Sham Contracting: Beware Of The Risks

Some companies attempt to categorise employees as independent contractors to obtain the various benefits of the contracting relationship, while maintaining the benefits of employment.

A recent case has once again highlighted employers cannot engage in sham contracting to avoid employee entitlements. Importantly, independent contractors run their own business and work for themselves.

The case

The employer, Metro, operated a homewares sales business. It hired four employees for short periods. The employees approached the public in shopping centres and obtained their details to conduct in home cookware demonstrations.

The employer contracted them as independent contractors, not as sales persons under the Commercial Sales Award 2010. They were paid commission only. The employer underpaid minimum rates of pay, failed to make any payments of overtime and failed to pay a vehicle allowance. Metro failed to pay annual leave as well. They were paid something between 88c to $6.37/hour. They were enticed to believe they were employees, but then lured into signing documents that provided for payment by commission.

The arrangement allowed Metro to maintain effective control over the working conditions and work of the employees. They had to follow the employer’s sales program closely and their job descriptions followed the language of employment. The employees were awarded $10,000 between them. The employer failed to pay.

The issue

The Fair Work Act 2009 prohibits sham contracting, that is, an employer cannot misrepresent to an individual the contract of employment is actually an independent contract.

A defence is available to an employer if they a, did not know, and b, was not reckless as to whether the contract was a contract of employment or a contract for service.

In Australian Building & Construction Commissioner v Inner Strength Steel Fixing Proprietary Limited the Federal Court of Australia said:

The establishment of unlawful sham contracting arrangements is objectively serious. Sham contracting, by its nature, provides a company with an unfair advantage over its competitors in that the company’s operating expenses are unlawfully reduced, making it more competitive against its rivals and providing increased company revenue.

In this case, not only were the employees disadvantaged, but Metro was able to profit from the fact that it did not meet the range of entitlements owed during this period of time. This can be contrasted with the position of employers properly meeting their obligations.

In Darlaston v Risetop Construction Pty Ltd & Ors, a consequence of sham-contracting and misclassification of employees as independent contractors means they are deprived of the basic protections provided for ordinary Australian employees, such as superannuation and deduction of taxation payments. There are also consequences that, “cannot be measured in monetary terms”, reflecting for example the fact that “a contractor does not have recourse to sick leave and may be more likely to work when not well”.

The court found Metro breached the sham contracting provisions of the Act in that it misrepresented to the four employees their contracts of employment were contracts for service under which they would perform work as independent contractors. Metro did not establish it was not reckless in the sense provided for in s.357(2) of the Act. It was not able to establish an absence of recklessness.

While the director said he did not “know” the real relationship was one of employer and employee, he disregarded the risk the complainants were employees in reliance on the label of “independent agent” applied in the Metro contractual documents. He did so in circumstances where the contractual documents were confusing and unclear. Moreover, in practice he treated the complainants as employees, despite being aware of the need to make a clear distinction between employees and independent contractors. Metro acted in a manner that was careless or incautious as to whether the contracts with the complainants were contracts of employment or not.

The director was not able to demonstrate he took all reasonable steps to ensure Metro was not reckless in the representation it made. Rather, he disregarded the risk that they were misclassified.

The employees took the work because it was a low income, high unemployment area. It is also relevant that the work the complainants performed for Metro was relatively low-skilled sales work. They appeared to have been drawn to the positions because of the offer of good pay and flexible hours. They were given a very limited opportunity to read and/or obtain legal advice on the documents they signed. They were at a clear disadvantage when negotiating terms of their employment.

Metro hoped and intended to avoid financial liability to the employees by characterising them as independent contractors so they would only be paid per sale.

The outcome

The penalty amounted to $161,700. Part of the reason for the large fine was Metro’s failure to appear at the penalty hearing, which demonstrated its attitude to the proceedings, lack of co-operation and contrition.

The court said a penalty should be imposed at a meaningful level even where a company is small or in financial difficulties.

The court had regard to the need to ensure compliance with minimum standards. The employer’s high level of recklessness was seen as a disregard for its statutory obligations.

Specific deterrence was also of relevance and significance in this case. The Magistrate was very concerned the director was possibly running other companies and the risk of reoffending was high.

Take out for employers

The message to employers is there are large fines for miscategorising employees as contractors. Contractors run their own business. To engage an individual on that basis will mean a business does significant research and obtains legal advice before this arrangement is entered into.


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