Industrial and Employment Law Alert: Legal risks in contracting: ‘Sham contracting’ and liabilities acquired from the procurement chain - 12 Jun 2012

Two recent prosecutions commenced by the Fair Work Ombudsman involving a South Australian supermarket trolley collection operation provide a warning for anyone for whom contracting is a means of engaging labour.

The prosecutions (and a number of recent Federal Magistrates' Court decisions in similar prosecutions) highlight that:

  • it may not always be appropriate to engage a person or company to provide services under a contracting arrangement;
  • trying to squeeze a work arrangement into a 'contracting box', when the circumstances call for an employment arrangement and compliance with applicable industrial regulation, can have expensive consequences; and
  • using contracting to push responsibility for compliance with applicable industrial regulation - and liability for non-compliance - down the supply chain may not work.

The recent legal activity has generally arisen out of the prohibitions in the Fair Work legislation against what is described as 'sham contracting', which can take various forms. Basically, sham contracting occurs when an employer promotes a work arrangement as an independent contracting arrangement when, legally, the relationship between the parties is a contract of employment.

Here, partner Andrew Tobin outlines what constitutes 'sham contracting' and discusses what employers can learn from recent prosecutions commenced by the Fair Work Ombudsman.

Contractor v employee

In simple terms, a true contracting arrangement is one between a person or entity in business for themselves who, as a contractor, is engaged to provide services to another as their principal. So the Jim's Mowing person you hire to mow your lawn once a fortnight is a contractor, while the person you hire as your personal assistant working business hours in your office five days per week is an employee.

Sham contracting

Typically the Fair Work Ombudsman, as the federal regulator of Australia's workplace laws, will get involved where the terms of engagement of a worker, supposedly as a contractor, results in payment of remuneration less than that which would have been payable had the worker been properly engaged as an employee.

An employee's terms and conditions will have been prescribed by the statutory safety net including the National Employment Standards, national minimum wage, terms and conditions prescribed by an award or, in some cases, terms and conditions prescribed by an applicable collective agreement.

For some employers, resorting to contracting provides some kind of safe haven from the protections that would otherwise apply to the relevant workers, theoretically exposing the arrangement to the give and take of laissez-faire principles.

Outside of those cases, sham contracting can be any kind of work arrangement by which the parties, for whatever reason, improperly structure their arrangement as one in which a worker, striving to look like an independent business, provides services to a principal as a contractor rather than as an employee. While the arrangement will usually involve, among other things, an ABN, a fancy contract, and payment upon invoices rather than by wages, for all other intents and purposes it will bear no discernible difference to the typical relationship between an employer and their employee.

In some cases, the use of contracting as a form of engaging workers is not about the money, at least from the employer/principal's perspective.

It is not unheard of at the top end of town for companies to engage some of their executives or senior employees under contracting arrangements, perhaps through the intermediary of a company. These cases are unlikely to involve any suggestion of underpayment, but that doesn't legitimise a contracting arrangement where, in truth, the worker is really an employee. It is difficult to see how a company's chief executive officer or chief financial officer, as two examples, can be engaged otherwise than as employees.

In those cases, issues other than underpayment of remuneration can arise, such as breach of the National Employment Standards relating to the provision of leave entitlements; breaches of the statutory superannuation and workers' compensation schemes; and non-compliant income tax arrangements on both sides of the engagement. Difficult liability and insurance questions can also arise in connection with loss or damage caused by a worker in this position. True contractors bear their own business risk, while employers will ordinarily be liable for loss or damage caused by their employees in the course of their employment.

Civil penalties

Sham contracting is illegal under the Fair Work Act, and employers found to be promoting or engaging in such arrangements, and the individuals involved in those matters, can be prosecuted for very substantial civil penalties.

Before we get to the trolley collectors, the penalty high point for sham contracting was reached on 31 May 2012 when the Federal Magistrates' Court fined a company, the operator of a resort in Tasmania, $280,500 for deliberately exploiting resort workers, or attempting to do so, in sham contracting arrangements (Fair Work Ombudsman v. Maclean Bay Pty Ltd [2012] FCA 337 (31 May 2012)).  The Court also fined one of the former owners of the resort almost $14,000 personally for her involvement in those arrangements, in addition to ordering the company to pay almost $40,000 in back pay to the affected workers.

The basic facts in that case were that the owner of the resort, in a cost cutting exercise, attempted to push all of its employees into contracting arrangements when, clearly, they were engaged to work in the employer's business as employees. One employee, a receptionist, was sacked because she resisted becoming a contractor. The court found that the employer was trying to avoid paying superannuation contributions, income tax and payroll tax.

That decision is one of several indicating that the Fair Work Ombudsman will seek orders against the individuals behind corporate offenders. The Fair Work Act not only outlaws primary contraventions of the legislation, but also imposes liability on those who are involved in contraventions. While involvement can arise in a number of ways, liability can follow a person who "has been in any way, by act or omission, directly or indirectly, knowingly concerned in or party to" the primary contravention.

Liabilities acquired from the procurement chain

The trolley collector prosecutions, which are yet to be determined, go further.

In both prosecutions, the Fair Work Ombudsman is seeking orders against Coles Supermarkets, among others, for very substantial underpayments of wages to trolley collectors employed to work at five Coles supermarkets in South Australia. What is interesting about the prosecutions is that, in both cases, Coles had no direct relationship with the workers. Rather, Coles had contracted the Starlink group of companies to provide the services. Starlink, in turn, had subcontracted a sole trader to provide the services. The sole trader had employed the trolley collectors.

The first prosecution alleges a total underpayment of wages and entitlements to four employees in the order of $143,000, and the second alleges a total underpayment to six employees of around $149,000.

The case against Coles in both prosecutions is to the effect that Coles "knew that under the contracting prices it paid to the Starlink companies, it was not feasible to provide the required trolley collecting services without undercutting minimum wage rates". In other words, the allegation is that Coles was involved in the contraventions of the employer, despite the fact that it was not itself the employer.

The prosecutions against Coles do not, strictly, involve an allegation that Coles engaged in sham contracting. Rather, Coles has been brought into a prosecution of the ultimate employer, and those responsible for managing the ultimate employer, for breaches of the statutory safety net of terms and conditions of employment. Even so, they are a notable example of how inappropriate use of contracting to outsource service arrangements can result in liability - for the sins of others down the supply chain.

The warning

Therein lies the warning for those who are accustomed to the use of contracting as a means of engaging labour. In the words of Nick Wilson, the Fair Work Ombudsman:

"Turning a corporately-sanctioned 'blind-eye' to outsourced work that is performed by another enterprise using contractors on below-award rates of pay may expose enterprises up the procurement chain to liability.

All parties should undertake due diligence when outsourcing work to contracted workers, particularly to lowest-cost providers, to ensure lower costs are attributable to efficiencies in the business and not due to the potential exploitation of workers on below-award rates."

For businesses that rely heavily on outsourcing, the potential implications are enormous. In practical terms, a risk adverse approach to contract negotiations and terms will, in many cases, require:

  • examining the business operations proposed by the contractor;
  • assessing whether the contractor will be able to deliver the services, on the terms proposed, in a manner consistent with industrial regulation;
  • imposing appropriate controls over further delegation, or subcontracting, of any part of the services to be provided;
  • taking appropriate warranties from service providers in relation to their industrial compliance; and
  • embarking on appropriate audit activity, supported by relevant contractual rights.

Additional costs may be involved for intending principals associated with due diligence and audit activities. In some situations, preliminary enquiries may indicate that entry into a particular arrangement is ill advised.

Service provider selection and contracting processes that fail to take appropriate account of considerations like these run the risk of exposing the principal to significant regulatory risks.

For more information, please contact HopgoodGanim's Industrial and Employment Law team.