An Attack on Businesses That Refer Work to Independent Contractors

A common way in which businesses that hire independent contractors operate is via the “services referral agency” model. Under this business model, a business primarily focuses on generating contracts for certain services, and referring those contracts to a database of qualified subcontractors/independent contractors to provide some or all of the services.

Businesses choose this model because it allows them to fulfill more contracts by using independent contractors to provide the services via a fee-sharing arrangement with contractors.  Customers like this model because it is an efficient and cost-effective way to find a contractor to provide the services they need, and with reduced risk to the client. Independent contractors, themselves, like the model because, by working through the referral agency, they are often able to tap into a reliable source of contracts, without always having to drum up business on their own. In slow times, this arrangement can be a godsend. Further, by working through the referral agency which typically handles scheduling, billing, and other contract administration matters, the contractor is able to avoid some of the administrative burdens of taking on volume contracts.

The model works. Indeed, the model works for everybody. That is, everybody except for state regulatory agencies.

Over the last several years, regulatory agencies like Washington State Department of Labor & Industries (L&I) have seemed bent – often irrationally – on killing the referral agency business model. Okay, that may be exaggerating for literary effect, I readily concede. To speak more dispassionately, regulatory agencies have been consistently taking the position that contractors who provide services through a referral agency will be effectively classified as employees of that referral agency.

And they’re using their interpretation of independent contractor law to do so.

As many of you who follow this page know well, for a service provider to qualify as an independent contractor, a business needs to establish that the contractor: 1) is free from direction/control; 2) works away from the company’s place of business; 3) operates as an independently established business; 4) files taxes and business expense schedules with the IRS; 5) has UBIs and open business accounts with state agencies; 6) keeps company books and records; and 7) has valid contractor registrations (if applicable). Each part must be satisfied, and thus failing any one part results in failure of the entire test.

As relates to service referral businesses, regulatory agencies like L&I are consistently concluding that independent contractors who work for referral agencies are necessarily under the referral agencies’ direction/control, and thus fail part 1 of the test. Here, they are concluding that because the agency obtains and administers the contract, and controls payment to the contractor, it therefore necessarily controls the contractor. Regulatory agencies are further determining that because the contractor is providing services through the referral business, it is not operating as an independent business, and therefore flunks part 3 of this test. Thus it can be (and often is) the case, that a contractor is operating a truly independent business, but the moment the contractor opts to provide the services through a referral agency, the contractor will be found by L&I to be an employee of the referral business.

The approach – specifically, the generalization that every contractor who provides services through a referral business is an employee of the business – is indefensible as a matter of law. Worker classification law is designed to protect workers who are truly employees but who have been improperly classified by employers as independent contractors. It is not designed to allow regulatory agencies to disregard demonstrated independent contractor status in favor of a presumption that providing services through a referral agency automatically turns an independent contractor into an employee. If this presumption is to be credited, it would convert most independent contractors into employees simply by virtue of providing their services in a subcontractor capacity, since most work passed on to a subcontractor is referred work with payment and administration running through the prime contractor.

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