By Kai Denton and Abraham Ash, Australian Business Lawyers & Advisors
Engaging independent contractors is a common and legitimate way to run a business. However, when a contractor arrangement does not reflect the reality of the working relationship, it can expose employers to significant legal risk.
There are two risks employers must understand:
- Sham contracting – which occurs when an employer misrepresents to a worker that an employment relationship is an independent contracting arrangement when the employer does not reasonably believe this; and
- Misclassification – where a worker is incorrectly and mistakenly classified as a contractor when they are actually an employee.
Understanding this distinction is critical. Getting it wrong can result in liability for employee entitlements, and in some cases, contraventions of the Fair Work Act 2009 (Cth) that attract civil penalties.
What is sham contracting?
Under the Fair Work Act 2009 (Cth) (the Act) (sections 357-359), it is unlawful:
- to misrepresent an employment relationship as an independent contracting arrangement;
- to dismiss or threaten to dismiss an employee to re-engage them as a contractor to perform the same work; or
- to knowingly make false statements to persuade someone to become a contractor to perform the same work.
Sham contracting therefore involves more than simply getting the classification wrong. It is concerned with how the arrangement is represented or brought about, including whether there has been misrepresentation, recklessness, or coercion by the employer to induce a contractor arrangement for what is, in substance, an employment relationship.
Importantly, these provisions do not capture mere mistakes. A contravention will only arise where the employer lacks a reasonable basis for characterising the relationship as independent contracting. Section 357(2) provides a corresponding defence where an employer can establish a reasonable belief that the worker was an independent contractor.
Misclassification – the underlying risk
Employers also face risk where an independent contractor arrangement mistakenly or inaccurately reflects the reality of the working relationship.
Importantly, the true nature of the working relationship in practice will be assessed by courts and regulators, not solely the terms of the contract.
Section 15AA of the Act provides that determining whether a worker is an employee or contractor requires an assessment of the “real substance, practical reality, and true nature of the relationship.”
This means that even where a written contract describes a worker as an “independent contractor”, that label will not be determinative if the day-to-day working relationship reflects employment. This may include circumstances where an individual:
- performs work under the direction and control of an employer, including in respect of how, when, and where the work is performed
- is integrated into the operations of the business, rather than operating an independent business of their own
- performs work that is ongoing or forms a core part of the business activities, or
- is remunerated in a manner more consistent with payment for time worked, rather than payment for the achievement of a particular result.
Importantly, misclassification can occur inadvertently and in good faith, without any intention to misrepresent or avoid employment obligations.
Why this distinction matters
If a contractor arrangement is found to be misclassified or to constitute sham contracting, the consequences can be significant and often apply retrospectively.
In either case, employers may be exposed to:
- unpaid entitlements
- back-pay of wages and superannuation claims, and
- unfair dismissal applications.
Where sham contracting is established, courts can also impose civil penalties against both employers and individuals. The maximum penalties that can be applied for each contravention are:
- $19,800 for individuals;
- $99,000 for businesses with fewer than 15 employees; and
- $495,000 for businesses with more than 15 employees.
Each breach can be treated separately. This means penalties can increase quickly if there are multiple workers or ongoing conduct.
How employers can assess whether a worker is truly a contractor
There is no single test that can assess if a worker is truly a contractor. Courts consider the real substance, practical reality, and true nature of the relationship, as opposed to a contractual label.
The following indicators may be considered:
Level of control and direction
Where a working arrangement prescribes detailed requirements about duties, standards of conduct, safety procedures, and how work must be carried out, this points toward an employment relationship.
For example:
- work schedules are set or approved by the business
- changes to hours or duties require approval, or
- the worker is expected to follow internal policies and directions.
Independent contractors typically retain greater control over how work is performed.
Integration into the business
Is the worker operating independently and running their own business, or as part of the employer’s business?
Where a worker is performing tasks that are central to the business’s core operations, this may indicate they are part of the business rather than operating independently.
Indicators of integration can include:
- performing the same or similar work as employees;
- being presented as part of the business to clients or customers, such as wearing business uniform;
- representing the business in dealings with third parties; or
- being described as part of the “team” or “business”.
Tools and equipment
Employees are generally provided with everything they need, such as:
- equipment and tools
- access to internal systems, or
- uniforms or branded materials.
Independent contractors, on the other hand, are more likely to supply and maintain their own equipment and resources.
Remuneration structure
How is the worker paid, and what are they being paid for?
Where a worker is paid:
- a fixed hourly or sessional rate
- on a regular and ongoing basis. or
- for their time and labour rather than a defined outcome,
this can indicate the arrangement is for the provision of personal labour, which is more characteristic of employment than independent contracting.
In contrast, independent contractors are more likely to be engaged to achieve a specific result, and their payment structure may reflect that (for example, quoting for a job or being paid per project).
Ongoing and indefinite
Is the arrangement project-based, or ongoing?
Where a worker is engaged on an ongoing basis without a clear end point, and continues to perform work as part of the business over time, this can suggest an employment relationship.
Independent contracting arrangements are more commonly:
- time-limited;
- project-based; or
- linked to a defined scope of work.
An indefinite, ongoing arrangement that looks like regular employment carries a higher level of risk.
Common situations that create risk
Employers should be aware that sham contracting often arises in situations such as, but not limited to:
- long-term “contractors” working exclusively for one business
- workers performing the same role as employees on the same terms
- changing an employee to a contractor without changing how the work is performed, and
- relying on a written contract that does not reflect reality.
These scenarios may reflect misclassification, and depending on the intention of the employer, may also raise sham contracting concerns.
How can employers mitigate their risk?
A proactive approach is essential. Employers should:
- review the actual substance of working relationships, not just the written agreement
- avoid simply re-labelling employees as contractors
- periodically review long-term contractor arrangements, and
- seek advice where there is uncertainty or where arrangements sit in a grey area.
Need help reviewing your contracting arrangements?
If you are unsure whether your current contractor arrangements are compliant, please get in touch with Australian Business Lawyers & Advisors via email: info@ablawyers.com.au.
Our team can help you:
- assess whether a worker is likely an employee or contractor
- identify risk areas in your arrangements
- review existing contractor agreements, and
- draft new contractor agreements.
Kai Denton is an Associate, and Abraham Ash a Director, at Australian Business Lawyers & Advisors.