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 made 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 final installment of 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. This final installment examines recent decisions from the Oregon Court of Appeals regarding what it means to have “authority to hire,” for purposes of ORS 670.600(3)(e).
What Does “Authority to Hire” Mean?
To satisfy the fifth criterion of the independently established business test, the service provider must have “the authority to hire other persons to provide or to assist in providing the services,” and, also, “the authority to fire those persons.” ORS 670.600(3)(e).
In Portland Columbia Symphony v. Employment Department (PCS), 258 Or App 411 (2013), the court provided some useful guidance on this criterion. There, the Employment Department conducted an audit and concluded that the symphony’s contract musicians were actually its employees, resulting in an assessment of back unemployment insurance taxes. On the symphony’s administrative appeal to the Office of Administrative Hearings, the administrative law judge (ALJ) upheld the Employment Department’s determination, concluding that the symphony had failed to establish the necessary three criteria of the independently established business test. Among other things, the ALJ accepted the Employment Department’s argument that the contract musicians lacked the “authority to hire” other musicians to substitute for them when they were unable to perform, since some musicians never hired substitute performers, and the symphony reserved the right to approve any substitute that one of its contract musicians proposed and paid any substitutes directly (rather than paying the musician with whom it contracted and leaving it to her to pay her substitute).
However, the court found that the ALJ erred by relying on irrelevant factors to conclude that the “right to hire” was not present. Specifically, it observed that: (1) the statute requires only authority to hire others to assist in performing the service, not proof that the contractor actually exercised that authority; (2) there is no requirement in the statute that the contractor pay his assistant or substitute directly (i.e., that the hiring entity pays the substitute directly does not disprove that the contractor had authority to hire); and (3) the statute does not require that the right to hire be “unfettered,” as it is common practice, where personal services contracts are concerned, for the hiring entity to reserve “veto power.” PCS, 258 Or App at 427-28.
These conclusions should be welcomed by businesses that use independent contractors to assist them in providing services to their customers. Still, PCS’s statement about the propriety of reserving “veto power” should also be taken with a grain of salt. The court made this statement in the specific context of analyzing the requisite proof for establishing the right to hire criterion of subsection (3)(e). However, in certain circumstances, reserving too much “veto power” might be viewed as direct evidence of the hiring entity’s retention of control, possibly dooming it on the statute’s direction and control element before the decision maker ever reaches the right to hire criterion of subsection 670.600(3)(e).
Indeed, the case of AGAT Transport, Inc. v. Employment Department, 256 Or App 294 (2013), illustrates this very danger. There, the court rejected AGAT’s “implicit contention” that it merely required its contractors’ substitute drivers to meet legal requirements for providing the services. (If true, this presumably would not have equated to “direction and control.”) In reality, the court found, AGAT went beyond a mere contract provision requiring its contractors to hire only qualified drivers. Instead, AGAT required that it confirm the substitute drivers’ qualifications, including requiring them to pass a drug screen “as specified by AGAT.” Id. at 305 n 8 (emphasis in original). This equated to control over the drivers’ use of “labor,” one of the “means” of performing services specifically identified in OAR 471-031-0181, the administrative rule through which the Employment Department has interpreted the statutory term “direction and control.”
In addition to the AGAT case, businesses and their advisors should be aware of the Court of Appeals’ recent decision in Broadway Cab LLC v. Employment Dept., 265 Or App 254 (2014). There, Broadway Cab argued that its contract drivers had “authority to hire,” for purposes of ORS 670.600(3)(e), because they hired mechanics to maintain their taxicabs. Id. at 275. The court rejected this argument, observing that hiring mechanics to do maintenance did not demonstrate that the drivers had authority to hire people to assist them in performing “the services.” Id.; see also ORS 670.600(3)(e) (examining whether the service provider has “the authority to hire other persons to provide or to assist in providing the services”).
PCS is a positive decision for Oregon businesses that use contractors to help provide services to their customers. If a hiring entity is willing to give its contractor authority to hire others to assist in providing the contracted services, it makes sense to formally confer that authority via the parties’ contract, even if both parties view it as unlikely that the contractor will actually exercise it. Under PCS, authority to hire and fire is enough, even if unexercised.
On the other hand, having conferred authority to hire, a business must be careful not to retain too much control over its contractor’s hiring decisions. The AGAT decision illustrates the practical limitations on a hiring entity’s right to exercise the “veto power” that PCS concluded hiring entities can retain under the “authority to hire” criterion. According to the court, by effectively taking control of the screening process, AGAT exercised direction and control over its contract drivers’ use of labor, dooming it on the first element of the independent contractor test. Had AGAT Transport instead left it to its contractors to vet their substitute drivers’ qualifications—including leaving it to them to arrange drug screens and process their results—it might have stood a better chance of avoiding a finding of control. (AGAT could have contractually allocated liability to its contract drivers if they failed to properly perform these contract duties, and AGAT suffered damage as a result.)
Thus, the teaching of AGAT is this: regardless what PCS says about “veto power,” a hiring entity’s safest move is always to stay out of the contractor’s hiring decisions to the full extent possible.
To read previous installments in this series, please click on the following links: http://gleaveslaw.com/.docs/pg/10257/rid/10041 (regarding the “direction and control” test); http://gleaveslaw.com/.docs/pg/10257/rid/10043 (regarding the “maintains a business location” criterion); http://gleaveslaw.com/.docs/pg/10257/rid/10044 (regarding the “bears the risk of loss” criterion); http://gleaveslaw.com/.docs/pg/10257/rid/10045 (regarding the “contracted services for two or more different persons” criterion); http://gleaveslaw.com/.docs/pg/10257/rid/10048 (regarding the “significant investment” criterion).
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.