Unemployment Benefit Claims and Independent Contractor Misclassification Liability: A Single Claim by One Worker Can Lead to Disastrous Results

It is rare for a business to challenge an administrative determination concerning a single worker’s claim for unemployment insurance benefits. Indeed, many employers tend to delegate responsibility to handle administrative proceedings before state unemployment offices to companies providing “unemployment claims services.” This is because the issue in most unemployment cases is simply whether the claimant resigned without cause or engaged in misconduct that disqualifies him or her from benefits. But, unemployment proceedings that deal with the issue of whether the claimant is an employee or independent contractor (IC) is neither a simple or straightforward matter,  nor does it typically affect only the unemployment benefits of the claimant.

Rather, as the following two cases show, a single claim won by a misclassified employee for unemployment benefits can lead to the beginning of an array of IC misclassification claims dealing with the company’s other ICs – unless the company engages in best practices.

The Recent Kansas Case on Exotic Dancers

On February 1, 2013, the Kansas Supreme Court issued a decision affirming an administrative determination commenced by a single exotic dancer’s claim for unemployment benefits. The Kansas Department of Labor initially determined that the claimant and all other similarly situated dancers were employees, not independent contractors as claimed by the adult club where the dancers worked. Milano’s v. Kansas Department of Labor, No. 102,114 (Kan. Sup. Ct. Feb. 1, 2013).   

The owner of the adult club appealed to the courts, but lost at each level of appellate review. Last week, the Kansas Supreme Court ruled that the dancers were “employees” and not independent contractors. One of the key facts relied upon by the Court was that the club set various “house rules” which, if violated, could lead to fines or termination of the dancers.

Why would a business spend legal fees to contest an unemployment case all the way to a state’s highest court?  As we stated in our White Paper on “How Companies Can Minimize the Risks” of IC misclassification: “If a business has not paid unemployment contributions to a state fund on behalf of that worker, the initial determination can have the same effect as an adverse audit . . . . Once a single worker is found to have been misclassified, the business is then normally charged for unpaid contributions for “all similarly situated” workers, along with costly penalties and fines.” In addition, an adverse administrative determination can be followed by class action claims for unpaid overtime or minimum wages and/or unpaid employee benefits, as shown by the next case that began as a claim for unemployment benefits by a single worker not classified as an employee.

The Massachusetts Franchise Cases

These cases involve the employee status of office cleaning workers who provided services to customers of Coverall North America under the terms of a janitorial franchise agreement they each signed with Coverall.

The first of the two Coverall cases involved a custodian who was required to sign a franchise agreement with Coverall in order to provide cleaning services to a Coverall customer. After the custodian was terminated by Coverall, she filed a claim for unemployment insurance. An administrative examiner ruled, after a hearing, that Coverall could not satisfy the statutory test in Massachusetts for independent contractor status. An administrative review board affirmed the examiner’s ruling. It found that Coverall could not establish each of the three requirements to establish the existence of  an independent contractor relationship with the janitorial worker under Massachusetts law .

On appeal, Coverall argued that the franchised custodian was an IC, but the Supreme Judicial Court of Massachusetts affirmed the administrative determination. It found that it needed only to examine the third requirement for IC status – that the services were “part of an independently established trade, occupation, profession, or business of the worker” – which it found to be lacking. Coverall North America v. Commissioner of the Division of Unemployment, 447 Mass. 852 (2006).

It did not take long for the second shoe to drop, and the next legal challenge has been far more costly to Coverall. It involved far greater exposure – a class action lawsuit under the Massachusetts wage law for misclassification. The custodians alleged that they were employees under the wage laws and were entitled to an array of damages.  A federal court found in their favor, holding that the workers were “employees,” even though they signed franchise agreements. Awuah v. Coverall North America, 707 F.Supp.2d 80 (D. Mass. 2010). The federal court then asked the state’s highest court to issue a ruling about certain types of damages, and the Massachusetts Supreme Judicial Court held that the janitorial workers were entitled to most of the damages they had sought. Awuah v. Coverall North America, 460 Mass. 484 (2011). The case is still pending and is being actively litigated today on motions for reconsideration.

Analysis and Best Practices

In a recent blog post, we noted that an adverse result favorable to one or more workers in any type of misclassification claim  “is likely to be the first of a number of misclassification challenges for the [business involved].” This is often the case where the first matter involves an unemployment claim. In addition to costly class action lawsuits for unpaid wages and benefits brought by the workers, such as what occurred to Coverall, we noted that a business is also subject to “governmental audits by the IRS [and state tax authorities], workers compensation boards, and/or the federal and state Labor Departments.”

1. What should a business do when it receives notice that a worker, whom it classifies as an independent contractor, is seeking unemployment benefits or that an unemployment agency is conducting an audit?

Assuming there is a valid argument that the worker is an IC and not an employee, including situations where the worker is in the “grey area,” the following are suggested best practices, using IC Diagnostics™ tools where applicable.   

First, recognize the potential consequences of an adverse determination by the unemployment agency. A finding that a single worker is not an IC but rather an “employee” eligible for unemployment benefits is not typically limited to the claimant. Rather, the decision is usually accompanied by an order directing the business to pay back contributions for the claimant “and all similarly situated workers.” Thus, in many ways, an unemployment claim can have the same effect as an audit covering most or all of the ICs retained by a business.

Second, submit a comprehensive position statement to the claims examiner or auditor. Address not only the factors listed in an unemployment statute or a publication published by the state agency for determining the status of the worker, but also other applicable indicia of employment status, such as those in the 48 Factors-Plus™ that the courts and administrative agencies have found to be pertinent to the issue of IC status. Sometimes, this submission must be done in a matter of days, so it is advisable to be prepared in advance.

Third, if  an initial determination by a claims examiner or auditor is adverse, request a hearing – and treat the hearing as a mini-trial. The same comprehensive set of 48 Factors-Plus™ should be addressed at the hearing to the extent they are applicable, with admissible evidence and suitable witnesses to briefly introduce documentary and testimonial evidence.

** A word of caution: an appeal of a decision by a referee or ALJ ordinarily may only address evidence introduced into the record; therefore, a full record should be made at the hearing. **

Fourth, in the event the hearing officer, referee, or administrative law judge (ALJ) rules against the business, file an appeal. Brief the appeal as you would a court case; it is important and beneficial to win at the administrative level. Indeed, winning early before the issue of IC misclassification gains traction can avoid further legal fees and lessen considerably the likelihood that further administrative or judicial claims will ever be brought.

** A word of comfort: if a company receives an adverse determination, there are still ways to avoid adverse determinations in other legal proceedings – if  the company takes certain of the steps described below. **

2.  What should a business do today, before it receives notice that a worker it treats as an IC has made a claim for unemployment benefits (or filed some other type of misclassification claim)?

Companies can minimize or eliminate worker misclassification liability by enhancing their IC compliance before being challenged at the regulatory agency level or in court.

Companies that rely on ICs as one of their key sources of manpower or simply to supplement their existing workforce can take steps to minimize misclassification liability by ensuring that their relationships with such ICs are properly structured, documented, and implemented. Bona fide IC relationships are permitted in virtually all states in the U.S., although state law tests for IC status often vary from one state to another.

As described in our White Paper, businesses that rely on ICs should consider engaging in a form of IC Diagnostics™. This can start with an assessment of the company’s current level of IC compliance as measured on the IC Compliance Scale™. Depending on the level of IC compliance, alternatives to enhance compliance with IC laws may include restructuring, re-documentation, reclassification, or redistribution.

Where restructuring is suitable, some businesses may need only a little while others may benefit from moderate to substantial restructuring to enhance the likelihood of a successful defense to an unemployment proceeding and other IC misclassification challenges.

Regardless of whether a business’s IC relationships need restructuring or not, documentation of the IC relationship can be critical under most state and federal laws governing the status of workers. Many IC agreements have not been updated since the crackdown on IC misclassification began in 2007 or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status and the 48 Factors-Plus™ is an essential aspect of IC Diagnostics™.

The other compliance alternatives – reclassification or redistribution of ICs, are more fully described in our White Paper.

Many companies utilizing ICs are well aware that they may not be in full compliance with laws affecting ICs, but find themselves in a form of corporate paralysis, unaware that there are a number of ways they can minimize or avoid IC misclassification liability. Indeed, for most of those businesses, IC compliance in the areas of labor, tax, and employee benefits is readily attainable under IC Diagnostics™.

Your comments are invited.

Richard Reibstein
Lisa Petkun
Andrew Rudolph

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