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New Bill Penalizes the Misclassification of Construction Workers

Pennsylvania Governor Ed Rendell recently signed the Construction Workplace Misclassification Act (Act 72 of 2010, previously House Bill 400).  The new law holds employers in the construction industry criminally liable for the misclassification of employees as independent contractors.  The legislation goes into effect on February 11, 2011.  On that date, Pennsylvania will join sixteen (16) other states that have enacted similar legislation seeking to eliminate the misclassification of employees, including its neighboring states of Delaware, New Jersey, New York and Maryland.

Pennsylvania estimated that approximately nine (9) percent of the state’s workforce is misclassified as independent contractors.  Of that percentage, a quarter of the misclassified workers are in the construction industry.  By classifying workers as independent contractors instead of employees, employers can avoid paying unemployment compensation and workers’ compensation taxes, and may gain an unfair advantage in contract bids.

The New Law’s Definition of “Construction”

The misclassification of workers and the penalties associated with it under the new law only apply to the area of “construction.”  The statute defines construction as: “The erection, reconstruction, demolition, alteration, modification, custom fabrication, building, assembling, site preparation and repair work done on any real property or premises under contract, whether or not the work is for a public body and paid for from public funds.”

Due to the broad nature of the definition, future interpretation by the courts will likely be necessary in order to determine who is and is not encompassed within the “construction” classification.

Who Classifies as an Independent Contractor?

Construction industry contractors will still be able to employ independent contractors, but must ensure that certain assurances are in place prior to engaging such individuals in work.  An individual who performs services for compensation in the construction industry will only be considered an independent contractor if he/she: (1) has a written contract to perform the services, (2) is free from control or direction over performance of duties and services, and (3) is customarily engaged in the business of providing the services contracted for.

The law provides guidance on determining whether or not the individual is “customarily engaged” in the particular profession.  The criteria utilized to determine whether an individual is “customarily engaged” in a particular business amounts to whether the individual:

  • Possesses the essential tools, equipment and other assets necessary to perform the services independent of the person for whom the services are performed;
  • Has an arrangement in which he or she realizes a profit or suffers a loss as a result of performing the services;
  • Performs services through a business in which he or she has a proprietary interest;
  • Maintains a business location that is separate from the location of the person for whom services are performed;
  • Has previously performed the same or similar services for another person while free from direction of control over the performance of those services OR holds himself/herself out to other persons as available and able to perform the same or similar services while free from direction or control over performance of the services; and
  • Maintains at least $50,000 in liability insurance during the term of the contract.

Penalties Under the New Law

Under the new Pennsylvania law, a first intentional violation of the law constitutes a third degree misdemeanor.  All subsequent violations constitute second degree misdemeanors.  Third degree misdemeanors carry a maximum sentence of one year in prison, while second degree misdemeanors carry a maximum two year sentence.  Furthermore, the misclassification could also lead a court to order any misclassified employee to cease work within 24 hours and, if the majority of the workers on the site are misclassified, could effectively shut down that employer’s operations at that particular site.  A violation of a stop-work order will result in a penalty of $1,000 per day.

Notably, there is a good faith defense available if the person for whom the services are performed believed, in good faith, that the employee qualified as an independent contractor at the time he or she performed the services.

In addition to the criminal penalties, the law provides for the state’s imposition of civil penalties up to $2,500 for each intentionally misclassified worker.  The negligent misclassification of an employee is a summary offense, subject to a fine of up to $1,000.  Additionally, the Department of Labor & Industry maintains the ability to assess civil penalties of up to $1,000 for the first violation and up to $2,500 for later violations.

In addition to employers, criminal liability also extends to individuals and businesses that contract with the employer if the individual or business knows of the misclassification by the employer.  The law contains a safe harbor provision, resulting in a defense for a good faith belief that the worker qualified as an independent contractor at the time the services were performed.

Whistleblower Protections

The new law expressly prohibits retaliation against an individual who exercises any rights under the law, including filing a complaint or informing any person about an employer’s noncompliance with the law.  Additionally, individuals who file a complaint, but do not prevail, are protected against retaliation as long as the allegations were made in good faith.  Any adverse action taken against an individual within ninety (90) days of that individual’s allegations is presumptively a retaliatory action and the burden is then placed on the employer to show that the action was based on a legitimate, non-retaliatory reason.

A violation of the whistleblower provision is considered a separate violation, subject to the same penalties as a misclassification, described above.

Implications and Conclusions

As the year draws to a close, it is imperative that employers in Pennsylvania’s construction industry closely examine their contracts and relationships with all purported independent contractors.  Employers should review their policies to ensure compliance with the new legislation to avoid potentially damaging fines and criminal penalties.

  • Stewart M. Weintraub

    Stewart Weintraub’s practice has centered on taxation for more than 40 years. He helps clients plan and structure transactions so that all state and local tax obligations are minimized. He represents clients in all aspects of ...