The High Court has overturned a decision of the Federal Court which allowed employers to avoid prosecution for sham contracting where the “employee” was engaged as an independent contractor through a labour hire provider.

Federal Court decision

The High Court decision was an appeal of the full Federal Court decision in Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] FCAFC 37.  In this matter, Quest dismissed some of its cleaning staff who were then engaged by Contracting Solutions as independent contractors.  Contracting Solutions then entered into a labour hire arrangement with Quest in which Contracting Solutions agreed to provide independent contractors to Quest (being Quest’s ex-employees).

In that decision, the full Federal Court found that Quest, by its conduct, represented to the workers that they were performing work for Quest as independent contractors for Contracting Solutions.  However, the Court also found that the workers were not operating a business and therefore neither was actually an independent contractor. 

As a result, the question remained what kind of contract was in place between the parties.  No party to the matter argued that the workers were employees of Contracting Solutions.  Therefore, the Court found that there was an implied contract of employment between the workers and Quest which was supported by a multifactorial analysis which revealed the common hallmarks of an employment relationship between Quest and each of the workers. 

Breach of Sham Provisions?

Section 357 provides that an employer that employs an individual must not represent to the individual that the contract of employment under which the individual is employed by the employer is a contract for services under which the individual would perform work as an independent contractor.

The Court found that Quest had not breached the sham contracting provision in s357 because the relevant representation had to be made by the party actually engaging the individual as an independent contractor.  In this case, although Quest made the representation, it was Contracting Solutions that actually engaged the workers.

High Court decision

The High Court disagreed with the reasoning of the Federal Court and found that Quest had breached the sham contracting provisions in section 357.  It did not matter that Quest had not sought to engage the workers directly as independent contractors.

The High Court found that to confine the prohibition in section 357 to a representation that the contract under which the employee performs work as an independent contractor is a contract for services with the employer would limit the section’s ability to achieve its purpose.  That purpose is to protect individuals, who are in truth employees, from being misled by the employer about their employment status.

The Court found that to confine the operation of section 357 as suggested by the Federal Court would mean that “An employer would be liable to pecuniary penalty if the employer said to an employee ‘you are employed by me as an independent contractor’.  The same employer would act with impunity if the employer said to the employee ‘you are employed by X as an independent contractor’.”

Key Points

The key point to learn from this decision is that if a company engages independent contractors who are in fact employees, the company may face prosecution under the sham contracting provisions.  This is the case whether the individual is:

  • engaged as an individual (eg. as a sole trader);
  • engaged via a labour hire company; or
  • engaged via an incorporated entity (eg. sole director company).

In addition, a finding that a contractor is in fact an employee will also have repercussions in respect of compliance with other employment laws and entitlements.  Potential risks include underpayments under applicable awards (including for a failure to provide annual leave), superannuation and tax liabilities, under-insurance (eg. failure to take out workers compensation insurance), and the threat of prosecution of directors or managers in their personal capacities under the accessorial liability provisions.

We highly recommend that all companies review any independent contractor relationships to determine whether or not the contractors are in fact employees and therefore whether there is a potential basis for prosecution for sham contracting.