By Sharon Rye, Attorney
A decision from the Oregon Court of Appeals that was published on October 31, 2012 highlights the ongoing challenge faced by employers in properly classifying employees and independent contractors. In Compressed Pattern, LLC v. Employment Department Tax Section, the petitioner employer, an architectural design company called Compressed Pattern, sought review of an administrative law judge’s determination that Compressed Pattern had improperly classified an employee as an independent contractor. The individual in question provided drafting services on certain architecture projects. Compressed Pattern provided him with design specifications and general deadlines, but the drafter set his own hours. Compressed Pattern did not provide him with any office space and materials. The drafter periodically sent invoices to Compressed Pattern, who paid him at an hourly rate, and he simultaneously performed some drafting work for others besides Compressed Pattern.
As many Oregon employers know, the Employment Department has a stringent test for when an individual qualifies as an independent contractor rather than an employee. The criteria considered by the Department of Revenue is different from that utilized by the Bureau of Labor and Industries and Oregon’s Workers’ Compensation Division. According to the Employment Department, workers may be classified as independent contractors if they:
- Are free from direction and control, beyond the right of the service recipient to specify the desired result, AND
- Are licensed under ORS 671 or 701 (State Landscape Architect Board or Landscape Contractors Board and State Board of Architect Examiners or Construction Contractors Board) if licensure is required for the service, AND
- Are responsible for other licenses or certificates necessary to provide the service, AND
- Are customarily engaged in an “independently established business.”
An “independently established business,” in turn, must meet three out of the following five criteria:
- Maintain a business location that is:
a. Separate from the business or work location of the service recipient; or
b. that is in a portion of their own residence that is used primarily for business.
- Bear the risk of loss, shown by factors such as:
a. Entering into fixed price contracts;
b. Being required to correct defective work;
c. Warranting the services provided; or
d. Negotiating indemnification agreements or purchasing liability insurance, performance bonds, or errors and omissions insurance.
- Provide contracted services for two or more different persons within a 12-month period, or routinely engage in business advertising, solicitation or other marketing efforts reasonably calculated to obtain new contracts to provide similar services.
- Make a significant investment in the business through means such as:
a. Purchasing tools or equipment necessary to provide the services;
b. Paying for the premises or facilities where the services are provided; or
c. Paying for licenses, certificates or specialized training required to provide the services.
- Have the authority to hire and fire other persons to provide assistance in performing the services.
Both the Employment Department and the appellate court focused their inquiry on whether the drafter was customarily engaged in an independently established business. The court ruled that the drafter did not maintain a separate business location, despite the fact that he worked separately from Compressed Pattern’s place of business, and focused on the word “maintain.” Borrowing, for free, workspace and equipment at another company did not, the court ruled, constitute maintaining a business location. Concerning whether the drafter bore significant risk of loss, the court held that his willingness to correct mistakes for free did not mean that he would have been required to do so – he was paid an hourly fee, and had no liability insurance or performance bond. Further, the court found that there was no significant investment in the business, as drafting does not require licensing, and the drafter did not purchase or pay for the equipment that he used. Ultimately, the court agreed with the administrative law judge’s finding that Compressed Pattern improperly classified the drafter as an independent contractor.
This case demonstrates that workers who appear to be extremely independent – setting their own hours, taking discrete projects, and working from remote locations – nonetheless cannot necessarily be classified as an employee under the criteria of the Employment Department’s independent contractor test. Employers who hire workers to perform tasks that can be done without significant investment, licensing, or a permanent workspace will have particular difficulty in meeting the Employment Department’s criteria, as was demonstrated by the Compressed Pattern case. Employers should also note that changes in the way an independent contractor goes about performing his or her work could mean that an individual who previously qualified as an independent contractor no longer does. For example, an independent contractor could become an employee by borrowing rather than leasing equipment, or by ceasing to work for other companies while going back to school. Employers who use independent contractors should conduct regular audits in light of these changes and emerging case law to ensure proper classification and to avoid the heavy penalties that can result from independent contractor misclassification.