Independent contractors and sham contracting

The distinction between an employment relationship and that of independent contractor is often vexed. However, the failure to properly characterize the relationship may lead to significant adverse consequences, including prosecution under the Fair Work Act 2009 (Cth) for sham contracting. In this article we focus on the risks associated with prosecution for sham contracting. However, it should be noted that in addition, employers who improperly classify employees as independent contractors may also be liable for underpayment of wages claims, leave claims, payroll tax and other ATO liabilities, superannuation payments; and civil penalties. Not to mention that misclassified employees will also have all the rights of employment including to unfair dismissal remedies, redundancy entitlements and the like.

Sham contracting has been a key focus for regulators in the past few years, and findings by the Fair Work Ombudsman Inquiry (“FWO Inquiry”) into these kinds of arrangements in the Victorian public sector indicate an intention by the regulator to treat the issue seriously, including through the commencement of penalty hearings against employers.

The FWO Inquiry which began in December 2013 into the Victorian Department of State Development and Business Innovation (“Department”) has found that although sham contracting had not been directly engaged in by the Department, it was noted that the Department had engaged in practices which increased the “risk” of workers being incorrectly engaged on a contractor basis.

The Ombudsman’s continued focus on sham contracting in the public sector comes at a time when recent case law indicates that Courts are showing an increased preparedness to impose considerably harsher pecuniary penalties on employers for deliberating entering into sham contracting arrangements.

For example, in Director of the Fair Work Building Inspectorate v Linkhill Pty Ltd [2014] FCCA 1124 (“Linkhill”) the Federal Circuit Court imposed penalties totaling $313,500 against Linkhill, noting that:

• Linkhill had deliberately engaged in sham contracting;
• Linkhill displayed no contrition for its behaviour; and
• The Court should indicate its disapproval of sham contracting setting penalties at a “meaningful level”.

In light of this renewed regulatory focus, it is beneficial for employers to refresh on the potential exposures for sham contracting as highlighted by the decision of ACE Insurance Limited v Trifunovski [2013] FCAFC 3 (“ACE”) in which the Full Court held that five insurance sales agents who had been engaged as contractors were, in reality, employees. Accordingly, the Court ordered ACE to pay over $500,000 in unpaid annual leave and long service leave entitlements.

In the more recent decision by the High Court of Australia in Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] HCA 45 (“Quest”), it was unanimously found that Quest breached the anti-sham contracting provisions in the Fair Work Act 2009 (Cth) (“Act”) when it misrepresented the employment relationship of two long-standing cleaners whom Quest tried to convert to independent contractors by entering into a tripartite arrangement  with them and a labour hire company to supply Quest with precisely the same cleaning services as performed by the employees. The Court held that that method of engagement was a deliberate sham and an absolute “no-go zone”.

Some key learnings that employers, and particularly small businesses, ought to take away from Linkhill, ACE and Quest include:

• applying caution to past decisions of Courts for guidance as to when a relationship is that of contractor or employee as each case is specific onto its own set of facts;
• that the characterization of the relationship by the parties is not determinative and will carry little weight;
• engaging workers through a labour hire vehicle (or other corporate entity) will not necessarily prevent a finding of an employment relationship being triggered; and
• careful consideration be given to the nature of the work; the distinction between employee and independent contractor depends on the application of a multi factorial test taking into account the particular circumstances.

Preventative steps that can be taken to risk manage the possible threat of litigation around this issue in your business include:

• undertaking a comprehensive review of all labour hire policies to ensure compliance with the Act;
• auditing the engagement of independent contractors to ensure each arrangement is appropriately and genuinely classified as an independent contractor relationship rather than one of employment;
• reviewing existing contractor arrangements to ensure that sound written contracts are entered into between the parties to properly document the terms on which services will be performed;
• developing rigorous hiring and on-boarding processes to ensure that the appropriate induction method is used on each occasion; and
• obtaining legal advice regarding the engagement of independent contractors over traditional employees to understand the benefits and associated risks.