United States: Staffing Agencies Using Independent Contractors Face Misclassification Liability And Expose Clients To Undue Risks

Last Updated: January 25 2013
Article by Richard J. Reibstein, Lisa B. Petkun and Andrew J. Rudolph

This month there have already been two cases in the staffing industry that highlight the risks posed to that industry and their clients where the workers being referred are paid on a 1099 basis. One case arose in New York and involved workers referred to clients holding marketing events that required extra staff for promotional work. The other case arose in California and involved customer service and technical workers referred to AT&T and Apple.

Many staffing and referral companies refer only W-2 employees to their clients or send only 1099ers who are bona fide independent contractors (ICs). There are, however, a number of staffing companies that send misclassified common law employees to their clients but pay them as if they were ICs. That creates substantial exposure for misclassification liability for the staffing companies and their clients – exposure that can be minimized or eliminated.

The New York Case:

On January 3, 2013, the New York State Unemployment Insurance Appeal Board issued identical decisions in 35 separate cases holding that the workers supplied by a staffing company to a client to perform promotional work for a marketing event were employees and not independent contractors. See, e.g., Matter of Appeal Board No. 556309. Each of the 35 cases involved claimants who sought unemployment benefits despite being treated as 1099ers.

The Appeal Board was not persuaded that the workers were independent contractors simply because they could decline assignments and could work for other agencies. In ruling that all 35 workers had been misclassified, the Appeal Board relied on five other administrative and court cases where workers in the promotional and event marketing industry were found to be misclassified as ICs:

  • one case involved a "promotional staffing company,"
  • another case ruled against a company that "provided models for trade shows and other 'events' where promotional materials were handed out,
  • the third case involved a promotional "marketing company,"
  • a fourth case dealt with misclassified appliance demonstrators, and
  • the fifth case involved a staffing agency "which provided models to stores for make-up demonstrations and sales promotions."

As a result of the January 2013 decision, the staffing company was held liable for contributions for all similarly situated workers.

The California Case:

On January 9, 2013, customer service and technical support service workers servicing AT&T and Apple settled their class action IC misclassification lawsuit with their staffing company, Arise Virtual Solutions, for $1.25 million. On that date, a federal district court in California granted preliminary approval of a class action settlement alleging that the staffing company misclassified over 200 of its service providers as independent contractors instead of employees.

The original lawsuit had sought damages against Arise, AT&T, and Apple for unpaid overtime, failure to reimburse workers for required business expenses, and failure to provide meal periods and rest periods under state law. After considerable motions and the filing of new complaints only against Arise, the parties settled. The $1.25 million settlement is subject to a fairness hearing scheduled before the court in May 2013. Perry v. Arise Virtual Solutions, No. C 11-01488 YGR (Jan. 9, 2013) (N.D. Cal.).

The settlement was reached after extensive discovery was taken including depositions and the exchange of over 81,000 pages of documents in response to over 300 document requests. AT&T and Apple are not parties to the settlement. Arise denied any wrongdoing in the settlement papers.

This case is one of a number of "class action" type cases filed against Arise for worker misclassification.

In October 2012, a lawsuit was filed against Arise in federal court in Florida alleging that it violated the federal minimum wage law. Dowell v. Arise Virtual Solutions, No. 12-cv-61947 (S.D. Fla.). That lawsuit alleged that Arise failed to pay its "individual business owners," "virtual service corporations," "client service professionals," "partners," and other independent contractors for time spent in extensive training teaching them to become customer service representatives for specific customers of Arise and for time they were on call time waiting for work. The lawsuit alleges that those independent contractors are employees under the federal Fair Labor Standards Act (FLSA) because they are trained, directed, and controlled in the manner in which they performed their work. In addition to required training, the customer service representatives were allegedly required to follow scripts when speaking on the telephone to customers for Arise's clients, which are cited as American Automobile Association, Apple, Disney, and Carnival Cruise Line. This case was recently withdrawn "without prejudice" to any party after Arise filed a motion seeking to arbitrate the claims pursuant to an arbitration clause in its agreements with the customer service representatives or their corporate entities.

Another lawsuit was filed against Arise in the same federal court in October 2012 with similar allegations: the customer service representatives retained by Arise are not independent contractors but rather employees who are directed and controlled in the manner in which they performed their work, yet they were not paid for required training courses and other time worked without compensation – all allegedly in violation of the FLSA. These customer service representatives provided services for Carnival Cruise Lines and AT&T, the complaint alleges. Otis v. Arise Virtual Solutions, No. 12-cv-62143 (S.D. Fla.). No answer or motions have yet been filed by Arise.

Analysis and Observations:

1. IC misclassification claims create an array of legal proceedings. These types of cases represent two of the many types of legal proceedings that staffing companies are increasingly facing when the personnel they refer to clients are not treated as W-2 employees. As noted above, there is no legal prohibition on staffing companies referring to their clients workers treated as 1099ers where those individuals meet the tests for ICs under applicable federal and state laws. However, administrative proceedings and lawsuits alleging IC misclassification are more prevalent, and more likely to create liability for the staffing company or the client, where there is considerable direction and control allegedly exercised by the staffing company, or its client, over the manner and means by which the workers perform their services. Other types of IC misclassification proceedings besides unemployment administrative matters and class action lawsuits include governmental audits – by the IRS, workers compensation boards, and/or the federal and state Labor Departments.

2. The corporate status of the IC does not eliminate misclassification liability. These cases also show that IC misclassification claims are not eliminated simply by entering into a service contract with a corporate entity. In the first of the two cases against Arise in Florida, the lawsuit claimed that the corporate status of the customer service representatives were allegedly a sham to disguise Arise's alleged IC misclassification. Lawsuits for worker misclassification continue to be brought even where the worker has created a business corporation and is providing services through his or her company. Staffing companies and other businesses that enter into IC and other types of agreements with corporate entities operated by individuals are not immune from worker misclassification lawsuits. Indeed, a number of state laws and court decisions disregard the corporate form of the IC and focus on whether the business can establish that the worker meets the applicable IC test.

3. Three costly observations. First, as one can imagine by the extraordinary amount of discovery that transpired in the California case involving Arise Virtual Solutions, the legal fees incurred in defending class action-type lawsuits are extraordinary and can be even more costly, in some instances, than the damages sought or the amount of a settlement, even a 7-figure settlement as in the Arise case.

Second, client companies can suffer as well from IC misclassification lawsuits , even when they are not the primary target. In the Arise cases, the client companies were likely to have incurred or continue to incur substantial legal costs themselves and may be subject to further legal claims. Moreover, where the client company itself directs or controls the workers found to be misclassified as ICs, it may be found to be a joint employer with the staffing company or the sole employer of the workers. In either instance, client companies run the risk of joint and several liability with the staffing company, or liability on its own, for violation of labor laws or for failure to withhold taxes and pay for unemployment and workers compensation coverage. Indemnification clauses do not offer complete, or sometimes any, protection to corporate clients, especially where the staffing company does not have the financial resources to make the client whole or where the indemnification clause language favors the staffing company. In contrast, where an indemnification clause favors the client, it can create potentially sizeable exposure for a staffing company, even if it exercises little or no direction or control over the workers, if they are directed and controlled by the client company to such an extent that they may succeed in showing that they are not ICs.

Third, the unfavorable decision by the New York Unemployment Insurance Appeal Board, described above, may lead to the issuance of additional notices to that staffing company from affected state and federal agencies. The staffing company involved should not be surprised if, within the next 12 months, it receives an assessment for penalties and interest from the state unemployment office, an assessment of penalties and interest charges from the state workers compensation board, and an assessment from the state tax commissioner and/or the IRS. If the promotional workers also claim that they regularly worked more than 40 hours per week, overtime claims may also be asserted by the state or federal Labor Departments or by the workers themselves in the state or federal courts. A lawsuit may also be filed by the workers claiming they should have been covered under the employee benefit plans or fringe benefit programs of the staffing and/or client companies, now that they have now been re-characterized by the Appeal Board as employees.


As noted in our White Paper, the current regulatory landscape involving IC misclassification has become far more unfriendly to those businesses that are based on an IC-model or rely on the use of ICs to supplement their workforce. Congress has yet to pass any IC misclassification legislation despite introducing bills each year since 2007; however, in each of the last five years, more and more states have passed laws designed to curtail the misclassification of ICs. The number of states has now reached 24. The U.S. Department of Labor and IRS have joined forces in a Misclassification Initiative and by increased enforcement, while state governments have formed task forces to crack down on businesses that should, but do not, pay state payroll or unemployment taxes or fail to provide workers comp coverage for workers who qualify as "employees" under the state labor, tax, and workers comp laws.

IC misclassification liability, though, can be eliminated or minimized through IC Diagnostics" and other compliance tools that provide businesses with the means to assess and enhance their level of IC compliance. As noted in our White Paper on the subject, businesses have alternative means to minimize or eliminate exposure: restructuring, re-documentation, reclassification, or redistribution - and all but the last alternative are available to companies in the staffing industry.

Cases like those reported above in New York and California are a clarion call to those companies in the staffing industry that have yet to take meaningful steps to reduce or eliminate this manageable risk. Clients of staffing companies should likewise take heed that redistribution of their workforce to staffing companies that are not IC-compliant may not be a sound business option. Further, use of an IC-compliant staffing firm does not, by itself, eliminate IC misclassification exposure for client companies unless they, too, take steps to enhance their own IC compliance in relation to the workers referred to them by a staffing company.

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.

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Lisa B. Petkun
Andrew J. Rudolph
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