Avoiding Sham Contracting in Social and Community Agencies: A Guide to Compliance
For social and community agencies in Aotearoa, managing limited government and philanthropic funding often presents tough decisions around employment. One approach that agencies may be tempted to use is hiring individuals as contractors instead of employees, especially when funding is time-limited. However, this strategy can backfire.
It risks falling into sham contracting – where workers are misclassified as contractors to avoid legal obligations and it can result in serious financial and legal repercussions. This issue has been recently highlighted in the NZ Court of Appeal decision on Uber drivers
In this blog, we consider how to avoid sham contracting including contracting best practices.
What is Sham Contracting?
Sham contracting occurs when a worker is incorrectly classified as a contractor instead of an employee, typically to avoid paying entitlements such as minimum wage, holiday pay, or sick leave. While contractors are self-employed and responsible for their own taxes, employees have more protections under the Employment Relations Act 2000 and related legislation (eg minimum wages, leave entitlements).
Why is Sham Contracting a Risk?
Misclassifying a worker as a contractor when they should be an employee is considered illegal and can result in fines, backpay, and reputational damage. It can result in severe penalties for organizations, including fines, legal fees, and reputational damage. If a worker classified as a contractor later disputes their status and is found to be an employee, the organisation may be required to backpay wages, holiday pay, and make tax adjustments.
Uber Drivers Case
The importance of correctly classifying workers was highlighted in the New Zealand Court of Appeal Uber case. In this case, the Court affirmed the Employment Court’s 2022 decision that Uber drivers should be classified as employees, not independent contractors.
The Court emphasized that employment status is determined by the nature of the relationship, not by the label used by the company. Factors such as the level of control over the worker’s tasks and the degree of economic dependence are key.
This ruling has significant implications for anyone who employs a contractor. For social and community agencies, the decision reinforces the principle that even if government funding is temporary, workers performing core tasks should not be misclassified as contractors simply to reduce costs and for funding reasons.
Key Indicators of Employment vs. Contracting
To avoid sham contracting, agencies must assess the relationship between the worker and the organisation. Various factors, are relevant, including:
Control: If the agency controls when, how, and where the work is performed, the worker is likely an employee.
Integration: If the worker is integrated into the organisation (e.g., using agency resources, working with permanent staff), they are more likely an employee.
Economic Dependency: If the worker is economically dependent on the agency and does not have the freedom to work for others, they may be classified as an employee .
Why Time-ending Doesn’t Justify Sham Contracting
It may seem logical for agencies to treat workers as contractors when funding is short-term. However, even in these cases, the nature of the working relationship remains the decisive factor. For example:
Project-Based Funding: If a project is funded for a limited time, you can still employ workers on a fixed-term employment contract. This provides flexibility while ensuring compliance with the law.
Casual Employment: Another option is to hire casual employees, who work irregular hours and are only called in when needed. This arrangement offers flexibility similar to contractors but with the protection of employment status.
Best Practices for Contracting
Understand Employment Law: Ensure you understand the difference between contractors and employees. Under the Employment Relations Act 2000 and related laws, workers classified as employees are entitled to legal protections such as paid leave, minimum wage, and KiwiSaver contributions.
Review Contracts Regularly: Ensure that any contracts reflect the true nature of the relationship. If your contractors are performing core roles or working regularly for your agency, they may be employees in practice.
Use Fixed-Term or Casual Employment Contracts: When funding is temporary, hire workers under fixed-term contracts with a clear end date tied to the funding period. This ensures compliance while giving your agency flexibility.
Obtain Advice: If unsure, get legal or HR advice. This is particularly important when engaging workers for roles essential to your service delivery, such as social workers, administrators, and frontline staff.
Step-by-Step Process to Contracting
Evaluate the Role: Determine whether the role is a core function of the agency. If the worker is performing tasks central to your mission (eg providing care, administrative duties), they are likely to be an employee.
Assess Control: Evaluate the level of control the agency has over the worker’s duties. High control usually indicates an employment relationship.
Offer a Suitable Contract: Where appropriate, offer a fixed-term or casual employment contract. Clearly state the start and end date in line with your project funding. Ensure the worker is aware of their employment status and entitlements.
Monitor and Update Agreements: Regularly review contracts and working arrangements to ensure they reflect the true relationship.
Conclusion
While government funding constraints may make contracting seem attractive, agencies must ensure they comply with employment law. Misclassifying employees as contractors can expose your agency to legal action, financial penalties, and damage to your reputation. By following best practices, including the use of fixed-term or casual contracts, agencies will steer clear of sham contracting while remaining flexible.