employer has to its employees. Employers are obligated to pay employee related expenses which include Social Security and Medicare taxes, employer-provided benefits, state unemployment compensation insurance, and workers’ compensation insurance. Employers must also pay minimum wage, overtime compensation, abide by civil rights laws, and employment laws (employees can sue their employers for violations of these laws). Hiring parties are not responsible for or susceptible to the foregoing.
Another point to consider is that an employer’s duty to pay earned wages is sacrosanct while a hiring party’s obligation to pay an independent contractor does not rise to the same level. In fact, hiring parties can use a “pay when paid” clause in an independent contractor agreement to avoid or delay payment to an independent contractor. A “pay when paid” clause makes payment to a subcontractor contingent upon the general contractor’s receipt of payment from the owner. Until the owner makes payment, the independent contractor cannot claim a breach of contract for failure to pay.
Disadvantages of Using Independent Contractors
A hiring party must be careful to avoid becoming enamored with the title “independent contractor” as its misuse can draw scrutiny from state or federal governmental bodies. It is not enough to declare someone as an “independent contractor” and assign them a title as a person operating under such a regime can still sue the hiring party as his employer and demand legal treatment as an employee. If such a claim is made, governmental bodies and courts will not limit their inquiry to the declaration of “independent contractor” status or the granting of title, rather they will look the level of control exerted over the person. For example, it is not uncommon for a hiring party who thought they hired an independent contractor to wind up with an overtime lawsuit that the hiring party ends up losing because it exerted control over the “independent contractor” that was tantamount to that associated with an employee. It should be noted that this disadvantage has more applicability to individual independent contractors versus corporate ones. Regardless, it should come as no surprise that a hiring party has little control over the independent contractor and, if applicable, its employees.
Another point to consider is that most employer/employee relationships are considered “employment-at-will”. This generally means that neither party is contractually bound to each other to remain in the employment relationship. An employer is free to terminate the employment of an employee at any time, for any reason or no reason so long as termination is not based on race, color, religion, sex and national origin. Meanwhile, an employee can likewise leave the employer’s employment at any time and for any reason whatsoever. When it comes to independent contractors, these freedoms are not available and any termination rights a hiring party has will be derived from contract. Things can get messy and end up in a breach of contract suit, if an independent contractor agreement does not provide for reasonable and orderly method of terminating it.
While hiring parties are generally immune from liability as discussed above, the immunity is not absolute. A hiring party may be sued by the independent contractor’s employees if they are injured as a result of the hiring party’s negligence. Hiring parties may also be susceptible to workers’ compensation claims brought by the independent contractor’s employees where the independent contractor failed to procure workers’ compensation insurance.
In conclusion, engaging in an independent contractor contractual relationship can neither be endorsed nor discounted. Each side of the independent contractor coin has its pros and cons. You will have to assess your situation, goals, and risk tolerance with your legal advisor to come up with what is right for you.