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Independent contractor vs. employee: Avoid the pitfalls of international worker misclassification

When I was growing up, my mom had many faces; one was an especially terrifying look. She’d squint her eyes, drain all the color from her cheek and purse her lips in such a way that my brothers and I would get a spine-tingling chill when she turned it on us. Usually she used it as a warning look for when we were on the precipice of doing something bad. But sometimes doing something bad felt good, particularly when I was 7. And I would take my chances.

So I know how a lot of businesses feel when they try to classify workers as independent contractors when they should really be treated like employees. It feels good to have flexibility, to save money, and to avoid the hassles of wage and hour laws. Plus, if the worker understands what it means to be an independent contractor and signs an agreement stipulating their independent contractor status, what’s the harm?

Well, there is a lot of harm. And if you could see me, you would see I’m wearing my Mom’s face. I wear this face a lot when talking about misclassification of employees because businesses often take their chances in this area. It’s a bad thing to do, because businesses often don’t understand the pitfalls of worker misclassifications. These pitfalls can lead to unpaid back wages, civil money penalties and attorney’s fees; it has also spurned a number of class action lawsuits. Simply filing a 1099 or signing a contract stating someone is an independent contractor doesn’t make a worker an independent contractor.

In Maryland, businesses are getting more sensitive about misclassification as many small companies are starting to get audited. Violations for misclassification issues can be steep; for willful violations there can be criminal charges. See the Maryland Workplace Fraud Act of 2009 to learn more.

This week I began thinking about international misclassification issues because of a small legal case in Delaware that caught my eye. The case was In re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS, in which the judge issued a bench ruling that has implications for boards of companies with operations outside the U.S. The hearing was about whether independent directors could dismiss a claim that they breached their fiduciary duty to stockholders when they failed to discover an unauthorized sale of assets in China. The judge refused to dismiss the claim; he stated, “[T]here is no such thing as a dummy director in Delaware…” The judge made it clear that the directors can’t absolve their failure to exercise fiduciary duties or a duty of loyalty to transactions that take place abroad with excuses about foreign languages, different business cultures or long-distances.

While U.S. companies are starting to understand the full brunt of the punishment for domestic misclassification issues, there still is a lot of ignorance about international misclassification of workers abroad. Most countries have stringent laws governing employees. It’s really tempting for small businesses to circumvent these laws by hiring an independent contractor abroad. With the Internet and modern technology – it’s a piece of cake to maintain a representative overseas. But if a company hires a sales person in another country as an independent contractor and expects the worker to work full-time for a wage or commission, then there is a good chance you’ve misclassified an employee in violation of that countries’ laws. Local employment laws govern employees, so even if a contract states that Maryland law will apply, the worker can legitimately sue the company in a court in the country where the worker actually worked.

If an independent contractor is deemed to be an employee, the punishment will likely require payment of a variety of fees and taxes pursuant to that countries’ employment laws, including: retroactive benefits, social security, employment taxes, a required severance – plus a lot of legal fees. In addition, if the company is deemed to have an employee in the country but failed to establish a legal entity in that country, then the company likely violated a host of corporate laws and could be facing fines and corporate back-taxes.

Despite strong punishments for misclassification cases, independent contractors in the worldwide workforce have been on the rise. Not surprisingly, new laws are being adopted to protect them. For example, under the UK Agency Workers Regulations of 2010, which took effect on October 1, 2011, a temporary UK worker who works for an employer longer than twelve weeks must be paid on a comparable basis to a regular worker. These protective laws aren’t generally meant to impact people who have traditionally served as independent contractors – such as a lawyer retained for a specific litigation, or a plumber hired to replace piping or an entertainer engaged to perform for an event. These laws are to protect employees from being treated like independent contractors.

In light of the Delaware case where the judge refused to let directors off the hook for an improper international transaction, I can’t help but wonder if companies will be more sensitive to the risk they take when hiring independent contractors abroad.

One comment

  1. Hi I work in Tucson Arizona. My boss offered me a position as an independent contractor, so I get no benefits or overtime. Last year I worked with the company and provided special education services to two schools. This year I am enrolled in full time graduate school and requested for my boss to reduce my hours. However I was hoping that because I am an independent contractor it would not reduce my pay. But because she pays hourly it was significantly cut down and she said that there is no way to pay me my wage when I am working less hours. Am I in the wrong for asking her for schedule flexibility while still keeping my regular wages.