It used to be that when someone said they were working for a company, it was a pretty safe bet that they were a full-fledged employee, with all the rights and benefits that come along with that status.

But that's no longer the case. Economists Lawrence Katz of Harvard and Alan Krueger of Princeton found in a 2016 study that the proportion of U.S. workers who do their jobs on a contingency basis hit 15.8 percent in late 2015, up from 10.1 percent in February 2005. The percentage hired through contract companies rose the most, to 3.1 percent in 2015 from just 0.6 percent 10 years earlier.

A McKinsey Global Institute survey released in October 2016 put the share even higher, finding that 20 to 30 percent of the working-age population in the United States and Europe is engaged in some sort of independent work, ranging from part-time Uber drivers to freelance corporate lawyers. A U.S. Department of Labor study that classified contingent and alternative work arrangements separately came up with lower figures, but still indicated there are plenty of these workers out there.

In the United States, tech companies including Alphabet Inc., parent company of Google, Apple Inc. and Facebook Inc. are known to use large numbers of temporary and contract workers in the United States and abroad but solid numbers are hard to come by. Companies including such financial giants as Voya Financial and many law firms also use independent contractors.

There are plenty of reasons for companies to use nonemployees, most notably, cost savings. But for these companies' legal departments, the growing contingent workforce has also led to a rising number of class action suits in the United States.

“There are pros and cons but there are clearly risks that need to be weighed and evaluated,” Stanford Law School fellow Daniel Cooperman says of the contingent worker calculus. Cooperman was formerly senior vice president, general counsel and secretary of Apple. He also headed the legal department at Oracle Corp.

Growing Pains

When it comes to misclassification of contract workers, the consequences can be serious. Those who merely file for unemployment, disability or other benefits upon termination may trigger worker classification probes by federal, state and local agencies that can result in substantial fines and penalties for companies if substantiated.

The IRS, for instance, has its own classification test. Penalties for intentional violations can reach 20 percent of wages paid and 100 percent of FICA taxes—including the employer's and the employee's share—plus additional penalties.

But one of the most worrisome risks for companies using contingent labor is the possibility of litigation, especially class actions. Litigation over the use of contingent workers, particularly in high-tech, can be traced back to Vizcaino v. Microsoft, a case from the late 1990s in which federal courts ruled that Microsoft Corp. had misclassified thousands of engineers as contractors, resulting in a settlement of $97 million.

Despite Vizcaino, the use of contingent and temporary labor has soared. “Since the recession in the United States in 2008, uncertainty drove employers to be more cautious about recalling or hiring full-time employees. The contingent worker model has exploded from that,” says Suellen Oswald, a principal in the Cleveland office of employment law firm Jackson Lewis, who often advises companies on such matters.

Technological advances in the last 15 years also spurred companies like Uber Technologies Inc., TaskRabbit and Care.com, whose app-driven business models depend on contingent and casual labor. Many observers expect the trend to continue.

As the number of contingent workers grows, however, so do the concerns—including some pretty basic ones.

Michael Boro, a partner at PricewaterhouseCoopers, who is an attorney, says many companies don't even know how many gig workers they have. That fact alone creates risks for the company, ranging from labor and tax law compliance to security, cybersecurity and liability concerns. While preparing for the Affordable Care Act with one global company, Boro notes, “I saw [they] had 12,000 employees, and they said, no, we have 9,000. When you look at how many people they are paying for work, I would say it was 12,000.”

Geoff Mohun, the GC of San Francisco-based workforce management company iWorkGlobal, says companies should be analyzing their contingent workers' roles to ensure classifications are correct before audit concerns arise.

“I would want to know how many independent contractors are working for us, how many are engaged, and then do an analysis of who is doing what,” Mohun says. “Because not all independent contractors are going to get reclassified, but my experience is, there's going to be some.”

He says that while a strong economy has so far prevented mass layoffs of contingent workers who then seek unemployment benefits, an economic downturn could lead to a “reckoning” for companies with misclassified workers.

Decisions, Decisions

For some companies, the reckonings over misclassification have come in the form of litigation, some of it quite high-­profile. These cases easily attract class sizes into the thousands, and statutory penalties can be heavy.

As they grapple with the legal implications of the growing contingent workforce, courts have established tests for whether a worker should be properly classified as a contract worker or an employee. California has been an epicenter of misclassification wage-and-hour suits, partly because of its many Silicon Valley-headquartered companies.

In February, in a closely watched suit, a federal magistrate judge in San Francisco ruled that a delivery driver for app-based meal delivery service Grubhub was not an employee under California law, because the company didn't control how he did his job, an argument used by many similar companies, including Uber Technologies Inc. for its drivers. The plaintiff later filed an appeal that is now pending in the Ninth U.S. Circuit Court of Appeals.

In the meantime, however, the California Supreme Court established a new, more worker-friendly standard under state law in April in a landmark case, Dynamex Operations West v. Superior Court of Los Angeles County. In the Dynamex case, delivery driver Charles Lee claimed that he and his fellow drivers had been misclassified as contractors when they were employees.

The California court agreed, in an 82-page decision adopting a so-called “ABC test” already used in Massachusetts and New Jersey for distinguishing between contractors and employees. According to the court, the three-factor test requires that the worker is free from the control and direction of the hirer in connection with the performance of the work both under the contract for the performance of the work and in fact; the worker performs work that is outside the usual course of the hiring entity's business; and the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

Since the state Supreme Court's ruling in Dynamex, the plaintiff in the Grubhub case asked the federal circuit court to send the case back to federal district court for reconsideration. Grubhub is fighting that.

Plaintiffs lawyers are gearing up for many other suits in the state, and across the country, on similar grounds. (Although the ruling applied only to California, that state is influential.) Meanwhile, employers have deployed lobbyists to the California Legislature asking state agencies to delay application of the ruling and for changes in the law.

In a conflicting federal decision on the East Coast, however, a federal district court judge in Philadelphia ruled in April that Uber limousine drivers in that state are independent contractors and not employees under the Fair Labor Standards Act in Razak v. Uber Technologies, dismissing a putative class action suit. The judge in that case, which is being appealed, said this was the first such ruling under federal rather than state law.

Heading Off Litigation

Employment lawyers and in-house counsel agree that forethought and planning on the early side—even before the contract-drafting stage—are needed to prevent or mitigate contingent labor legal woes.

In-house counsel should work with executives, human resources personnel and outside counsel from the start to decide how manpower needs within a specific business should be met in order to prevent misclassifying woes, says Jacqueline Kalk, a shareholder at Littler Mendelson in Minneapolis, who often advises startups. “I like to focus on: What are you really doing?” she says. “How much control are you going to give the worker, which is the biggest issue. How much of their own destiny does the worker control?”

Under Dynamex and the ABC test, it also will be important that contractors aren't used for a core business, in California at least, says Oswald. “At a hospital for instance, a core business is treating patients and outsourcing cafeteria or payroll would be OK. It could be problematic to outsource the nursing staff or doctors, depending on how they define their core services,” she says.

Considering in which jurisdiction the workers will be operating is also critical. “In the U.S. there are 75 tests or more, state, local and federal,” Kalk says. “When you make your decisions you really have to think about where you are. In San Francisco, it may be that these people need to be employees, but in South Florida, it might be they can be contractors,” she says. For instance, she says, “I have discussions that you would be okay with the IRS, but I can't get you by California or Massachusetts tests. You can imagine how the [client] reaction goes.”

Misclassification is also a worry for global companies hiring contractors in countries with strong worker protections, such as European Union member states, says Nancy Cremins, chief administrative officer and general counsel at Globalization Partners Inc., a professional employment organization based in Boston. “If you are hiring workers to work in Germany they have to be treated along German norms,” Cremins says.

For businesses that are already up and running, in-house counsel should require periodic audits of independent contractors already at work—everyone who is paid on a 1099 instead of a W-2 form—to make sure the company is not running afoul of recent court rulings and changes in state and local laws. Some contracts may have to be canceled and restructured.

“For instance, an independent contractor agreement cannot have a noncompete provision, because the essence of being an independent contractor is to offer services to a wide variety of companies and not be held to a restrictive covenant,” Oswald says. If the contract is with a staffing company, “there ought to be an audit of the written agreement between the business and the staffing firm to make sure [it] is providing what it is required to provide.”

In-house counsel also should review insurance policies to help make sure the company is covered for liabilities, because hiring contractors doesn't off-load all liability for injuries to workers, or for discrimination and sex harassment on the job. For instance, if an employee is injured on the job, worker's compensation insurance usually covers the cost. But if the worker is independent, she's not covered by the insurance and the company could be held liable. Contracts with staffing companies should stipulate what coverage they are providing.

Also, in-house counsel must consider how to keep control of corporate standards when a large proportion of its workers are not its direct employees. In addition to the reputational risks for the company from bad actions by contractors, there are also morale risks to consider from creating a dual-class workforce.

Situations as simple as office Christmas parties can become complicated when a large part of the workforce is contingent. For morale purposes, company leaders may want to include independent contractors who work side-by-side with employees to a lunch or party—but strengthening those relationships can also strengthen a misclassification case, according to Andrew Moriarty, an employment law partner at Perkins Coie and former senior corporate counsel for labor and employment at Amazon.com Inc.

“One holiday party issue is, 'Should we invite the independent contractor to the company holiday party?' The conservative legal advice is no, because that makes the person arguably look more like an employee,” Moriarty says. “Do independent contractors get invited to the holiday party? Yes, they do. Not everywhere, but some places. Some places are just taking that risk.”

If they're invited, a second risk comes up—the company's possible liability for their actions, especially if alcohol is present. The more companies accept accountability for independent contractors, or set rules for how they can behave, the closer they may creep toward employee status on an ABC test scale.

“On issues like sexual harassment, and safety at the site that the employer controls … people are focusing more heavily on protecting the work environment and making sure there's a safe work environment,” Moriarty says. “Whatever misclassification risk is associated with that, the companies are just accepting that as the cost of doing the right thing.”

Complications also arise from a PR and accountability standpoint. If independent contractors are poorly treated by their employers or staffing agencies, that can negatively reflect on the companies to which they're outsourced.

“Liability and accountability is starting to creep in even when you use an independent contractor. How do we know they are treating their people according to our standards? The lines are getting blurred. The company doesn't want the responsibility but there is a concern that it will reflect on them,” Boro says. Recently, for instance, Microsoft said it would require its staffing agencies such as custodial services to provide new parents paid family leave.

As Cooperman points out: “As a GC of a global company, that keeps you up at night, because you know someone, somewhere is misbehaving. So when you have workers who are not your people, you must make sure they are properly trained and schooled on behavior and the rules of the workplace in your company, and that they comply with those rules. That is a subtle issue, but a pretty important issue if the numbers [of contingent workers] are significant.”