Subcontractor or Employee? Misclassification Under the Construction Industry Fair Play Act

October 23, 2020

Construction hard hat

Subcontracting is fundamental to the construction industry. Few if any general contractors self-perform (with their own employees) all the work necessary to construct a building, a road or a bridge. Instead GCs and other prime contractors subcontract substantial work to other companies or self-employed persons who have the necessary skills in a particular trade or service, such as masonry or steel erecting or plumbing or roofing.  In fact, subs will oftentimes further subcontract parts of their work to others. But under current law in New York, those who subcontract with persons who are self-employed, or with contractors that are economically disadvantaged, may find themselves facing a subcontractor misclassification claim from the State Department of Labor.

It might be said that every worker on a construction project performs a service for the general (or other prime) contractor, in the sense that each performs work for which the GC or other prime is contractually obligated.  But historically that “prime” contractor is not responsible for assuring that all workers are paid proper wages, that payroll taxes for all workers are remitted, or that all workers are insured for workers’ compensation and unemployment benefits. Those obligations fell, in the past, to each worker’s employer, or to the worker himself when he is self-employed.  But there have been too many occasions where contractors have misclassified their employees as “subcontractors” so as to avoid paying the wages, taxes and benefits associated with “employment.”

To address this problem, in 2010 New York lawmakers passed the Construction Industry Fair Play Act, which created a legal presumption that everyone working on a construction project is the “employee” of each contractor “above” her, absent proof either that she meets all the statutory elements of self-employment under a so-called “ABC test,” or that she worked for a “separate business entity” as determined by the State Departments of Labor using a strict 12-point checklist. Under either test, contractors have become legally responsible as “employer” for workers that they hadn’t previously been responsible for, and for monetary penalties for subcontractor misclassification.

The “ABC” test for self-employment is specifically designed to protect the individual worker whom a contractor has misclassified as a subcontractor rather than an employee, in order to avoid the costs associated with formal employment. The “ABC” test certainly captures those cases. But it also creates liability in otherwise legitimate subcontracting situations.

Before 2010 a contractor could not lawfully treat a worker as a sub if the contractor exercised control over the means and methods that the worker used to achieve a particular result.  By exercising such control, the contractor made that worker its employee. This was the consequence regardless of whether the worker was supposedly self-employed or was “employed” by another company that was effectively absent from the job. The “ABC” test starts with this same rule, directing that a construction worker may not lawfully be classified as a subcontractor unless he or she was (A) “free from control and direction” by the contractor, both contractually and “in fact.” But it also requires (B) that the worker be performing services that are “outside” the contractor’s “usual course of business,” and (C) that those services be the work of an established trade that the worker “is customarily engaged in.”  Under the Act as interpreted by the Department of Labor, an individual worker may be treated as a subcontractor rather than an employee only if all three of these requirements are met and only if there is a written subcontract agreement confirming that arrangement.

The requirement that all three “ABC” criteria be met to establish self-employment certainly makes it easier for the Labor Department to punish historic subcontractor misclassification. But it also effectively eliminates subcontracting opportunities for self-employed individuals who engage in work that might be regarded as within the contractor’s “usual course of business,” whatever that means. It likewise strangles opportunity for self-employed persons whose business – for example cleaning – may not be regarded by the Labor Department as an established trade or profession.  Meanwhile, from the contractors’ point of view, the “ABC” test is at least clear enough to enable them to avoid unexpected employer liability and fines for misclassification, by limiting their engagement of self-employed individuals, even if at the expense of entire classes of would-be entrepreneurs.

There is no such clarity, however, in the alternative 12-prong test that the Construction Industry Fair Play Act applies to determine whether a subcontractor is a “separate business entity” from the contractor that would engage it. As explained, the application of this test can only limit opportunities for small or start-up businesses, particularly those that may be hamstrung by social or economic disadvantage.

Generally, it had always been true that a contractor was not responsible for the wages or benefits owed to its subcontractors’ employees, as long as those subcontractors were sufficiently independent of the contractor in controlling their employees, and especially the means and methods they employed in performing the subcontracted work. But under the Fair Play Act’s “separate business entity” test this “control” factor is only the first of at least 15 requirements (some prongs have multiple requirements) that must be met if the hiring contractor is to avoid becoming the “employer” of its subcontractor’s employees.

Some of the additional conditions seem reasonable enough: Like the requirements that the would-be subcontractor not depend on the contractor for its existence, that it do business with the contractor in its own name and not hold its people out as employees of the contractor, that it controls its own gains and bears its own losses, that it makes its services available generally in the marketplace on whatever terms it choses, and that it holds whatever license its services require.

But some mandatory criteria are virtually unknowable to a non-controlling contractor, like whether the sub reports its services on Federal tax returns as those of an independent entity, or whether it reports its employees’ incomes to the IRS. If the subcontracting business fails in either of these obligations its workers can become the responsibility of the prime contractor who engaged it.

Other conditions on the checklist discriminate against small businesses that are economically disadvantaged. These include requirements that the sub furnish its own tools and equipment, that it have “a substantial investment of capital .  .  . beyond ordinary tools and equipment and a personal vehicle,” and that it pay its employees “without reimbursement from the contractor.” A prime contractor that assists an otherwise bona fide small business with this kind of help also makes itself responsible for that subcontractor’s wage and withholding obligations, and for the sub’s employment-related insurances, not to mention a potential fine to the Department of Labor for “subcontractor misclassification.”

It’s difficult to determine what the full impacts of the Construction Industry Fair Play Act have been over the past ten years. The reported cases applying it — mostly from the Labor Department’s Unemployment Appeals Board – have shown that its hurdles are difficult for an accused contractor to overcome.  But there is no way to know what effect it has had in reducing opportunity for entrepreneurial individuals and financially disadvantaged businesses.

Authored by Anthony J. Adams, Jr., a founding partner of Adams Leclair. His practice has focused on commercial litigation and all aspects of construction law, including public contracts, private contract negotiation, claims, labor relations, risk management and other general business matters.

Sign-Up for Our Newsletter

Receive timely updates on important legal matters relevant to your industry.

  • This field is for validation purposes and should be left unchanged.