The decision in McKee v. Reid's Heritage Homes Ltd. sends a chilling message to employers who have long term relationships with independent contractors and believe therefore those contractors are not entitled to severance payments of any magnitude. The decision clarifies the common law test on whether a worker is an independent contractor, a dependent contractor or an employee. In the decision, the Ontario Court of Appeal (OCA) affirmed the trial judge's finding that although McKee provided sales agent services through an incorporated entity and hired, trained and managed her own sub-agents, nevertheless, she was an employee entitled to 18 months notice of termination. This decision follows the OCA decision in Braiden v. La-Z-Boy Canada Ltd. in 2008 and confirms that courts in Ontario are not afraid to look past the corporate veil by finding that persons providing services through an incorporated entity are employees.
Reid's Heritage Homes Ltd. is in the business of building homes in Southwestern Ontario. In 1987, McKee, through her company, commenced advertising and selling homes built by Reid's. The parties had a handwritten agreement that provided for McKee to sell 69 homes in exchange for a fee of $2,500 per home sold. The agreement also included an exclusivity clause and permitted termination by either party on 30 days notice. Following the sale of the 69 homes described in the agreement, McKee continued to sell (but not advertise) homes for Reid's and was paid a fee of $1,500 per home sold.
Reid's provided McKee with stationery and forms for selling homes, gave her the title of Sales Manager and paid her through her corporation. McKee was successful and hired, trained and managed subagents with whom she split her commissions.
The relationship ended in 2005 when Reid's required McKee and her sub-agents to become direct employees. McKee and Reid's could not agree to terms and McKee sued for wrongful dismissal.
Trial Judge's Findings
The trial judge found that the original agreement was spent after the sale of the initial 69 homes and that the termination provision was not applicable at the time of the constructive dismissal in 2005. The trial judge found that McKee's business activity was part of Reid's business since selling the homes is the "most integral part of the defendant's business" and concluded McKee was an employee rather than an independent contractor or dependent contractor. As a result, she was entitled to 18 months notice of termination of her employment.
The Dependent Contractor
Historically, workers are classified as an independent contractor or an employee. On appeal, Reid's did not argue McKee was an independent contractor. Rather, it argued McKee was a dependent contractor, an intermediate category of worker, who it alleged is entitled to notice of termination, but less notice of termination than an employee.
The OCA agreed that an intermediate category of dependent contractors exists and defined dependent contractors as "those non-work relationships that exhibit a certain economi dependency, which may be demonstrated by complete or near-complete exclusivity".
The OCA concluded that rather than assessing whether a worker is an (1) independent contractor, (2) dependent contractor or (3) employee, the initial step is to determine whether the worker is (i) a contractor or (ii) an employee. Only if the court concludes the worker is a contractor should the court move to the second step of distinguishing between independent contractors and dependent contractors.
The OCA confirmed the factors a court will review in assessing whether the worker is an employee or contractor and in applying those factors concluded that the trial judge's determination that McKee was an employee was reasonable:
1. Exclusivity of service (McKee worked exclusively for Reid's);
2. Control over work (McKee was subject to control as to where she was to sell, the promotional methods she was to use and how much she was to sell the homes for);
3. Ownership of tools (Reid's supplied her stationery and forms);
4. Risk of profit or loss (No evidence McKee risked any significant capital in her sales operation); and
5. Whether the activity of the worker is part of the company's business organization (McKee was a crucial element of Reid's business organization).
What This Means to Employers
The decision in McKee v. Reid's Heritage Homes Ltd. is a good reminder of several best practices for employers:
1. Review substance of relationship with contractors. Substance trumps form and even the best drafted contract or the fact that a worker is incorporated will not be determinative of the worker's status.
2. Properly manage and renew contracts. This is important to:
(a) Identify long-service contractors for whom there is a greater likelihood of a claim that the worker is an employee or dependent contractor entitled to reasonable notice; and
(b) Ensure contracts are valid and in force (e.g., the 1987 agreement was spent and of no help to Reid's).
3. Include a termination provision in your contractor agreements. In particular, consider limiting potential liability by including a termination provision that meets or exceeds the minimum requirements of applicable provincial standards legislation in the event the contractor is found to be an employee or dependent contractor entitled to reasonable notice of termination.
Many of our clients use contractors as part of their regular business, including incorporated sales agents. The heavy penalty of paying an incorporated sales agent 18 months compensation in lieu of notice is a reminder for employers to conduct a review of their use of contractors to assess the likelihood that the contractors are in fact employees or dependent contractors. Please contact one of our employment services lawyers to discuss any issues you have relating to your existing use of contractors, revising your standard form contractor agreements or converting your contractors to employees.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.