Employee or Independent Contractor: Drafting Stronger Master Service Agreements in Light of Dynamex

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By Price Murry and 
Rubeena Sachdev

 

Following the decision in Dynamex Operations West, Inc. v. Superior Court, California law has changed in favor of classifying workers as employees versus independent contractors. California employers should use the ABC test to determine a worker’s classification.

Many companies are trying to outsource the risk created by this case by employing third party companies, rather than hiring independent contractors directly. As a result, we expect that staffing companies will see an increase in business over the next few months. As the staffing industry continues to respond to this new development, companies should update their agreements to conform to current law and business practices.

In the typical Master Service Agreement (MSA) it is important to outline the relationship between the consultant, the staffing company, and the end client. Ideally, the service agreement should explicitly describe:

  • The employer/employee relationship between the staffing firm and the consultant, and
  • That the end client is not the employer of the consultant

Because they are the employer of the consultant, the staffing firm must handle all liability for social security and payroll taxes, unemployment insurance taxes, and worker’s compensation insurance. They must also manage all compliance with state and federal regulations on wages, hours, and working conditions of employees.

Key Things to Include in Master Service Agreements

Below is a list of important provisions and tips for California staffing companies and end clients to remember during MSA contract drafting, negotiation, and dispute resolution.

Term/Termination and Liquidated Damages

Term can be a difficult issue to address in service agreements. Often, one party wants the flexibility to terminate for convenience, while the other wants a specified term to reduce the bench time of any employees. Often this results in some period of notice, say 14 days, with carve-outs to terminate for specific reasons. This result frequently creates disputes around proper notice and whether a carve-out event occurred.

Companies should be careful to note who must be given notice, and what happens in the event of early termination. Many agreements will require notice to terminate, but also promise to pay for any work done prior to termination. This can lead to a difficult dispute where one party wants to claim damages stemming from lack of proper notice, while the other wants final payment.

Liquidated damages provisions provide one solution for termination disputes. These provisions attempt to avoid a dispute by specifying the remedy that results from a specific harm. For example, some companies use a liquidated damages provision claiming all outstanding invoices if one party does not follow proper termination processes. While this may seem fair, it often creates additional litigation because the damages are not proportional to the harm, and the parties each feel justified in their position. If a company wants to use liquidated damages it should ensure the measure is proportional to the harm. Even if they could demand more, the other side will dispute it as a penalty and the cost-saving purpose is lost.

Representations and Warranties

Representations and warranties are in some respects the catch-all provisions of a contract. These include boilerplate provisions such as the authority of each signatory to execute the contract, and more nuanced provisions like the competence of your workforce. Companies should be careful to avoid representing something as true when it is uncertain or could later be proven false, such as the qualifications of their employees.

This is an area that is easy to overlook until a dispute arises, such as warranting the functionality of software for a period after the contract concludes. In the event of a dispute as the contract nears conclusion, companies may look to these provisions to extend support or withhold final payment.

Non-Compete Agreements and Trade Secrets

It is a delicate process to prevent the customer, sub-contractor, or employee from cutting the staffing company out of the deal, regardless of the state in which the company operates. Companies spend a lot of time, money, and effort developing relationships that may only be as strong as the legal terms protecting them. Many states, such as Virginia, will void an overbroad non-compete rather than allow it to be rewritten in an acceptable form. In California non-competes are generally void under California Business and Professions Code Section 16600. An ineffective non-compete can be fatal for a company acting as part of a chain of contractors leading back to the end client.

It can be beneficial to use an additional, separate legal theory based on trade secrets. Customer lists can frequently be protected as a trade secret, and courts are more likely to prohibit the misappropriation of a trade secret than to enforce a non-compete. To claim this protection, the agreement should:

  • Specifically designate the customer list as a trade secret
  • Ensure there are reasonable measures in place to maintain its secrecy

It is best practice to ensure everyone is under a duty of confidentiality, otherwise any information they have access to will not qualify as a trade secret. Courts will scrutinize trade secret claims for whether information was truly kept secret, so companies should ensure there are both policies and records ensuring the confidentiality of trade secrets.

Indemnification

Indemnification generally allows one party to seek financial reimbursement from the other in designated situations. A classic situation is when an employee seeks indemnification from their employer for acts committed in the scope of the employment. Contracts typically address indemnification issues like intellectual property, breach of contract, or employment matters.

Post-Dynamex, clients or other contractors in the chain have growing liability concerns as joint employers for any employment law violations by the company employing the consultant. Employment law indemnification may become increasingly important in this light.

In most cases businesses will use indemnification to carve out liability otherwise disclaimed in the limitation of liability or warranty section. However, companies should be wary of promising to indemnify another for risks that are outside of their control. Indemnification can lead to open-ended liability based on an event the company has no way to manage.

Limitation of Liability

Limitation of liability is perhaps the most frustrating provision in a Master Service Agreement when a dispute arises. While broad limitations are generally considered preferable by both sides to an agreement, a broad limitation without carve-outs can be disastrous in the event of a dispute.

Many contracts will limit either party’s remedies to three, six, or twelve months’ worth of payments. The rationale is to limit liability to the money paid in the contract, however, the damages may be worth much more than three months’ worth of payments. If for example, a sub-contractor steals a customer in violation of a non-compete or by misappropriating a trade secret, three months would not suffice. Without careful drafting, that would be the maximum relief available.

A business’s position on limits of liability should depend on their position in the overall relationship. A business that is paying for services should seek broad carve-outs and indemnification to ensure it is protected by any liability created by the service provider’s acts. On the other hand, a service provider should protect itself by limiting the buyer’s remedies and requiring the buyer to monitor its own risks. Shifting the risks and liabilities between the parties will depend on the relative negotiating power of each, but limitation of liability can be a trap for the unwary and a blessing for the prepared.

Attorneys’ Fees

Attorneys’ fees are often excluded from contracts because the parties are concerned about having to pay the other side’s attorneys in the event of a dispute. The legal expense can easily escalate and become greater than the amount originally in dispute! However, without this provision, it may be too expensive for a business to prove they are in the right and collect on their invoices.

An attorneys’ fees provision can be especially crucial when the dispute surrounds the non-payment of an invoice, which can be as low as $10,000 and barely stay out of small claims court. In these situations, the threat of owing twice the original invoice after attorneys’ fees can be quite motivating to the other party. The lack of such a provision can all but preclude recovery of the original invoice.

Companies should generally include an attorneys’ fees clause whenever they are receiving payment in exchange for services. Many companies will fabricate a reason to not pay the final invoice. Without an attorneys’ fee clause, the service provider has the difficult decision of walking away or spending money on attorneys that may not be recovered even if they win.

Of course, attorneys’ fees work both ways. There are circumstances where it may be better to include the pressure of each party bearing their own costs and fees.

Governing Law and Choice of Law

Finally, an unexpected cost in dispute resolution can be fighting or defending a dispute in an unfamiliar state. Many companies will specify a choice of law without also specifying a choice of venue. This leads to the unfortunate situation where a company may have the law they want (New Jersey), but they must litigate the case somewhere else (California).

Certain states like California have law based on public policy that will override any contract to the contrary, which can frustrate businesses attempting to enforce a foreign choice of law. This simple mistake can have a huge impact in situations where California’s employee friendly law comes into play, such as invalidating a non-compete clause that may have been enforced in a different state. An easy fix is to make sure venue and personal jurisdiction issues are addressed in the agreement.

Conclusion

The Dynamex decision caused a huge change in favor of classifying workers as employees rather than independent contractors. However, businesses can easily avoid the entire question by using an outside firm to staff their projects, rather than hoping their contractors will not be reclassified as employees. Companies in a position to take advantage of this sea change should make sure they are prepared for the influx of business by having agreements that will help them earn and protect their assets, rather than the contract itself becoming an expensive liability.

This article is intended for general informational purposes only and does not constitute legal advice. Using this document or any other material provided by Chugh, LLP does not create an attorney-client relationship. All information should be independently verified before relied on or acted upon. Please speak to an experienced attorney for case-specific questions.

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