Introduction
Classifying employer-employee relations
Repercussions of misclassification
Determining salary for social benefits
Question of restitution
Comment
In Israel, as in many other jurisdictions, employer relations are determined based on objective criteria. A recurring maxim of Israeli labour courts states that:
[i]t is a fundamental notion that being an "employee" is nearly a matter of status, and that this status is not determined by the parties, or by any one of them, but rather by the circumstances as they stand. Thus, what governs is the substance of the relations actually forged, and not necessarily the desires of the parties.
Despite this, it has been largely left to Israel's labour courts to determine what "circumstances" and "substance" create employer-employee relations.
It has also been left to these courts to determine the civil ramifications of misclassification (ie, the event when the parties wrongly define their employment relationship as that of "contractor-client"). Quite often, this question emerges not in the context of pure exploitation, but rather when the misclassification is borne of mutual desire, with the misclassified employee receiving consideration far beyond what they would have received if properly classified.
Israeli courts have struggled to establish consistent and durable precedent in these cases, alternating between their insistence on the mandatory and "objective" nature of employment relations, and the desire to avoid benefitting those who would take advantage of this.
Classifying employer-employee relations
Interestingly, it is Israel's Tort Ordinance (New Version) of 1968 that provides the only statutory definition to the terms "employer" and "employee". The definitions are stated as follows:
- An employer, under said statute, is "a person who, in relation to another, has complete control of the way in which such other performs his work".
- An employee is defined as "a person whose work is so controlled".
Despite this, Israel's courts have rejected said definitions for the purpose of employment law and have established a different array of tests, as follows:
- First, the main test adapted by the National Israel Court has been the so-called "integration test", which examines the extent to which a person forms an integral part of the workplace.(1) Over the past decades, this test has been refined to include both a positive and negative subtest, defined below:
- A positive subtest examines whether the person is vital to the regular functioning of the workplace.
- A negative subtest examines whether the person has their own business and provides similar services to others.
In addition, other, secondary tests have been added to complement the "integration test". Such secondary tests include, among other things:
- the "method of payment test", whether the person provides invoices; and
- the "personal affinity test" (ie, whether the person can provide a substitute for services, thus forming the so-called mixed test).(2)
On rare occasions, courts may also be willing to examine the applicability of a specific labour statute in view of its object, regardless of whether the entirety of said relationship should be classified as an employment relationship.(3)
Repercussions of misclassification
In simple events of misclassification (ie, classifying an employee as a contractor), an employer will typically be required to pay the misclassified employee those employment-related rights based on the consideration that was provided to them as a contractor. Hence, for example, if misclassified employee received 50 shekels per hour (approximately £12) for "services", an employer will be required pay, on-top of this wage, such benefits as:
- pension;
- severance contributions;
- annual leave; and
- recuperation pay.
However, a more difficult question arises when the employer or engaging party claims that the so-called "employee" received a higher fee as a contractor than they would otherwise have received as an employee. In such cases, an employer will typically demand restitution of this surplus sum so that it can be offset against those social rights that they are now obligated to pay.
This, in fact, involves two separate claims:
- that the salary of the misclassified employer should be set at a lower rate for the purpose of calculating social benefits (eg, pension contributions and vacation days); and
- that these benefits should be offset by the surplus consideration paid to the employee due to their misclassification.
These two claims can be examined separately.
Determining salary for social benefits
With respect to the determination of the hypothetical salary that ought to be applied for the purpose of payment of various social benefits, Israeli courts have gradually accepted the notion that an employer may provide evidence that, were the misclassified employee properly classified, they would receive a lower salary. The burden rests on the employer to prove such a claim and, if successful, social benefits will be calculated based on this "adapted" salary.
Evidence can take the form of the earnings of other employees performing similar roles in the workplace, correspondences between the parties calculating the fee based on an alternative salary, or any other data deemed relevant by the court.
Likewise, in Dr Binyamin Gidron v the State of Israel,(4) the National Labor Court ruled that parties were free to establish a personal wage above legal requirements under labour laws and at the same time agree that, should their relationship be found to be one of "employment", regular labour wages (according to a collective bargaining agreement) apply.
Accordingly, to this day, many workplaces in Israel request that contractors sign a so-called "Gidron Clauses" that establish an alternative salary, should it be determined that employment relationships exist between the two. Despite this, it is unlikely that this clause alone will serve as sufficient evidence to establish an alternative salary.
Assuming an employer has "cleared the hurdle" of establishing a lower alternative salary, the question then emerges: can they claim restitution of the sums paid in excess of the alternative salary? And can this be used to offset the social benefits they are now required to pay the misclassified employee?
These questions have often polarised Israel's National Labor Court, with precedents frequently changing. Whereas some justices have sought to deter employers by denying them restitution,(5) others have emphasised the injustice this may cause.
Recently after a series of rulings that were repeatedly overturned, Israel's National Labor Court attempted to "turn a new leaf" and establish clear rules on the matter. In Gabriel Kuta v the State of Israel,(6) the Ministry of Justice the court ruled the following:
- A distinction is to be drawn between monetary and non-monetary compensation.
- With respect to monetary compensation, restitution shall always apply. If an employer has been able to demonstrate an alternative lower salary, the hypothetical salary cost will be compared to what was in fact paid to the misclassified employee. In the event of a gap in favour of the employee, the employer will be required to pay the gap.
- However, in cases of misclassification, non-monetary compensation may be awarded to the misclassified employee due to their loss of intangible employment rights (eg, right to unionise and gain tenure).
- To establish whether (and to what extent) it is appropriate to award such non-monetary damages, courts should consider, among other things:
- the bad faith of each party;
- who dictated or initiated the misclassification;
- the compensation paid to the misclassified employee; and
- the market context.
Accordingly, in Kuta the court embraced a pure "computational" approach, whereby the question of misclassification is largely arithmetic (did the misclassified employee receive less compensation because of the misclassification?). At the same time, the court adopted a means of deterrent in the form of non-monetary compensation.
As has been demonstrated above, despite recent misclassification case law being perhaps more "pro-employer", this practice still carries significant risks and is better avoided.
In view of the above, it is recommended that employers seek legal advice when facing any uncertainty regarding the correct classification of any service provider.
For further information on this topic please contact Shlomo Kaplan at Efrat Deutsch & Co by telephone (+972-3-6096960)or email ([email protected]). The Efrat Deutsch & Co website can be accessed at www.edz-law.co.il.
Endnotes
(1) This test was first established in Hearing (National) 3-27 the City of Netanya v David Birger CR" LC(1) 1977.
(2) This was primarily established in HCJ 5168-93 Shmuel Mor v National Labor Court CR 50(4) 628.
(3) AHCJ 4601-95 Chai Yosef Sarusi v National Labor Court, CR 52(4) 817.
(4) HLC 46/3-128, 15 June 1987.
(5) For example, LA 110-10 (National) Rafi Rofeh v Markam Insurance Agency Ltd 12 December 2011.
(6) LA 15868-04-18, 7 April 2021.