Businesses commonly use contractors, in lieu of employees, to provide certain services to their customers. For example, a business may use contractors to help deliver the merchandise or install the products that it sells, provide transportation to and from its business location or special events that it sponsors, or provide troubleshooting or repair services. Using contractors to provide such services can be a very efficient and cost-effective business model if they are truly independent contractors. On the other hand, if a business’s "contractors" are actually employees mislabeled as contractors, it may be setting itself up for a legal and financial disaster.
In recent years, Oregon’s legislature and its state agencies (especially the Employment Department) have dedicated considerable attention and resources to cracking down on businesses that misclassify their employees as independent contractors. Investigations by state agencies frequently result in the "reclassification" of a business’s contractors as employees, with some very harsh consequences, including assessments of years of back employment taxes, along with accrued interest and some very stiff penalties.
One of the most important independent contractor classification tests in Oregon is set out in a statute, ORS 670.600, that defines who is an "independent contractor" (and, by implication, who is an employee) for purposes of state employment taxes. Any business that regularly uses contractors to provide services—and any accountant or attorney who advises businesses on the propriety of treating certain service providers as "contractors" for employment tax purposes—should be intimately familiar with this statute and how the Oregon courts have interpreted and applied it.
Under ORS 670.600, any individual or entity (e.g., corporation) that provides services to a business for remuneration will be deemed its employee unless the individual or entity, in addition to possessing any license necessary to lawfully provide the services in question, is: (a) free from direction and control over the means and manner of providing the services; and (b) "customarily engaged in an independently established business." To meet the "independently established business" test, the hiring entity must prove that three or more of the following five criteria are present: (1) the service provider maintains a separate business location; (2) the service provider bears the risk of loss related to the provision of services; (3) the service provider provides contracted services for two or more persons within a 12-month period (or routinely engages in business advertising, solicitation, or other marketing efforts "reasonably calculated" to obtain new contracts to provide similar services); (4) the service provider makes a significant investment in the business; (5) the service provider has the authority to hire other persons to provide or to assist in providing the services and has the authority to fire those persons. See ORS 670.600(3).
In the past few years, the Oregon Court of Appeals has issued several important decisions applying ORS 670.600. This is the third in a six-part series of articles that discusses what the courts' decisions tell us about how to interpret the "direction and control" element of the statute, and how to interpret each of the five factors of the “independently established business” test. My first installment, regarding the "direction and control" test, can be found at http://gleaveslaw.com/.docs/pg/10257/rid/10041. The second article, regarding the "maintains a business location" criterion of the independently established business test, can be found at http://gleaveslaw.com/.docs/pg/10257/rid/10043. This third installment examines recent decisions from the Oregon Court of Appeals regarding what it means to "bear the risk of loss," for purposes of ORS 670.600(3)(b).
What Does "Bears the Risk of Loss" Mean?
The "bears the risk of loss" factor, found in subsection (3)(b) of the statute, appears to be the legislature’s attempt to examine whether the contractor in question faces the types of risks and costs that we think of as being typical for someone who is running his or her own business. For example, a business owner will often face the cost of purchasing liability insurance or the risk of taking on a project that becomes unprofitable because he or she is required to spend significantly more time completing it than initially anticipated. Reflecting such costs and risks, the statute provides that the "risk of loss" criterion can be established by showing the presence of factors such as: “(A) The person enters into fixed-price contracts; (B) The person is required to correct defective work; (C) The person warrants the services provided; or (D) The person negotiates indemnification agreements or purchases liability insurance, performance bonds or errors and omissions insurance.” ORS 670.600(3)(b).
A recent decision from the Oregon Court of Appeals, Portland Columbia Symphony v. Employment Department ("PCS"), 258 Or App 411 (2013), provides important guidance regarding how to apply these factors. In PCS, the court found that the symphony had properly classified the contract musicians in issue as independent contractors. Id. at 413. Among the court’s more important findings, it found that the administrative law judge (ALJ) had erred on the risk of loss factor by "applying factors that have little relationship to the type of work that the musicians were performing." Id. at 427. The court explained that it is not always necessary to apply each example of "bearing the risk of loss" referenced in the statute. Rather, the decisionmaker must determine which factors are actually relevant by "account[ing] for the nature of the work." Id. at 426. Of the examples listed in the statute, the court found, "the most relevant factor is the one that the ALJ did not even mention: the fixed price contracts." Id. (Presumably, because the contract might end up requiring either limited rehearsal time or extensive rehearsal time, which equates to a risk of earning relatively little for a significant investment of time, which equates to lost time that could have been spent on more profitable work.)
PCS is helpful for businesses using contractors because it suggests that showing just one of the statutory examples of risk of loss can be sufficient to establish the "risk of loss" criterion, at least if the example in question is plainly the "most relevant" given the "nature of the work." Moreover, a subsequent decision from the Court of Appeals involving cleaning and maintenance workers, Ponderosa Properties, LLC v. Employment Department, 262 Or App 419 (2014), reinforces and extends the reasoning employed in PCS. Preliminarily, the court’s opinion states explicitly what PCS necessarily implies: that subsection (3)(b)’s examples are "disjunctive," and, therefore, that "[a]n individual is not required to satisfy all of them as if they were four elements." Ponderosa Properties, 262 Or App at 431. Again, as in PCS, the court found that, in the circumstances presented, the parties' fixed-price contracts were alone adequate to demonstrate that the service providers in question bore the risk of loss, stating:
"The fixed-price assignments demonstrate that the cleaners bore significant risk. Regardless of the condition of the unit or the time necessary to complete the task they would be paid only a fixed rate." Id. at 431-32.
That the cleaners were also required to "fix defective work" only "underscored" that they bore a genuine risk of loss. Id. at 433. Thus, although the court recognized that these two factors were only "two among a nonexclusive list of factors" set forth in the statute, it found them sufficient to establish the risk of loss criterion "as a matter of law" on the record before it. Id. at 433 n 7.
Undoubtedly, PCS and Ponderosa Properties are both quite helpful to businesses that use contractors to assist in providing services to their customers. However, it is important to recognize that the opinions in each case leave room for the Court of Appeals to reach a different result in the future if a case comes before it in which: (a) the one example of risk of loss that is present is not the "most relevant" (as it was in PCS); or (b) there are other examples you would normally expect to see for the type of work in issue that are not present in the case at hand.
Moreover, not all of the recent case law on the risk of loss criterion has been favorable to businesses. For example, in Compressed Pattern, LLC v. Employment Department, 252 Or App 254 (2012), the hiring entity attempted to show "risk of loss" by showing that the service provider was "required to correct defective work" without additional compensation. See ORS 670.600(3)(b)(B). In support of this argument, the service provider (an architectural drafter) testified that he was "willing" to correct defective work, and would have done so for no additional charge. Compressed Pattern, 252 Or App at 262. However, this was not enough. The court found that the ALJ was justified in "discounting" the drafter’s willingness to correct his own mistakes, given "the nature of the parties' arrangement—i.e., no written contract; no evidence that Singer would have been required to correct defective work; payment based on hourly fee; and no liability insurance or performance bond carried by Singer." Id. (Emphasis in original.)
An important take-away from Compressed Pattern is this: although courts commonly look through contract language if it does not reflect the realities on the ground, having in place a good written contract that memorializes the essential elements of the independent contractor relationship is nonetheless of critical importance. Practically, this should be viewed as a necessary (but not sufficient) condition to having independent contractor classification withstand scrutiny by state agencies and the courts. For example, if the parties intend that the contractor will fix defective work for no additional charge, they should not rely on an informal understanding. Rather, they should spell this out explicitly in their contract.
At the same time, in detailing the presence of the risk of loss criterion—or, indeed, any other criterion of the statute’s "independently established business" test—the hiring entity should take care to avoid mandates and directives wherever possible, instead using recitals of true facts and provisions requiring periodic proof of the continued existence of those facts. For example, a contract should not state that the contractor "shall maintain liability insurance," which an agency could mistake as evidence of "direction and control." Instead, the better option is to recite that the contractor has such insurance, and include contract provisions requiring the contractor to produce proof of continued coverage periodically (perhaps every six months).
Dan Webb Howard is an employment law attorney and appellate practitioner with the law firm Gleaves Swearingen LLP. If you have any questions regarding this article, he can be reached at email@example.com.
DISCLAIMER: The information in this article is offered for general information and educational purposes only. It does not constitute legal advice and does not create an attorney-client relationship. You should not act on the information in this article before seeking the advice of an attorney.