NJ Supreme Court to Employers: A Sham Paper Trail Won’t Protect You if You Misclassify Employees as Independent Contractors

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August 4, 2022 | By: Lisa I. Fried-Grodin, Esq.

The New Jersey Supreme Court has just sent a strong message to companies that try to justify classifying workers as independent contractors without a legitimate basis to do so.  The message: Don’t try to cover up an actual employment relationship by relying on a document trail designed to make a worker look like a contractor when the documents do not reflect reality.

In East By Drywall v. Department of Labor, the East by Drywall hired a combination of business entities and workers (16 in total) to do its work (installing, taping and finishing drywalling in residential homes) over a three-year period.  Once the company secured a drywall job, the Principal would look for workers and require each worker/entity to provide a certificate of insurance and tax id number to “ensure they were independent businesses”.  East Bay Drywall set the pay these workers would receive, provided them with the materials to do the work, maintained responsibility for the finished product, paid them when the job was done and issued a 1099 to each worker/entity. Most of the workers provided their own tools,  some left the project before it was finished if they got a better job, and some told the Principal they worked for other businesses (but the Principal had no actual proof that was true).

The state’s highest court found that all 16 of these employees were not independent contractors but actually misclassified as employees because despite the paper trail, East Bay Drywall did not present sufficient evidence that all of these workers/entities were actually maintaining businesses that were separate and part from East Bay Drywall.  Satisfying this requirement is one of the three requirements for establishing independent contractor status under New Jersey’s ABC test.  The essence of the ABC test is that a worker is an employee unless the individual is (A) “free from control or direction” and (B) providing service that is “outside the usual course of the business” or “performed outside of all the places of business of the enterprise for which such service is performed;” and (C) “customarily engaged in an independently established trade, occupation, profession or business.” N.J.S.A. 43:21-19(i)(6).

Because all of the business registrations showed only one individual in the ownership structure and throughout the time these individuals worked for East Bay, their business registrations and certificates of insurance were not active for the full period of work, the Court agreed with the New Jersey Department of Labor that these documents  did not show that these businesses were active independent business. That  fact combined with the fact that East Bay did not present evidence that these workers/entities had independent business locations, other customers, advertised or had employees led the Court to conclude that these entities were independent entities in name only. “A business practice that requires workers to assume the appearance of an independent business entity – a company in name only – could give rise to an inference that such a practice was intended to obscure the employer’s responsibility to remit its [unemployment] fund contributions as mandated by the state’s employee protection statutes,” Judge Jose Fuentes wrote in the opinion. “That type of subterfuge is particularly damaging in the construction context, where workers may be less likely to be familiar with the public policy protections afforded by the ABC test and consequently particularly vulnerable to the manipulation of the laws intended to protect all employees,” he said.

As a result of this misclassification, this employer owes $42,120 to the state for unpaid unemployment and temporary disability contributions.  The New Jersey Department of Labor hailed the decision as a significant victory for its enforcement efforts.

Given the  prevalence of remote work and the ambiguity of part B of the ABC test which requires that  an independent contractor perform services “outside the usual course of the business” or “outside of all the places of business”, in the Opinion, the Court suggests that the NJDOL issue regulations providing clarity  on what these terms mean.

This case highlights the point that analyzing whether or not a worker is an employee or independent contractor is fact-sensitive. Employers who get it wrong face potentially significant consequences in the form of criminal penalties and civil fines, penalties and damages.  Independent contractors cannot collect unemployment benefits, temporary disability benefits and generally have less rights than employees. An employee who is misclassified as an independent contractor will forfeit those rights if they don’t challenge their misclassification.

Fried-Grodin Employment Law  regularly helps employers and employees understand and ensure that workers are properly classified.