What is old is new again – Employee v Independent Contractor

In our previous client alert, we covered the Fair Work Legislation Amendment (Closing Loopholes No. 2) Act 2023 (“amending legislation”) and the numerous effects it would have on how business is conducted in Australia. In this article, we examine the new laws dealing with the engagement of independent contractors and the new definition of employment.

Definition of Employment

The Fair Work Act 2009 (Cth) (Act) now contains a new definition of “Employment” and resets the test as to whether a person is an independent contractor or employee. It effectively turns back the clock to the position prior to the changes introduced by the High Court in 2022.

Historically, the legal position to determine whether an individual was an employee or contractor turned on a multi-factorial test, whereby the Court would examine the actual course of conduct of the parties and all surrounding circumstances, to determine the whether the relationship was one of employment or not. In this approach, significant weight was given to factors such as the control exercised by the principal over the individual, whether the individual was able to work for others, how they conducted themselves in practice and so forth (“Multi-factorial Test”).

However, in 2022, the High of Australia handed down the decisions of (Construction, Forestry, Maritime, and Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 and ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2). These decisions changed the legal landscape and held that the starting point to determine the nature of the relationship is the contract entered into between the parties. Since these decisions, it has been crucial that employers use suitably drafted written agreements when engaging independent contractors.

According to the new definition in section 15AA, “employment” is defined by the real substance, practical reality and true nature of the relationship between an individual who may be an employee and a person who may be an employer.

To ascertain the real substance, practical reality, and true nature of the relationship, the totality of the relationship is taken into consideration, including the contract governing the relationship and how the contract is performed in practice. Factors that may be considered when considering the totality of the relationship include:

1. the nature of the work conducted;
2. the autonomy provided;
3. the payment of remuneration, tax arrangements;
4. who controls how the work is done;
5. who sets the hours of work;
6. who bears financial risk; and
7. who provides work equipment.

The amendments to the Act now make it clear that regardless of what the written contract might say, if in practice the relationship looks and operates as one of employment then it will be considered an employment relationship. As one eminent judge said in relation to this area of the law, “one cannot create something which has every feature of a rooster, but call it a duck and insist that everybody else recognise it as a duck”..

This means that employers need to ensure that they give careful consideration to the true nature of the relationship, because if they get it wrong, and treat an employment relationship as one of independent contractor and principal, they may be subsequently liable for numerous employment liabilities including, annual leave, personal leave, award rates of pay, penalties and loadings amongst others. It may also give rise to claims of sham contracting and resultant penalty orders.

Interestingly, the legislature has recognized that individuals want certainty in this area, and also may wish to choose how to treat their relationship. The Act now allows individuals that earn above the High Income Contractor Threshold, to effectively “opt out” of the provisions dealing with the definition of employment. This means they and the principal can choose to treat the relationship as one of independent contractor, without the risk of it being deemed an employment relationship.

The “Opt Out” Regime

From 27 February 2024, a principal may notify an independent contractor of their right to “opt out” by issuing a written notice if the principal believes that the individual:

1. earns above the high-income threshold; and
2. will be regarded as an employee under the new definition.

Within 21 days of receiving notice from a principal or of their own volition, an independent contractor may issue an “opt out” notice. Notably, independent contractors are only able to issue one “opt out” notice during the relationship and must include a statement that their earnings being in excess of the high-income threshold.

According to section 15AC of the Act, upon issuing an “opt out” notice on, before or after 26 August 2024, the status of an independent contractor is preserved from then on regardless of whether the relationship falls within the scope of the new definition.

What if an independent contractor no longer wishes to “opt out”?

Independent contractors may issue a “revocation notice” expressing their desire to revoke their election to “opt out” in writing. Once a “revocation notice” is issued the independent contractors will be subject to the new definition of employment and will be potentially eligible for employee entitlements. Notably, a “revocation notice” can only be issued once throughout the course of the relationship.

Despite the limited ability for certain individuals to opt out of the new definition of employment, the changes re-introduce a level of uncertainty and complexity for businesses. In this regard, a business may engage an individual on a mutual understanding that the individual is an independent contractor. However, despite this, the individual could be later found to be an employee given the ‘true’ nature of the relationship. This could leave businesses at risk for claims relating to employee entitlements such as backpay, award entitlements, superannuation and leave. Accordingly, businesses will need to assess the true nature of all engagements with independent contractors and evaluate the totality of the relationship. It is important to ensure the relationship is correctly classified so that the risk of liability and underpayment issues does not arise later.

Sham Contracts

Employers must not represent a contract of employment as a contract for services. In other words, if the parties know or are reckless to the fact that the relationship is actually an employment relationship, but nevertheless treat it as one of independent contractor and principal, the new amendments make the penalties for sham contracting extremely onerous.  Amendments to the Act make it harder for employers to defend misrepresenting employment as an independent contracting arrangement. Employers who do misrepresent employment as an independent contracting arrangement must prove they did so with a reasonable belief it was accurate. When determining the matter Courts will consider whether an employer’s belief is reasonable by having regard to the size and nature of the business and any other relevant matters.

New Unfair Contracts Regime

Currently, independent contractors may exert their rights under the Independent Contractors Act (Cth) 2006 (“Independent Contractors Act”) through the Federal Court. However, this process is rarely pursued due to it being a costly and time  consuming procedure. In response, the current Federal Government expanded the powers of the Fair Work Commission (“FWC”) to provide a more accessible and inexpensive jurisdiction for independent contractors to pursue claims. From 26 August 2024, the FWC jurisdiction will include the ability to adjudicate on matters relating to unfair terms in services contracts.

In determining whether a term or terms are fair, the FWC may take into account:

1. the relative bargaining power of the parties;
2. whether the contract displays a significant imbalance between the parties’ rights and obligations;
3. whether the term is reasonably necessary to protect the legitimate interests of the parties;
4. whether the term imposes harsh, unjust or unreasonable requirements on the parties; and
5. whether the contract as a whole provides for a total remuneration that is:
   1. less than what regulated workers performing the same work would receive under a relevant award or enterprise agreement; or
   2. less than employees receive providing the same or similar work.

Independent contractors earning above the High Income Contractor Threshold will remain subject to section 12 of the Independent Contractors Act, and in turn will be forced to go through the Federal Court. However, independent contractors earning below the threshold will be eligible to apply to the FWC to hear matters relating to unfair terms in services contracts entered into on or before 1 July 2024. The high income contractor threshold is yet to be determined.

What orders can the FWC make in relation to unfair terms in services contracts?

If the FWC is satisfied that a term is unfair it may issue an order setting aside all or part of the services contract; or amend or vary all or part of the services contract.

Businesses that engage independent contractors should re-evaluate their template contract terms to determine whether the terms of the engagement can be considered ‘fair’ having regard to the relevant factors.  Due to the accessible and inexpensive nature of this process, business should prepare for an increase in claims initiated by independent contractors.

Key Takeaways:

The new laws make significant changes to the current workplace landscape.

As such, we recommend businesses:

1. Before engaging an individual as an independent contractor, evaluate the totality of the relationship having regard to the new legislative definition;
2. Conduct a thorough review of any current engagements with independent contractors to ensure the relationship cannot be misconstrued or deemed to be one of employment;
3. Consider whether independent contractors may fall within the scope of the “opt out” regime and consider whether to notify an individual of their right to “opt out”;
4. Ensure that all contractor arrangements are bound by a comprehensive written agreement that define the terms and conditions of the engagement; and
5. Review and update template contracts for services and assess whether the terms can be considered fair and reasonable in light of the new unfair contract terms regime. It is also important to ensure the document contains appropriate terms that accurately reflect the principal and contractor relationship.

If you wish to discuss any aspect of this client alert, require specialist advice in relation to determining whether your business will be affected by these amendments, or assistance reviewing current employment practices or processes, please do not hesitate to contact us.

This alert is not intended to constitute, and should not be treated as, legal advice.