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 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 fifth 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 criterion 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. And my fourth article, regarding the “contracted services for two or more different persons” criterion, is at http://gleaveslaw.com/.docs/pg/10257/rid/10045. This fifth installment examines recent decisions from the Oregon Court of Appeals regarding what it means to make a “significant investment in the business,” for purposes of ORS 670.600(3)(d).
What Does a “Significant Investment in the Business” Mean?
To satisfy the fourth criterion of the independently established business test, the service provider must make a “significant investment in the business.” ORS 670.600(3)(d). The statute provides three non-exclusive examples of what a “significant investment” might look like: (a) purchasing the tools or equipment necessary to provide the services; (b) paying for the premises or facilities where the services are provided; and (c) paying for licenses, certificates, or specialized training required to perform the services. ORS 670.600(3)(d).
In Compressed Pattern, LLC v. Employment Department, 252 Or App 254 (2012), the court addressed what is required to establish this criterion. There, the architecture company (Compressed Pattern) challenged the department’s reclassification of an individual (Singer) who provided the company with architectural drafting services. Compressed Pattern asserted that evidence of Singer’s efforts to obtain an architectural license—including paying more than $1,500 to take seven licensing exams—was sufficient to prove that he ‘pay[ed] [sic] for licenses * * * required to provide the services’ and, consequently, that he made a ‘significant investment in the business’” for purposes of the statute.
The court rejected this argument, stating relevant part:
“During [the relevant] time [period], Singer’s services for petitioner and others involved only drafting, and an architectural license was not required for those services. Singer apparently had been pursuing an architectural license since 2002, including while he was an employee for GBD Architects. Singer also told an Employment Department investigator in February 2010 that he did not have a business. Thus, there was evidence in the record to support the ALJ’s factual finding that, although Singer had invested in an architectural license, he had not made that investment for the purpose of investing in any existing business.” Compressed Pattern, 252 Or App at 263.
Thus, Compressed Pattern suggests that it is not necessarily sufficient to show that the service provider has made significant investments relating to his services, and that those investments substantially enhance the quality of his services. Rather, the court’s opinion suggests that at least two additional requirements must be satisfied if the hiring entity is to be certain that subsection (3)(d)’s “significant investment” criterion is satisfied: (1) if the investment relates to a license or certificate, obtaining that license or certificate must be required to provide the services, not just enhance the service provider’s skills or marketability; and (2) the service provider must have an actual “business” in place when he makes the investment.
The court’s conclusion regarding the second point is understandable, given that subsection (3)(d) states that the service provider must make a significant investment in “the business,” rather than “the services.” Nonetheless, the court’s conclusion is fundamentally misguided, because it fails to account for the broader context. Specifically, the court’s opinion fails to consider the relationship between subsections (3)(d) and (2)(b) of the statute, the latter of which requires proof that the service provider have an “independently established business” to establish her independent contractor status. Subsection (3)(d) provides that proof of a “significant investment” is one criterion that the hiring entity can use to show the existence of an "independent business". Therefore, it makes little sense to require the hiring entity to show that the service provider has an "existing business" before it can establish that criterion.
Interpreting the statute in that manner, as Compressed Pattern seems to, puts the cart before the horse. A hiring entity trying to prove that its service provider has an “independently established business” should not be required to prove that she has a business to prove one of the very criteria that the statute makes available to establish that fact. Evidently, this argument was not raised by the petitioner in Compressed Pattern (at least, the opinion makes no reference to any such argument). However, in future cases, parties challenging reclassification who can show that their service providers made significant investments related to providing the services at hand should argue—based on the need to harmonize subsections (2)(b) and (3)(d) of the statute—that this is enough to prove the existence of the “significant investment” criterion, without the need for additional proof that their contractors specifically made such investments in an established “business.” The most logical interpretation of the statute is that the term “business,” as used in subsection (3)(d), should be read expansively, as encompassing any services performed for remuneration. Simply put, Compressed Pattern reads the term “business,” as used in that subsection, too narrowly.
Similarly, since the examples of “significant investments” set out in the statute are plainly intended to be non-exhaustive, it seems inappropriate to conclude, as Compressed Pattern seems to, that investments in licenses or certificates must necessarily be disregarded as irrelevant if the license or certificate in question is not strictly required to be able to perform the services in question lawfully. Since a license “required to provide the services” is merely cited in the statute as one example of a “significant investment,” parties challenging reclassifications in the future, who can show that their service providers invested significantly in licenses, training, or certificates that substantially enhanced the quality of their services or their marketability, might want to argue that this is sufficient to establish the “significant investment” criterion, even if there was no legal requirement that the service providers undertake the training or obtain the licenses or certificates to be able to lawfully provide the services in issue. The petitioner in Compressed Pattern did not appear to raise this argument (no such argument is referenced in the opinion, in any event), which in itself should be a valid ground for distinguishing Compressed Pattern in future cases involving significant investments in education or training.
Compressed Pattern is a tough decision for Oregon businesses that use contractors. However, as noted above, there are some good arguments available to distinguish the case if your business or client comes under scrutiny by the Oregon Employment Department or Oregon Department of Revenue. In the meantime, businesses that use independent contractors to assist in providing services to customers should take care to memorialize in their agreements with those contractors the significant investments the contractors have made, and continue to make, to be able to effectively provide the services.
In so doing, the hiring entity should take care to avoid mandates and directives wherever possible, instead using recitals of true facts in their place. For example, a contract should not state that the contractor “shall” pay rent for a separate office, as an agency would likely view this as evidence of “direction and control.” Instead, the better option is to recite that the contractor pays rent for an office space (or shop, or storefront, etc.), and include contract provisions requiring that he or she periodically produce proof that she is continuing to lease that space.
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 firstname.lastname@example.org.
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.