You Call it Sub-Contracting, They Call it Wage Theft

Glenn Israel

Wage theft and payroll fraud are the new and inflammatory labels being applied to failure to pay overtime and/or minimum wage by misclassifying employees as independent contractors or as otherwise exempt from overtime. However, you don’t have to have criminal intent or engage in fraudulent conduct to be found guilty of these offenses. Employee misclassification may violate the federal Fair Labor Standards Act, state and federal tax laws, various state laws regarding unemployment and workers’ compensation insurance, and the Affordable Care Act. None of these laws require you to act intentionally. A simple mistake in employee classification can cost you tens or even hundreds of thousands of dollars.

Most employers are honest, but sometimes they make honest mistakes. Unfortunately, some employers intentionally violate the law and mistreat their employees. Those unscrupulous employers have brought the unwanted attention of the federal Department of Labor, state Attorneys General, the National Labor Relations Board, and your local Carpenter’s Union to bear upon the construction industry where sub-contracting is a standard operating procedure. Plaintiffs’ attorneys also are eager to represent employees in these cases because they stand to collect twice the amount of wages owed, plus attorneys’ fees.

How do you avoid becoming the next target of an investigation or law suit? How do you stay out of the news media and avoid being branded as a “wage thief”? As a member of the construction industry, you must be exceedingly careful about your employee classification decisions. The fact that “we have always done it this way” or “everyone does it this way” does not provide a defense to an employee misclassification claim. The only defense is to get it right the first time.

The best way to avoid misclassification claims is to conduct a classification self-audit. If you don’t know how to do this you should consult with qualified labor and employment counsel before you begin. In general, to conduct a self-audit you examine each of your employees as if you are an investigator for the DOL or the Attorney General’s office. In order to do that, you need to be familiar with the applicable laws.

The first place to look is the legal definition of “employee.” Unfortunately, many of the state and federal laws and regulations contain slightly different definitions. The Internal Revenue Service previously had a 20-factor test that was used to make this determination. More recently, the IRS has distilled its 20 factors down to a three-pronged analysis. First the IRS looks at “behavioral control” – does the company control or have the right to control what the worker does, when he does it, where he does it, and how he does it. The more control the company has, the more likely the worker is an employee.

Next, the IRS looks at “financial control” – does the company dictate the financial terms or are they negotiated, does the worker provide tools, materials and supplies or are they provided by the employer, and is the worker in business for himself such that he has some control over whether he makes a profit or suffers a loss or is he simply paid for showing up and doing what he is told.

Finally, the IRS looks at the “nature of the relationship” – does the worker perform tasks that are not a central part of the company’s business such as accounting or marketing or does he perform traditional construction tasks, does the worker receive any benefits such as insurance, vacation pay, sick time, or holiday bonuses, and is there a contract that specifies what the worker is expected to do and how much will be paid for the project of is the worker paid an hourly wage or a piece rate.

Applying these tests is not an exact science. Also, as mentioned above, some of the other state and federal agencies employ a slightly different set of standards. However, if you look at each of your employees through this lens, some will clearly be employees and some will clearly not be employees. It is only those who don’t clearly fall into one category or the other that you have to worry about and, hopefully, that will only be a small part of your workforce. You should discuss the employees who fall into the grey area with experienced labor and employment counsel. Making the final determination often requires asking yourself, “What would the IRS do?”

Once you have determined which workers are “employees,” you need to look at whether any of those employees may be exempt from overtime pay under the state and federal overtime laws. In general, there are exemptions for executive, administrative, and professional employees and also for “outside salesmen.” Executive employees are those whose primary duty is to supervise the work of other employees. Importantly for the construction industry, working foremen generally are not considered to be exempt executives. Administrative employees are those who make high level decisions regarding the administration of the company such as the H.R. Director or the Controller. However, employees who assist or work with those high level decision makers generally are not exempt from overtime. Professional employees are those who do work that requires a high level of skill and training, typically an advanced degree, such as architects and engineers. Although many tradesmen are highly trained and highly skilled, they are not considered professional employees. Outside salesmen are those employees whose primary duty is making sales on the road. Some employees obviously fit into one of these categories. Most do not. If in doubt, you should consult with labor and employment counsel.

To make matters even more complex, some state and federal agencies have begun to take the position that a general contractor can be held responsible for employee misclassification by the sub-contractors that it employs at a job site. In other words, if you are building a retail store and you bring in a drywall sub-contractor who misclassifies all of its hangers and tapers as independent contractors, there is some risk that you may be found to have violated the law. This area of the law is still developing, but best practice at this point would be to ask sub-contractors to certify that they are properly classifying their employees and to indemnify you from claims arising from their failure to do so.

Employee classification is a complex and nuanced process. Unfortunately, as a result of a few bad actors, the state and federal regulators have targeted the construction industry for their crackdown on wage theft and payroll fraud starting with the assumption that the construction industry is purposely violating the law. Even more unfortunate is the fact that some sub-contracting arrangements that have been common in the industry for years and which historically have worked well for all parties, do not technically comply with the law. In light of these facts, there is no time like the present to conduct a classification self-audit.