What is an independent contractor?
The first thing that is important to know is the definition of the term "independent contractor" itself. An independent contractor is an individual or business entity that performs work or provides services on a contract basis. In other words, the relationship between the contractor and the person or business that has hired them is based on contract law rather than employer/employee laws. Generally speaking, the agreement with an independent contractor outlines the scope of work to be performed, as well as the price for that work. Once the work is completed, the independent contractor will issue a bill and the hiring party is expected to pay what is owed.
So, how does this differ from an employee? Employees are not hired on a contract basis. Rather, they are bound by an employment contract (or offer letter and handbook policies) that allows their employer to dictate the terms of the relationship. An employer has the legal right to assign and direct the way work is done, including the manner in which the employee reports to them, the hours of the day that the employee must be at work , the way in which the employee is compensated (as far as hourly pay, commissions, bonuses, etc.), and even when the employment may be terminated.
Because that is the essence of an employee/employer relationship, an employee is entitled to certain benefits under the law. Primarily, employees are entitled to whatever benefits are set out in their employment contract with the company. Additionally, employees are entitled to unemployment, overtime and minimum wage protections, protection from workplace discrimination, paid leaves of absence to address own or family illnesses or other personal situations, paid time off to vote, and workplace safety protections. On the other hand, because independent contractors are not subject to the various workers’ compensation statutes, they are not entitled to workers’ compensation benefits.
There are several typical and common examples of occupations that are often categorized as independent contractor roles. By way of some examples here are a few of the most common independent contractor employment arrangements:
Contractor v. employee: Liability issues and rules
The legal distinction between an independent contractor and an employee is not limited to a discussion of whether the person is truly an independent contractor under the law. After classification, the type of relationship has legal implications, particularly in the area of tax liabilities and claims for benefits.
Tax Liability
The IRS uses a ten-factor test to determine whether a worker is an employee or independent contractor. Control over the work is one of the factors. The penalty for misclassifying an employee can be severe, including the payment of payroll taxes as well as interest and penalties. The IRS may seek back wages, state and federal taxes, including income tax, FICA, unemployment insurance and workers compensation. In addition, the IRS may seek criminal penalties, jail time for intentional misconduct, and fines.
Claims for Benefits
Workers’ compensation laws apply only to employees, never to independent contractors. It would be illegal for a company operating under the workers’ compensation system to deny its injured employee coverage because the company maintains he was an independent contractor. A jury is likely to reject that defense and impose liability on the company. Furthermore, making such an argument suggests that the company knows that the contractor was in fact an employee, and if subsequently proven so, any punitive damages will be bigger for the company’s attempts to hide behind the independent contractor status.
Liens also attach to the employee’s claim for benefits, thus establishing a lien on any judgment for damages from civil suits. To establish the independent status of the employee, courts examine the manner in which the company controls the work and considers many of the same factors as the IRS.
Liability 101 for independent contractor workers
When an employee is involved in a work-related accident, liability can be assessed against both the offending driver and their employer, known as vicarious liability. An employer would only be liable for an employee’s actions if they were acting within the scope of their employment. The employer might also be liable for intentional torts, however, most commonly it is negligent behavior.
When an independent contractor is involved in a work-related accident, however, the law is much less clear as to the liability of the contracting company. Since independent contractors are not considered employees, there is no guaranteed vicarious liability. While some courts have extended vicarious liability to cover independent contractors in order to promote public safety and protect injured victims, the law on this issue is far from settled and can vary widely from state to state. Overall, liability of contracting companies for their independent contractors in cases of work-related injuries or accidents tends to go under these categories:
An independent contractor may be considered an employee for vicarious liability purposes if they are "aided by" the employer in the work they are doing for the company. Some cases have held that an employer may be liable for the actions of an independent contractor if the company "retains control" of the contractor’s work and the injured party is in an economically vulnerable position.
In general, courts have held that where the independent contractor is acting beyond the scope of the contracted work, the contracting company cannot be held liable. That means, even if the company customarily provides the equipment, schedules the work, and generally exerts a level of control over the worksite, where the harm suffered is outside of the scope of the contracted work, the company will not be found liable.
Courts often employ the Restatement (Second) of Torts Section 413, which allows for liability of a company if an independent contractor is engaged in inherently dangerous work and the company "should know the work is likely to cause injury, unless special precautions are taken." In this case, a contracting company may be found vicariously liable for the negligence of an independent contractor.
If an independent contractor negligently causes an accident, the contracting company may be held liable, especially if they vetted the contractor, because the law generally holds contracting companies to a "reasonable care" standard. Any contract that does not specify a prohibition on the use of subcontractors does not waive vicarious liability. If an injured party can show that an independent contractor was not qualified (like a company driver without a commercial driver’s license), then there may be a successful argument for vicarious liability. Finally, if an independent contractor fails to maintain proper insurance, a case for vicarious liability may exist.
Dealing with liability for what your contractor does
In some circumstances, however, an employer may be legally responsible for an independent contractor’s actions. Generally, depending on state law, there are two circumstances in which an employer may be liable for a contractor’s acts: (1) when the contractor is an employee; and (2) when the doctrine of vicarious liability applies. The first situation is easy enough to understand. An employer can be held responsible for an employee’s misdeeds under the legal theory of "respondeat superior," which obligates an employer for negligent or intentional acts of its employees so long as the employee was acting in the course and scope of employment.
The second is more complicated. Vicarious liability deals with situations in which an employer may be held accountable for a contractor’s wrongdoing. For example, if an employer fires a supervisor, and that supervisor goes to a new job and takes the employer’s trade secrets to discredit the employer, then the former employer may be liable to the new employer if a court views the supervisor as its independent contractor. This is just one hypothetical, but you can imagine the potential for liability in many other situations.
In U.S. Fire Ins. Co. v. Universal Servs., Inc., the U.S. Court of Appeals for the Fourth Circuit considered the vicarious liability of employers for the acts of contractors. Universal Services, Inc. ("USI") managed a pump station for a North Carolina public housing authority. USI hired Tidewater Demolition & Disposal Inc. ("Tidewater") to demolish the pump station. A truck owned by Tidewater and driven by a Tidewater employee collided with the front of a home, killing a minor child. In the ensuing lawsuit, a jury found both USI and Tidewater liable and awarded damages. USI brought a post-trial motion seeking judgment as a matter of law. According to USI, the trial court erred in not granting judgment as a matter of law because Tidewater was an independent contractor. The trial court denied USI’s motion, finding that USI could be vicariously liable for Tidewater’s negligent acts while still being a principal independent contractor. USI appealed.
The Fourth Circuit affirmed the trial court’s order denying USI’s motion for judgment as a matter of law. Under North Carolina law, "the employer of an independent contractor may be vicariously liable to persons harmed by the contractor’s negligent acts if the employer negligently hired or retained the contractor." USI’s argument was that it was an independent contractor not a principal and was, therefore, not liable as a matter of law. Specifically, USI contended that it was a general contractor and Tidewater was a subordinate contractor, making Tidewater the principal independent contractor. The nature of the contractual relationship should not determine whether USI had vicarious liability, however.
The pivotal question the court considered was "whether USI retained sufficient control over Tidewater to render Tidewater subject to vicarious liability." If so, then USI could be vicariously liable for Tidewater’s acts. USI argued that because it was a general contractor, USI did not have sufficient control over Tidewater’s daily operations. The court concluded, however, that USI retained sufficient control over Tidewater’s work. Even if USI were a general contractor and III is a subordinate contractor, USI would still be vicariously liable if it retained sufficient control over Tidewater’s work. As USI retained sufficient control over Tidewater’s work, the court held that even though Tidewater may have been a principal independent contractor, USI was nevertheless vicariously liable for Tidewater’s negligence.
How independent contractors can limit your liability
To properly protect their interests, contractors must consider insurance, liability and indemnification provisions, and contracts. There are strategies for mitigating liability exposure. When carefully reviewed and strategically crafted, these provisions can be tailored to fit the realities of the relationship and therefore provide meaningful protections to contractors.
As with other types of businesses, it is important for contractors to obtain general liability insurance to protect against claims of bodily injury and property damage. If contractors are providing a service that might cause them to be liable for professional malpractice, they must carry professional liability insurance – often referred to as errors and omissions coverage.
Contractors must also review any liability and indemnification provisions in any agreement or contract to which they are a party. Hopefully, liability and indemnification provisions will operate to shift liability to the party that incurs the liability. For example, if subcontractors are to be indemnified by a GC for its negligent acts, then the parties should agree on extended coverage in those indemnification provisions to include coverage for the GC’s employees, agents, assigns, and/or consultants. Since subcontractors will only have liability and indemnification provisions in their contracts with a GC, they should agree to the same extensions for the GC with its agents, employees, assigns, and consultants.
It is also important for subcontractors to have carefully drafted contracts with the contractor/GC that adequately allocate the risks arising from a variety of circumstances. This includes an examination of whether subcontractors are independent contractors (i.e., whether subcontractors provide the services offsite or on-site), whether the contractor places too much control over the specifics of how the work is to be performed, and whether the contractor reserves a right of termination. Contracts should also include other provisions that clearly state that the contractor is not the employee of the GC for the purposes of workers’ compensation insurance and that the responsibility as principal employer will rest with the GC. Similarly, contractors should be clear that nothing in the contract creates a partnership, joint venture, or agency relationship among the parties. These types of provisions avoid any assumption of responsibility by the contractor for the acts of a subcontractor.
Finally, if the contractor anticipates that subcontractors may incur liability, they should consider whether the contractor should pay for that liability.
Covering your liability in your contracts
In the efforts to strike a balance between protecting the legitimate interests of the business and the rights of an independent contractor, it is essential to provide in the contract for responsibilities in several key areas where liability may be incurred.
First, the contract should require the independent contractor to follow applicable law. The potential risks presented by failing to be compliant with laws and regulations although they may not be related to the independent contractor’s services will no longer be borne by the employer. For example, under general federal subcontractor regulations, it is prohibited for an independent contractor to knowingly employ or continue to employ an individual for work under a federal contract if the individual cannot provide within thirty days documentation that the individual is legally eligible to work in the United States. (See, e.g., 48 C.F.R. § 52.222-54(a)(8)). If the independent contractor fails to properly vet employee legal work authorization, the employer may be liable for the cost of having to terminate and replace the individual on the contractor’s workforce.
Second, the contract should prohibit the independent contractor from assigning its responsibilities to other parties. Apart from requiring the independent contractor to perform the services personally, this clause prohibits the independent contractor from hiring other independent contractors or subcontractors , which may have an impact on the availability of affordable coverage. General liability insurance policies often do not cover injuries sustained by subcontractors that are injuries to other employees for purposes of the employer’s liability portion of a workers’ compensation policy. Many states have similar provisions in their state workers’ compensation statutes. That means that generally the independent contractor and the employer share this liability.
Third, if the independent contractor is permitted to assign its responsibility to other parties, the contract should require the independent contractor to obtain similar liability limiting provisions in favor of the employer from those parties.
Fourth, the contract should require the independent contractor to indemnify the employer for liability incurred by the employer as a result of the independent contractor’s breach of product liability, patent infringement, indentured servant/forced labor, and data and information safety, security, confidentiality, and privacy duties.
Fifth, the contract should require the independent contractor to maintain various types and limits of insurance that are covered by the employer’s insurance policies. Many employers will include some or all of this coverage in the employer’s own corporate insurance policies such as employment practices liability insurance. However, in order to avoid dual coverage, any liability stemming from the independent contractor’s services should be excluded from coverage under those existing policies.
How state and federal law affect liability issues
As with many employment concerns, the regulation of independent contractors can vary considerably from state to state. Some regulations are relatively uniform, such as anti-discrimination regulations like Title VII and the Americans with Disabilities Act. Others, like wage and hour regulations, vary considerably more. The states, for example, treat wage and hour issues differently, and some states are more employer-friendly than others. A state may choose to adhere to the DOL’s definition of independent contractors, or it may not. States are free to make their own determination of how to deal with the independent contractor/employer analysis.
In addition to OSHA regulations that may treat independent contractors as employees, some other federal regulations have the effect of treating independent contractors as employees. For example, the Federal Employees’ Compensation Act (FECA), which governs workplace injury compensation for federal employees, treats independent contractors as employees even though the DOL’s regulations do not.
Crucially, in addition to varying state and federal regulations, common law varies considerably based on the jurisdiction. Most states recognize a variety of theories of liability for independent contractors. For example, while the economic realities test may be the most widely used method for determining whether someone is an independent contractor or employee, some states deviate from it. Some states, like New York, do not even follow a similar "common law control" test. Instead, states tend to look at a variety of factors to determine whether an independent contractor/employer relationship exists.
Further, in some states, if independent contractors are misclassified as employees and are permitted to perform the duties of an employee, they may have successor liability against the misclassified independent contractor, but independent contractor status generally terminates if the wronged party goes to work for another company. However, this rule may be altered by contract. In California, for instance, language in an independent contractor agreement that disclaims the imputed liability of the contractor in the event of a successor claims is generally enforceable, negating any successor claims against a successor of a predecessor who misclassified a worker as an employee. This is true even in the context of a sole proprietorship.
Current contractor liability trends
The trend in providing greater protection for independent contractors is being followed by states and in federal legislation. The federal legislation, as current with the proposed Paycheck Fairness Act and the Employment Non-Discrimination Act (ENDA), would roll back many protections that have been put in place in the last few years. State legislatures, on the other hand, seem to be focused on strengthening those protections. One trend has focused on barring non-compete agreements for independent contractors. In 2012, Oregon passed a law with this provision. Colorado and Washington, both haven’t passed such a law, but are considering doing so; it has been introduced but not acted upon. Nevada and North Dakota have gone further; they have enacted laws that bar non-compete agreements for even all employees, not just independent contractors. Delaware, Maine, Massachusetts, Pennsylvania, Rhode Island and Vermont are all considering introducing bills to ban non-competes in the next sessions. New York just expanded its non-compete law to include non-solicitation clauses. Last year, Minnesota went further and banned non-competes for all employees who earn less than $15 an hour. This year, California and Illinois are considering such a ban also. Part of the trend has been an expansion of legal protection to help independent contractors prove they are independent, and not misclassified employees. Wisconsin recently passed a law that prohibits any contract between a company and those it deems independent contractors from containing a clause that prohibits the contract worker from suing the company. Tennessee and West Virginia have enacted similar laws in that they only apply to construction workers, but protect workers by prohibiting those companies that misclassify their workers from benefiting from this misclassification. California and Minnesota have considered, but not yet enacted, certain protections for workers. Connecticut is considering legislation that would prohibit companies from misclassifying their employees as independent contractors. Another area where there is a trend is prohibiting companies from retaliating against independent contractors for making complaints against the company. The new California Wage Theft Protection Act is one example. Last, there is trend of states targeting the companies that seek to exploit independent contractor provisions such as pay-roll cards. Massachusetts has passed a law targeting companies offering payroll cards to independent contractors. The card fees the independent contractors must pay are unfairly burdensome; for example, a program that charged $10 a month and $0.75 to withdraw cash and would only provide the company with $100,000 in incentives. These trends are leading to more protection for independent contractors, who are most often the weakest parties in any deal.
Cases and examples of contractor liability
The pivotal question in determining liability in cases involving independent contractors is generally whether the contractor has enough discretion and control over its work for liability to attach to the principal. The contrast between the following case studies demonstrates how thin that line can be.
The Holloway Construction case involved a disputed contract for the digging of a water line across an interstate highway for the City of Fort Worth, Texas. The parties agreed to a 440 foot cut, but the contractor, Holloway Construction, dug a trench much deeper than 10 feet and failed to shore the sides of the trench as required by state regulations. Holloway debited the subcontractor, Freight Trans, Inc., 75% of the contracting amount for failing to finish the project on time and for delays on other projects. Freight Trans then sued Holloway for breach of contract and breach of fiduciary duty. The jury returned a verdict against Holloway for $250,000.00 on each of these claims, and additionally awarded interest and attorneys’ fees. After Holloway’s appeal was denied, it filed a Petition for Review with the Texas Supreme Court.
Freight Trans argued, among other things, that Holloway owed it a fiduciary duty under the parties’ relationship. The court of appeals agreed and stated , "Holloway functionally replaced the City for purposes of enforcing contract terms and conditions at the job site… [Holloway] was Freight’s representative for all matters related to the performance of the agreement and had full authority and control over the work performed by Freight."
In Santos v. Hemesath, 43 Cal.2d 243, 272 P.2d 48 (1954), plaintiff was injured when he fell into an excavation site created and maintained by Hyundai, which was doing street widening and sewer construction work on the street in front of plaintiff’s home, where he parked his car. The excavation site was maintained by Hyundai’s foreman, who was also plaintiff’s brother-in-law. Plaintiff’s car was broken into while he was at church, resulting in $6,000.00 in damages to the car which his insurers paid. Plaintiff sued Hyundai for the damages to his car and prevailed in both the trial court and court of appeals.
Hyundai claimed that according to agency principles, plaintiff’s brother-in-law was an independent contractor. The court disagreed and held that because the defendant "retained the right of control over the contractor up to the point where the progress and quality of his work are concerned, but not over the details of the progress and quality of his work are concerned, but not over the details of the actual doing of the work," the defendant was liable for its brother-in-law’s negligent maintenance of the open excavation site.