What is sham contracting? And what are the consequences of incorrectly classifying an employee as an independent contractor? Elizabeth Lee answers these questions through lessons learned from a recent action against a Pizza Hut franchisee.
- What happened in the Pizza Hut case?
- What is Sham Contracting?
- What are the risks in incorrect classifications?
- How does it impact a business sale?
- Contractor vs Employee – what are the differences?
- What do we mean by task-oriented work?
- What in payments will the court look at?
- Action Steps
Joanna: Hi, it’s Joanna Oakey here. Welcome back to Talking Law! Today we have the fabulous Elizabeth Lee back in with us again, who heads up our Commercial Division over at Aspect Legal. Hi Liz, welcome back!
Liz: Hi Jo!
What happened in the Pizza Hut case?
Joanna: Today I really wanted to talk about a recent case that we saw, where we saw a Pizza Hut franchisee taken to court over sham contracting allegations. I think this is a really interesting topic and quite timely for us to be talking to our listeners about.
So essentially in this case the Fair Work Ombudsman has launched an action against a Pizza Hut franchisee over allegations that the company engaged in sham contracting activity. Essentially it’s all about how much they were paying a delivery driver at one of their Gold Coast locations. And in this case it was really interesting because it became quite apparent that the franchise owner had been paying the driver at a flat rate of $16 an hour which is less than would be required if the driver was treated as an employee.
But the reason they thought they could get away with this was because they had classified him internally as an independent contractor. They had asked him to supply an ABN in order to start the role. And they thought that that was enough to give them the opportunity to essentially pay less than the minimum wage that would be applicable if this person was an employee.
I think this ties in nicely with generally the concept of sham contracting so Liz maybe you can give us a bit of a quick overview on what sham contracting is.
What is Sham Contracting?
Liz: So sham contracting is where an employer misrepresents someone as an independent contractor when the nature by which they work is more akin to being an employee.
Joanna: Great. OK. Yeah. And I think that’s I mean it’s really important here because I guess the relevance of this is that organisations for a long period of time in the last decade I think had been moving away in part from employment relationships and moving further into contracting relationships internally. And we’re almost seeing a reverse of that situation now.
The independent contracting relationship has so much risk potentially attached to it that many organisations are moving away from that as a model moving forward and moving people who were independent contractors into being seen as employees. So maybe Liz if you can explain to us why is it that businesses are being concerned about this area? What is it that is I guess the risks that relate to a business if they are incorrectly classifying someone as an independent contractor when they’re really an employee?
What are the risks in incorrect classifications?
Liz: Yeah, so in the past before the Fair Work Act sort of focused on this area these independent contractors were also subject to ATO and payroll tax authority audits and so forth. And so inherently there were already risks that attached to organisations that employ this category of workers who were classified as independent contractors. And in the past organisations were able to sort of manage that risk by having appropriate indemnities from the independent contractors.
However, since the introduction of the Fair Work Act and the sham contracting provisions under the Fair Work Act there are now statutory penalties that come with situations where organisations are found to be incorrectly employing employees as independent contractors when they should be employing them as employees.
Joanna: So I guess the risk for business owners is firstly that they might be seen to be acting in contravention of this legislation. So that’s a big one because they can face penalties as you said and be liable to back pay for entitlements and that’s certainly what happened in this Pizza Hut case.Joanna: The franchiser ended up being liable to back pay the entitlements that were owed. But it’s not just the backpay right? It’s all of the legal costs that are involved in running or defending this sort of case. Not to mention your time and attention being taken away from the business and look hell, it’s not good for the branding of your business either right.
Liz: Yes, correct. The franchisee is at risk of having to back pay, not the franchiser. But having said that, with the set-up of these franchisees being subject investigation. All other franchisees who have adopted a similar structure, business model are at risk as well. So there are ramifications for the franchiser because it does make the whole proposition, commercial proposition of the franchise become less economic for the franchisees.
Joanna: Yeah. And look it’s an interesting progress at the moment because in the recent past we have also seen a number of other franchise relationships brought in to line under this legislation.
Liz: Yeah that’s correct. Since I think 12 months ago, 7-eleven were under scrutiny for underpaying employees and not paying their proper entitlements.
Joanna: And I guess it’s difficult, possibly it’s difficult sitting in the shoes of the franchisees. It looks in some of these cases like there might be similar conduct between a number of franchisees and it’s possible that the franchisees just don’t understand what they’re doing is incorrect and they sort of get part of that mob mentality. Everyone around them is doing it so they think it’s fine too.
Liz: Yes, correct. Absolutely.
How does it impact a business sale?
Joanna: And look, I guess the other thing that’s really interesting to note is that we also see this raise its head as an issue at the point of sale as well. So organisations who have contractors in their books quite often face issues at the time of sale if those contractors, if there’s any grey area at all in whether or not they have adopted the correct classification for these staff as being contractors rather than employees. So that’s something else to bear in mind as well. You might have the regulators bearing down on you or you might also end up in a situation where you’re whittling down your sale value or your options in terms of who you can sell to at the point of sale.
Liz: Yes, correct.
Joanna: Let’s look then at working out how do we work out the difference between who is a contractor versus who is an employee. So for any of our listeners out there who have staff who they are classifying at the moment as contractors, how do we work out whether or not there’s any greyness at all in that classification?
Contractor vs Employee – what are the differences?
Liz: Well, unfortunately there’s no hard and fast rules about this. And every worker situation will be different. But having said that, there are some strong indicators to help businesses work out whether their workers are truly independent contractors or if they’re in essence an employee.
Joanna: Take us through all of those, Liz. I’d love to hear them. Let our listeners in on these interesting factors that they should really be considering.
Liz: So the indicating factors – how is the work conducted? And generally who is in control of how the work is conducted? That’s a really big critical factor that is taken into account. Is the worker tasked with performing a job? So that it’s up to the worker to determine how it’s performed or when it’s performed. And really the person’s obligation is to deliver the end product.
Joanna: And I think some of that is really important. It’s really hard to work out when we look at that factor of how is the work conducted and who’s in control. It’s obvious that that organisations want to have some control over the standards of the performance that is being provided, if that’s services for example. So it’s a really grey line, isn’t it?
And I guess this is where organisations have to be really careful if they want an agreement with their contractors that really ties down the concept of control and reporting. Then they’re going to create potential grey areas for their organisation as to whether or not this person really is an independent contractor or whether they’re really an employee.
Liz: Yes particularly with franchises I think it becomes more of an issue where the franchisers are looking to have consistency in approach amongst their service providers.
Joanna: Yep, exactly. And any sort of situation I guess where you’re taking a templated approach and then rolling it out – which can be difficult when you’re dealing with issues like this where there’s the need to ensure that you really have a relationship where you’re dealing with an organisation and a service provider as opposed to someone that is effectively an employee.
OK, so we’ve talked about work conduct and who’s in control and is the work task oriented. Maybe talk a little bit more about that. What do we mean by whether or not the work is task oriented?
What do we mean by task-oriented work?
Liz: Well, when performing the role, is the contractor being asked to produce a particular result? I think when we talk about task, it’s about completing a particular job and not about how it’s performed.
Joanna: Yeah absolutely. OK. And I think that’s a good point. And once again this is where the question comes into play. Well if someone is paid on an hourly basis, is that – that’s not so task oriented, right? That’s period of time based and once again that sort of approach while in and of itself wouldn’t absolutely make the relationship one that would be seen to be an employment rather than a contracting relationship. It’s certainly one of those things that the courts might consider in relation to working out whether it is or isn’t.
Liz: It depends on the nature of the work they perform. Certain work lends itself to being assessed on an hourly basis and charge on an hourly basis. Just because you’re charging on an hourly basis doesn’t mean that you are an employee, and it’s not task oriented.
Joanna: Yeah, absolutely. Absolutely. But it’s one of those things that factors in the consideration and if there is payment on an hourly basis then you’re also ticking all of these other boxes as well in terms of what looks like an employment relationship rather than an independent contracting relationship. This is the sort of thing that maybe can tip it over the edge.
Liz: Yes that’s right. But then there are other indicators too. So for example, is the worker responsible to remit all taxes that are payable? Is the worker responsible for accounting for subordination payable and so forth?
So these payments to authorities are, I don’t think there’s any grey line there. It’s very clear that they should be paid by the independent contractor if they truly are independent contractors.
Joanna: Yeah absolutely. And I guess also the concept of provision of tools and equipment as well is another consideration I think that the courts will look at.
Liz: Yes that’s right. But that doesn’t mean, on the flip side, that an organisation can’t supply tools and equipment to the independent contractor.
So for example for security reasons they might have to have special laptops that have special security encryption and so forth that they might provide to the independent contractor to use. Certainly again no hard and fast rules about that. At the same time it could be an indicator.
Joanna: Yeah absolutely. OK. And then what about invoicing. What in payments will the courts look at?
What in payments will the court look at?
Liz: Well, workers are generally paid on a regular basis. It doesn’t matter how much work they do or how little work they do, they have entitlement to be paid weekly, fortnightly or monthly, whereas contractors, they generally can only bill for what they’ve produced. And generally they will issue an invoice for the work performed whereas employees generally wouldn’t.
Joanna: Great. I think that’s a really good walk-through. The sorts of things that we should be looking at or looking for in trying to consider whether or not there is any grey at all in the circumstances surrounding the way that we are engaging with staff members. So maybe let’s talk for our listeners then about the main action steps for them if they’re not sure what to do in this area.
Liz: Yes. So firstly if organisations have contractors they should critically assess whether or not these contractors are true contractors or whether they are really employees who are simply being classified or categorised as contractors.
Joanna: Yeah absolutely. So the first step then is to look at whether or not you’ve got contractors in the first place.
Liz: Yes, that’s right.
Joanna: This might be a consideration for people who were looking to engage staff in the future as well. If you’re deciding whether or not to engage staff as contractors or as employees.
Step 1 do you have contractors or are you thinking of bringing contractors on in the future?
Step 2 consider whether or not that’s really an appropriate classification for them. So really work through some of these risk areas and some of these indicating factors to work out whether or not they naturally more fall in the space of being an employee rather than a contractor because I think the point that we’re getting to here is that it’s really not worth the risk of pain and hassle that you might cause yourself in your business to incorrectly classify workers as contractors if indeed they really are employees.
Liz: Yes correct. Because the financial consequences are great if it’s incorrectly done.
Joanna: Yeah absolutely. And so then what’s the last action step I guess that we would usually recommend. And so the third action step that we need to be looking at in this area is then if we decide to engage some of our staff as contractors and if we’ve gone through the process of considering whether or not this is really an appropriate classification for them.
Step 3 – the last element is making sure we put in place proper agreements to ensure that we have protected our organisation that we’ve made it absolutely clear that cover all of these areas that relate to the areas of risk. So we make it absolutely abundantly clear that the relationship that we have in place is one of a contracting relationship rather than the employment relationship.
And as Liz said earlier on in the piece it’s about making sure that we have the right indemnity clauses in the contract once we’ve ascertained that in fact a contracting relationship is the correct relationship for us to be using moving forward with this staff member.
So I guess it’s worth mentioning that we certainly can assist in this area if any of the listeners are sitting out there thinking they really aren’t sure whether contractors that they’re dealing with at the moment are contractors or whether or not they’re getting into this grey area of being employees. I guess our suggestion would be come along, organise a free first initial discussion with us with Liz or one of the other team members of our commercial team and we can give you some guidance as to whether or not you’re in a grey area. And we can help analyse what the best approach will be for you moving forward in relation to how to deal with these staff members.
So that’s it. We’ve had a good run through today of the area of Sham Contracting. We’ve talked about the interesting case that brought this to light recently with the action against Pizza Hut franchisees and we’ve looked at how you can ascertain whether or not this is a risk in your own business and if it is, what you can do to try and reduce the risk in your own business. Thanks Liz for coming along!
Liz: Thank you Jo. It’s been a pleasure!
Joanna: If you’d like more information about this topic head over to our website at talkinglaw.com.au. Through that website you’ll also be able to download a transcript of this podcast episode if you’d like to read it in more detail. You’ll also find there details on how to contact our lawyers at Aspect Legal like Liz and the rest of the team, if you’d like help with any of the items we covered today. And finally if you enjoyed what you heard today please pop over to iTunes and leave us a review. We’d be very thankful. Thanks again for listening in. You’ve been listening to Talking Law. See you next time.