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 fourth in a six-part series of articles that discusses what the court’s 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. My third article, regarding the "bears the risk of loss" criterion, is at http://gleaveslaw.com/.docs/pg/10257/rid/10044. This fourth installment examines recent decisions from the Oregon Court of Appeals regarding what it means to “provide contracted services for two or more different persons," for purposes of ORS 670.600(3)(c).
What Does "Provides Contracted Services for Two or More Different Persons" Mean?
To satisfy the third criterion of the independently established business test, the service provider must "provide contracted services for two or more different persons within a 12 month period, or … routinely engage in business advertising, solicitation or other marketing efforts reasonably calculated to obtain new contracts to provide similar services." ORS 670.600(3)(c).
That the statute refers to "contracted" services could be read to suggest that the party opposing reclassification must affirmatively prove that the service provider’s relationship with the third party satisfies each element of ORS 670.600. However, in Ponderosa Properties, LLC v. Employment Dept., 262 Or App 419 (2014), a three-judge panel for the Oregon Court of Appeals reached the contrary conclusion.
Before Ponderosa Properties reached the Court of Appeals, an administrative law judge (ALJ) for the Office of Administrative Hearings (OAH) had ruled in favor of the Employment Department, concluding that the cleaning persons in question were Ponderosa Properties' employees, rather than independent contractors. Among other findings, the ALJ found that Ponderosa Properties had failed to meet its burden of proof on the "provides contracted services for two or more different persons" criterion. In so ruling, the ALJ disregarded testimony from two cleaners that they provided cleaning services to other businesses, reasoning that it was insufficient because there was "no evidence that the services were performed as independent contractors." Id. at 434 (quoting from the ALJ’s opinion; omitting emphasis supplied by the court).
The court, however, concluded that the ALJ had misapplied subsection (3)(c) of the statute by "interposing unnecessary requirements in its analysis." Id. Regarding the burden of proof on the party challenging reclassification, the court opined that it “suffices" to show that the service provider provided contracted services "for two or more different persons." Id. Ponderosa Properties therefore was not required to affirmatively “prove the elements and criteria required to establish that each individual was an independent contractor" as to other entities for which she worked. Id. Moreover, no proof of a “formal or written contract" between the service provider and third parties was required to prove the “two or more different persons" criterion; rather, qualifying proof can consist of evidence of contracts that are “oral or written, one-time arrangements or long-time commitments." Id. at 435. However, at the same time, the court did suggest that its conclusions regarding whether subsection (3)(c)’s criterion had been adequately proved may have been different had there been evidence in the record that the a cleaner’s only cleaning services for a third party were performed "as a typical employee," for example, as a "salaried custodian for a nearby school district." Id. at 434.
Thus, to summarize, the teachings of Ponderosa Properties, with respect to the "two or more different persons" criterion of ORS 670.600(3)(c), are: (a) the party challenging reclassification (e.g., a hiring entity that has received a tax assessment from the Employment Department) has the burden to prove that the reclassified service provider provided similar services to others, but does not have the burden of proving that each element of ORS 670.600 was satisfied with respect to these services rendered to a third party; (b) evidence of one discrete job performing similar services for remuneration for another person or entity within the relevant 12-month period will normally be sufficient to meet this burden, even if arrangement is informal and the engagement is brief; but (c) if the Employment Department affirmatively presents evidence that the service provider provided services to the third party (or parties) as an employee, this might serve to rebut the hiring entity’s proof and disprove the existence of the "two or more persons" criterion. (At least, this remains a possibility unless and until the Court of Appeals addresses this issue squarely and reaches the contrary conclusion.)
On the whole, Ponderosa Properties is a very positive decision for business. However, not all of the recent case law developments on the "two or more different persons" criterion of ORS 670.600(3)(c) have delivered good news. For example, in the very recent decision of Broadway Cab LLC v. Employment Dept., 265 Or App 254 (2014), the Court of Appeals rejected the taxpayer's argument that the taxi drivers in question routinely engaged in advertising or marketing efforts reasonably calculated to obtain new contracts for similar services (the alternative way to prove that ORS 670.600(3)(c) is satisfied, in lieu of showing actual performance of services for "two or more different persons"). Of note, the court reasoned that "a person’s 'routine' marketing efforts must be undertaken to help that person 'obtain new contracts to provide similar services,' not to promote the services of another organization." 265 Or App at 272. The court found that the marketing efforts in question failed that test because the drivers "could not legally provide transportation services except under Broadway’s auspices," and, therefore, "any advertising efforts that the drivers undertook would, in the end, promote Broadway itself, given that the drivers drove solely in taxicabs marked with the company’s name and colors." Id. In short, that the drivers' self promotion could lead to more calls and more money in their own pockets was insufficient; rather, they had to routinely solicit work that they could and would perform separate from their work for Broadway to meet the "routinely engages in business advertising" criterion.
Ponderosa Properties is a very good decision for Oregon businesses that use contractors. If the court had sided with the Employment Department, this would have created an excessive and unrealistic burden on any business hoping to rely on the "contracted services for two or more different persons" criterion to establish that its contractor is engaged in an "independently established business." Essentially, the Employment Department advocated a "case within a case" method of proving this criterion, whereby a business would have to prove every element of its contractor's relationship with a third party to the same degree that it is obligated to prove the elements of ORS 670.600 with respect to its own contractual relationship. Businesses that use contractors can breathe a sigh of relief that the court rejected this onerous burden of proof, especially since third parties will not always be cooperative or responsive to a business’s request for assistance in its dispute with the state.
Still, a hiring entity that plans to rely on the "two or more different persons" criterion needs to exercise care to document the contractor's provision of services to third persons, and should be vigilant that the contractor at no point becomes reliant on the hiring entity as his or her sole source of income. Among other things, the hiring entity should consider including a provision in the service contract requiring that the contractor submit appropriate documentary proof every six months that he or she has provided similar contracted services to another entity within the past six months. That proof should also indicate that the services were rendered as an independent contractor, and not as an employee. (For example, a W-2 or paystub would not be helpful to proving the "contracted services to two or more different persons" criterion.)
At the same time, 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 perform services for other parties," as an agency would likely view this as evidence of “direction and control. Instead, the better option is to recite that the contractor provides services to others, and include contract provisions requiring that he or she periodically produce proof of continued rendition of such services to third parties. And, as Broadway Cab teaches, those services should be unconnected to the contractor’s agreement with, or services for, the business seeking to establish his or her bona fides as an independent contractor.
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.