Independent Contractor Considerations for Family Businesses

Who Is an Independent Contractor?

"Independent contractor" is a category of worker that is legally distinct from an employee. The distinction between the two is one of substance, not title or a recital in an agreement.

In other words, just because an employer calls a worker an independent contractor does not mean the individual is one in fact. Courts and agencies have the final say over the classification of a worker and, when making that determination, will look to the "economic reality" of the relationship, not the label assigned by the employer.

Typically, to qualify as an independent contractor (i.e., not an employee), the worker:

• Has a business license;
• Has multiple clients;
• Has discretion to utilize helpers or substitutes;
• Is engaged for a specific assignment with a defined duration/end point;
• Performs work that is different from the entity that engages them;
• Retains control over the manner and means of performing the work,
• Is not subject to direction and control (outside of scope of work) over how their work is performed, and
• Is only accountable for the end product.

In contrast, a worker who is supervised by an employer and must follow the employer’s requirements as to the manner and means for performing work is usually an employee.

Advantages of Engaging Bona Fide Independent Contractors

Less Exposure to Liability for Third-Party Claims or Employment Law Claims

There are two ways in which independent contractors expose their employers to less liability than employees do: (1) claims from third parties, and (2) direct claims.

A common theory of vicarious liability known as "respondeat superior" permits plaintiffs to sue employers for certain wrongdoings of their employees. Such a lawsuit could cause the company to pay out a massive amount of money, whether as a settlement or judgment.

However, "respondeat superior" generally does not apply to independent contractors. As a result, engaging true independent contractors decreases the chances that a business will be on the hook for third-party claims, although the business should still protect itself by requiring indemnity, hold harmless, and insurance coverage from the independent contractor.

In addition, bona fide independent contractors are not covered by as many employment laws as employees are. For instance, independent contractors are not eligible for statutory overtime pay, to unionize, or to take time off to care for a child or sick family member. Because independent contractors fall outside the coverage of most employment and labor laws, employers have less exposure to employment law claims when engaging independent contractors.

Potential Reduction in Labor Costs

Businesses engaging independent contractors do not include them in their group medical or other benefit plans, contribute to Social Security or Medicare on their behalf, and are off the hook for a number of similar expenses. Those expenses can constitute a significant portion of a business's total labor costs. As such, businesses may see a labor cost reduction even if they pay a contractor a higher base compensation than they would pay an employee.

Disadvantages of Engaging Independent Contractors

Intellectual Property

Independent contractors, unlike employees, own the rights to any intellectual property they develop while completing the work they were contracted to do. This is true, for example, of the copyright in code written by a programmer, the trademark in a logo designed by an artist, and the patent of a new manufacturing machine developed by an engineer.

Those intellectual property rights can all be assigned to the employer through the execution of a properly prepared work-for-hire contract. However, such an assignment is another potential point of friction to consider when engaging an independent contractor.

Termination Damages

Often, independent contractors cannot be terminated at any time in the sole discretion of the business. An independent contract is a business-to-business agreement. This means that a business often cannot terminate an independent contractor simply because it wants to go in a different direction, the way it might do so with an employee.

Instead, employers can only cancel a contract if the contractor violates some term in the independent contractor agreement. Depending on the situation, this decrease in flexibility could be problematic for an employer. The terms in each independent contractor agreement vary considerably, so employers will need to closely examine the relevant agreement if they are thinking about terminating an independent contractor.

Conclusion

The decision of whether to engage an independent contractor is context specific and may hinge on the terms an employer can get the independent contractor to agree to. But, above all else, the business must be sure that the individual they classify as an independent contractor clearly meets the applicable criteria.

The burden of proof is on the business to demonstrate that the individual is not, in reality, an employee who has been misclassified as an independent contractor. The damages for misclassification can be large, and many businesses find themselves on the losing end when engaging an individual who has no business license or other clients, and who works exclusively or nearly exclusively for the business, as an independent contractor.

Be sure to consult qualified and experience legal counsel before engaging or terminating an independent contractor.