Posted by Liz Greene
It’s easy to get bogged down in the details of 1099 reclassification risk. This is a complex topic, and there is a lot to learn about what you have to do to use independent contractors. Sometimes, however, the minutiae of contractor classification fade for just a moment into the background, and the essence boils down to a far simpler, perhaps more enlightened directive: don’t hate.
To explain what I mean, for today’s installment of the 1099 Risk Blog I’d like to highlight the recent Baby Trend misclassification and wrongful termination case. You may be familiar with the story: a California superior court entered an $8.4 million jury verdict against Baby Trend Inc. and the owner, Denny Tsai, for misclassifying and wrongfully terminating Robert Gardner, an individual, top-performing sales representative. After legal fees, the consequences for Denny Tsai and Baby Trend are estimated to exceed $10 million.
This may be the most expensive misclassification case on record for a single employee.
Before you start to get misty-eyed on behalf of Baby Trend, it’s important to know that this wasn’t an overzealous court going after big pockets. Although California is known for rigorously enforcing proper independent contractor classification, and the state presumes employee status, in this case, the jury found by clear and convincing evidence that Baby Trend and Denny Tsai acted with malice, oppression, and fraud.
According to this press release, the $8.4 million judgment is based upon the Court's determination that Baby Trend engaged in unfair business practices in violation of California law and the jury's Special Verdict finding that Baby Trend (1) wrongfully discharged Gardner in violation of public policy, (2) failed to reimburse Gardner for expenses benefiting Baby Trend, (3) made wrongful deductions from Gardner's compensation in violation of California law, (4) breached the contract between Gardner and Baby Trend in the process, and (5) defrauded Gardner.
It is possible that if Baby Trend and Tsai had only acted in good faith and paid Gardner the agreed commissions, the fact of misclassification would never have become a painful issue. It seems that malice may be the downfall of the company, and there are unconfirmed reports that they are headed toward bankruptcy.
Our recent independent contractor compliance webcast with attorney Eric Rumbaugh highlighted two important points on contractor risk, and both are painted in living color now with the Baby Trend case. The first is that big misclassification cases almost never start with an IRS audit; rather, the audits arise from disgruntled or injured workers who are unhappy about being terminated and file for unemployment, are shorted on payments, are injured on the job and discover there is no worker’s comp coverage, are denied rich benefit plans that co-workers can access, and/or are otherwise mistreated and seek legal assistance.
The second important point is that any tax reclassification settlement with the IRS typically represents only the “tip of the iceberg” when the total financial damages of a major reclassification case are considered. Both of these points are borne out with the Baby Trends case: 1) the lawsuit was triggered because Gardner wasn’t paid as agreed and then was wrongfully fired for questioning the commissions, and 2) the price tag -- so far-- does not include any State or Federal back taxes or penalties that Baby Trends may have to pay.
If you’re wondering, “What’s my takeaway?” let me be so cavalier as to sum up a two step plan of action for mitigating the risk of IC reclassification and associated problems.
1. Classify workers properly. This is complex, sure, but it isn’t rocket science. If you aren’t confident in your expertise in the state and federal nuances of worker classification, there are companies that focus on independent contractor compliance and proper engagement – talk with an Independent Contractor Engagement Specialist (ICES). A preliminary consultation about your business situation probably won’t cost anything. Say yes to the free education, and then take appropriate action in your organization. Quickly.
2. Don’t hate. Don’t harass, oppress, discriminate, or wrongfully terminate. Don’t exercise malice and greed. Don’t hate the fact that you should cover everyone with worker’s compensation – just do it. Don’t defraud people who perform work for you – pay them what you have agreed to pay them. Don’t hate paying payroll taxes, and don't try to force employees into independent contractor status who don’t belong there.
If you follow these two fundamental steps, you should be on a good path. Make sure you or your compliance vendor (Independent Contractor Engagement Specialist or ICES) is providing a rich benefit plan to everyone performing services for your company. Choose a program that keeps contractors happy, yes genuinely happy, so that they have no impetus to file suit against you.
The public record of the Baby Trend case is available here if you accept the TOU and enter case number 05CC11681.
More info about the case. According to the July 14th BNA report,
Gardner had an agreement with Baby Trend that paid him a commission on all sales to major retailers Toys R’ Us and Babies R’ Us, but at a certain point, Baby Trend began “shorting” him on his commissions, Young said. After Gardner complained, the company ordered him to attend a June 30, 2005, meeting, which he said he could not make, Young added. He then was fired from his job. The company argued that because Gardner was an independent contractor, it could deduct whatever it wanted from his commissions, but under California labor law, the determination of whether a worker is an independent contractor or an employee largely turns on the measure of control the employer has over that worker, Young said.
The jury had been convinced that by ordering Gardner to the June 30 meeting, and then firing him when he could not attend, Baby Trend had sufficient control to classify Gardner as an employee, Young said. The judgment assessed $6.9 million in damages jointly against Baby Trend and its owner, including economic damages of $5.1 million, lost earnings of $1.5 million, and mental suffering of $275,000; and another $1.5 million against Baby Trend, including failure to reimburse, $1.0 million; waiting time, $165,231; and breach of contract, $306,137. The jury also found that Baby Trend and its owner acted with malice, oppression and fraud, but the jury then deadlocked on punitive damages, Young said. However, motions for attorneys’ fees and costs, and supplemental penalties, could push the judgment to more than $10 million, he said in a July 7 statement.
The jury had been convinced that by ordering Gardner to the June 30 meeting, and then firing him when he could not attend, Baby Trend had sufficient control to classify Gardner as an employee, Young said. The judgment assessed $6.9 million in damages jointly against Baby Trend and its owner, including economic damages of $5.1 million, lost earnings of $1.5 million, and mental suffering of $275,000; and another $1.5 million against Baby Trend, including failure to reimburse, $1.0 million; waiting time, $165,231; and breach of contract, $306,137. The jury also found that Baby Trend and its owner acted with malice, oppression and fraud, but the jury then deadlocked on punitive damages, Young said. However, motions for attorneys’ fees and costs, and supplemental penalties, could push the judgment to more than $10 million, he said in a July 7 statement.
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