Governor Signs Law that Imposes Strict Standards, Substantial Fines and Criminal Penalties

On October 13, 2010, Gov. Edward G. Rendell signed the Construction Workplace Misclassification Act, making Pennsylvania the latest in a growing number of states to target an industry where misclassification of employees as independent contractors is believed to be most prevalent.

Strict Standards for Independent Contractors in the Construction Industry

The law, which takes effect 120 days following enactment, creates a strict definition of “independent contractor.” No individual can be classified as an independent contractor unless he/she:

A. has a written contract to perform services with the construction industry business,

B. is free from control or direction over the performance of such services under the contract and in fact, and

C. is customarily engaged in an independently established trade, occupation, profession or business.

This type of three-part standard is commonly called an “ABC” test – but the Pennsylvania standard is less onerous than the “ABC” laws governing independent contractors in the construction industry in New Jersey and New York.

The new law contains a six-criteria requirement to satisfy the third prong of the “ABC” test. Under this “ABC-6” standard, an individual is only “customarily engaged in an independently established trade, occupation, profession or business” with respect to services performed in the construction industry if all six of the following criteria are met:

  • the individual must possess the essential tools to perform the services independent of the business for which the services are performed
  • under the individual’s arrangement with the business, the contractor must realize a profit or suffer a loss
  • the worker must have a proprietary interest in his/her business
  • he/she must have a business location separate from the company for whom the services are being performed
  • the individual must have previously performed the same services for another person, or “holds himself out to other persons as available and able, and in fact is available and able, to perform the same or similar services,” and
  • the contractor must maintain liability insurance during the term of the contract of at least $50,000.

Violations and Penalties

Section 4 of the new law provides that a company or its “officer or agent” is in violation of the Act if the business “fails to properly classify” an individual as an employee under the Pennsylvania Workers Compensation Act or Unemployment Compensation Act or fails to provide coverage or make contributions on behalf of an individual who should be classified as an “employee” under those laws.

Each individual misclassified by an employer is a separate violation of the law. Therefore, construction industry businesses that retain a significant number of independent contractors will face substantial liability for misclassification in Pennsylvania.

Violations are enforced in a variety of ways. The Pennsylvania Secretary of Labor may seek a stop-work order from a court, assess penalties of up to $1,000 for the first violation and up to $2,500 for each subsequent violation, and/or refer intentional or negligent violations of the Act to the Attorney General for criminal prosecution. An intentional violation of the law is a criminal misdemeanor; a negligent misclassification is a criminal summary offense.

Other Provisions of the New Law

The law includes what appear to be two groundbreaking provisions. First, in an effort to avoid the imposition of penalties for mistaken misclassifications, the new law provides that it “shall be a defense to an alleged violation of this Section [4] if the person for whom the services are performed in good faith believed that the individual who performed the services qualified as an independent contractor at the time the services were performed.”

Second, the law provides that a party that does not meet the definition of employer but “intentionally contracts with an employer knowing the employer intends to misclassify employees” is subject to the same penalties and remedies as an employer found to be in violation of the new law. This provision may cover employment agencies and other providers of labor for the construction industry.

Another unusual provision of the law is a section that makes it a violation of the Act for a business to require or demand that an individual enter into an agreement or sign a document which results in the improper classification of that individual as an independent contractor. It is unclear if the “good faith” defense applies to this provision of the law. If not, merely directing a worker to sign a Form W-9 (Request for Taxpayer Identification Number and Certification), which the IRS requires businesses to obtain from independent contractors, could be a violation of the law, even if the business mistakenly believes the individual is an independent contractor. Hopefully, the new law will not be enforced in that manner.

The law includes a non-retaliation provision. Retaliation is prohibited against any person who exercises rights under the law, including the right to file a complaint or inform another about an employer’s noncompliance with the Act.

Finally, the law provides that the Pennsylvania Labor Department shall create a poster for job sites and make the poster available on its Web site. The Act seems to have overlooked the typical statutory language that employers in the construction industry must post a copy of the Labor Department’s notice.

Steps to Ensure Compliance

In advance of the effective date, construction industry businesses that engage independent contractors should take action to ensure compliance with the law. Steps to be taken may include the following:

  • conducting an internal audit to determine how many individuals are retained as independent contractors
  • reviewing business agreements, records, and actual practices relating to the “ABC-6” factors
  • restructuring the parties’ agreements and relationships in a bona fide manner including actual practices in the field to ensure that current, legitimate independent contractor relationships, which may be capable of withstanding even greater scrutiny under the restrictive tests in the new law, can be maintained and will not be stricken down and penalized
  • reclassify workers and groups of workers previously classified as independent contractors, including those who would otherwise qualify as such under the common law test, if they cannot survive the “ABC-6” test, even after a bona fide restructuring
  • ensure that any reclassified workers as well as existing employees are reported to Unemployment Compensation and covered by the company’s Workers’ Compensation policy, and that income taxes are withheld and payroll taxes are reported and paid to federal, state and any applicable local government tax agency.

Members of Pepper Hamilton’s Independent Contractor Compliance Practice Group and Construction Practice Group can assist with these and other compliance measures for businesses in the construction industry in Pennsylvania.

Conclusion

Pennsylvania has joined 16 other states that have enacted legislation in the past three years seeking to curtail misclassification of employees as independent contractors in a particular industry or in all industries. The laws in those states (as well as Massachusetts, which has had an independent contractor law since 1992), can be found at http://independentcontractorcompliance.com/legal-resources/state-ic-laws-and-selected-bills/. There also are two pending federal bills addressing independent contractor misclassification (the Employee Misclassification Prevention Act and the Fair Playing Field Act of 2010), which can be found at http://independentcontractorcompliance.com/legal-resources/federal-ic-laws-and-bills/.