How do I work with contractors?

First, determine whether a person should be retained as a contractor or an employee in light of the applicable laws. Misclassifying workers as contractors can subject companies to substantial liability under wage and hour as well as tax laws.

For example, California’s Labor Code makes it unlawful to willfully misclassify a worker as a contractor and imposes penalties for doing so—and in some situations, it can subject directors and officers at the company to personal liability. For a more detailed explanation of the potential legal risks and significant penalties associated with worker classification, please refer to FAQ “What are the risks of misclassifying a person as an employee versus a contractor?” or consult with an employment or trade secrets attorney.

Assuming the company decides to retain an independent contractor, there are reporting obligations, tax formalities, and additional precautions the company should take while working with independent contractors.

• Enter into a consulting agreement. Best practice is for the company and independent contractor to enter into a consulting agreement that defines the relationship. The consulting agreement should make clear that the consultant is not an employee. It should also provide the company with confidentiality and invention assignment protections. The consulting agreement is also a great place to limit liability and provide protections for the company, such as an arbitration provision. Due to the legal complexities and potential misclassification liabilities, the company should consult with any member of the employment or trade secrets litigation practices at WSGR to assist in drafting consulting agreements.
• Do not treat the contractor as an employee. Companies should limit the amount of control over the contractor and the contractor’s services to the company. Avoid situations where employees and contractors are in direct supervisor-subordinate relationships, and avoid situations where employees and contractors are performing the same function. Contractors should ideally carry their own insurance, and they should be in business for themselves. Contracting with a corporation is typically better than contracting with an individual. Contractors should also be allowed to sub-contract the work for which they were retained.
• Remember that a state’s anti-discrimination laws may still apply to the contractor.
• Reporting Obligations. A company retaining an independent contractor in California MUST report the relationship to the Employment Development Department. The required report may be found here. Check with an employment law attorney for reporting requirements in other states.
• The company and the independent contractor should observe tax formalities. The company should require independent contractors to take responsibility, in writing, for paying all applicable taxes. The company should issue Form 1099s to all contractors.

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