Best Practices – Time and Material Contracts – Why Time and Material Contracts Might Not Be A Viable Contracting Method in the State of California.

For this week’s article I have teamed up with a friend and colleague who is an expert in staff augmentation and contracting of contingent labor.

Paul Smith

Paul Smith is the Global Category Leader for Corporate Professional Services at IBM.  Paul is responsible for developing strategies for sourcing and procurement of contingent labor for Client’s of IBM Procurement Services.

In case you are not familiar with IBM Procurement Services, here is a link where you can learn more.

Mr. Smith has over fifteen (15) years of procurement experience focused on Contingent Workforce and Permanent Recruitment.

I asked Paul to join me this week because Assembly Bill-5 (“AB5”) (which took effect on January 1 2020) could affect the way you contract construction labor in the state of California.

Time and Material Contracts

It should not be too controversial to hear that contracting construction work on a time and material (T&M) basis is not a best practice.

Regardless, I come across Stakeholder who rationalized hourly rate contracts all the time.

They claim that schedule is their top priority and have no time to develop a scope of work. They point to years of prior engagements with “no problems” and tell me their incumbent contractor can be trusted.

Regardless of whether any those statements are true, the financial risk created by hourly rate contracts is the same.

However, I’m not an absolutist and from time to time, I do use T&M contracts, but I have always maintained that the scope and duration of such engagements should be limited.

With the introduction of AR5 the reasons for avoiding hourly rate contracts are even greater.

Assembly Bill-5

AR5 establishes stricter criteria for classifying workers as Independent Contractors.  In order to qualify as an Independent Contractor AR5 requires the employee to pass the “ABC test”.

The test states that the hiring organizations must prove the worker; (A) is free from the control typically exercised over the employee by said hiring entity; (B) performs work inessential to the hiring entities core operation, products and services; and (C) routinely does work in a recognized business, trade or occupation of the same nature as the work performed.

The consequences to mis-classifying Independent Contractors include,

  • Back taxes
  • IRS penalties
  • Back pay
  • Litigation expense & attorney fees
  • Reputation damage

Due to complaints from Companies and freelance workers (who expressed difficulty making a living under the new law) the California State Assembly is working to make the law better by exempting certain professions and contractual arrangements from the ABC test.

Many experts believe construction and specific types of trade laborers could be made exempt from AR5, but as noted by Seyfarth and Shaw in a recent Lexology article, such exceptions will be governed by the existing 30 year Borello test.

The Borello test refers to California Labor Law 2750.5 and has been the standard for determining whether a worker is an employee or an independent contractor since 1985.  The Borello Test came about from a citation made by Department of Industrial Relations against S.G. Borello & Sons.  The citation stated that migrant harvesters of cucumber crop working for Borello were employees rather than independent contractors because of the level of control they held over the harvesting of the crop.

As a result Borello requires that the contractors meet the following seven criteria:

  1. The subcontract is in writing.
  2. The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license.
  3. If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration.
  4. The subcontractor maintains a business location that is separate from the business or work location of the contractor.
  5. The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services.
  6. The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided.
  7. The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

Regardless of which test you use, the idea of “Worker Control” will remain a central determinant to worker classification.

Exactly what “Worker Control” means will likely be decided in the court system, but generally speaking, if you (or your managers) are directing the day to day duties of a consultant you could be in violation.

In the meantime as the law continues to evolve, we recommend taking the following steps to protect your organization from the commercial and reputational risks associated with AR5:

  1. Educate senior leadership on the risks and consequences associated with worker relationships
  2. Familiarize your organization with policies and procedures related to 3rd party worker types
  3. Periodically review contingent and contract worker relationships to determine if the relationship evolved into employer / employee
  4. Ensure SoWs have a clearly defined Problem Statement, outline Milestones/Deliverables and payment is contingent upon Acceptance of Milestones/Deliverables regardless of fee-structure
  5. Make it clear that workers supplied by 3rd parties are employees of the 3rd party; i.e. recognition and rewards, raises, performance evaluations, etc. must be coordinated by the 3rd party and resource, directly
  6. Ensure that language within internal policies related to Benefits stipulates 3rd party worker types may not participate in company benefit packages

Closing

Owners who insist on contracting construction and trade labor on hourly rate contracts expose themselves to needless commercial risk.  The legal implications of hourly rate contracts have always been a concern, but with these new amendments and a focus on construction labor, compliance with the law has never been more important.

Companies outside of California need to begin changing their behaviors as well.  History shows us that the state of California tends to be at the forefront of such matters, and regulations tend to migrate East and eventually we will all see similar amendments throughout the Country.

How do you use Time and Material contracts?  Have you ever had a problem with Co-employment?  Tell me your stories.

Thanks for reading.  If you enjoyed this content, please feel free to browse my previous articles and please like, share, comment, and subscribe.  This helps promote my content and is greatly appreciated.

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