Contractors Should Consider How They Build Their Workforce

Should Subcontractors Be Hired as “Employees” or Independent Contractors?

Two recent events remind the insurance industry of the importance of understanding the relationship of a worker at a construction site and protecting the insured when the construction worker has a “problem.” In both events, the arrangement between the worker and the user of the worker is being tested.

Feeling the effects of the economy, a construction business in Florida recently closed because of financial concerns. A worker said he had been with the company for nine years and was paid as an independent contractor using an Internal Revenue Service (IRS) 1099 form. The workers was concerned about his ability to collect unemployment.

If the worker was truly “misclassified,” then the business will have to pay taxes and fines. If the business cannot pay, the owner will be personally liable. The situation could rise to a level of fraud, which could mean jail time.

In another situation, a worker was brought to a job site by a concrete pumping company. The pumping company used an employee leasing arrangement. The worker borrowed a ladder from the general contractor. The ladder broke, and in the fall, the worker broke his leg. During the treatment of the broken leg, the worker’s diabetes and heart condition exacerbated the injury. The worker is now permanently and totally disabled.

The pumping company did not “enroll” the worker with the employee leasing company, and the workers’ compensation carrier for the employee leasing company says it will not respond. A Florida appellate court ruled that position correct. So the injury falls back to the general contractor, but under which policy?

The answer is the general contractor’s workers’ comp policy, because the subcontractor did not have workers’ comp coverage, and the worker was an employee of the subcontractor, who didn’t have workers’ comp coverage.

Meanwhile, the worker also is seeking payment from the general contractor for the faulty ladder, so the general contractor’s commercial general liability policy is responding.

That leaves the general contractor’s workers’ comp and GL carriers to defend, with each pointing fingers at each other. Whichever policy the loss is charged against, or if it’s both, it will affect the policyholder’s renewal pricing.

Both cases emphasize the need for the insured to understand potential problems at a job site.

Injured Worker Coverage

When a construction business has a worker who is hurt on the job, who pays for the injuries? When the worker is a direct employee or leased through an employee leasing company, the answer is easy. Either the direct employer’s workers’ comp carrier or the employee leasing firm’s workers’ comp carrier pays benefits, as mandated by the state in which the accident occurs. The injured employee, in most cases, only recovers the benefits provided by state statutes and cannot sue the employer.

The exception is when the employer’s actions were so grossly negligent and outside of the typical work environment that the employer should or could have taken steps to protect the employee. In that case, the employer’s negligence is not protected from lawsuits.

It is difficult for a worker to prove that an employer was grossly negligent.

Problems can arise when the contractor did not intend a worker to be an employee. The injured worker then has only two avenues for benefits because of a job-related injury:

1. Establishing that he or she is indeed an employee of the business; or
2. Suing the business under tort liability for its negligence in causing the injury.

The Employer/Employee Relationship

Even if a worker initially wanted to be an independent contractor, he or she may claim to be an employee after an injury to qualify for workers’ comp benefits. So consider how much control the user of the employee has.

Often, the injured worker attempts to establish that he or she was an employee of the general contractor. In that situation, the user of the worker must prove that the worker was not an employee under state workers’ comp laws. If the user of the worker is unsuccessful and is held to be an employer, it is responsible for the injuries.

Because this is a common scenario, many states have a protocol to determine an employee/employer relationship. States have defined “independent contractor” in their workers’ comp statutes, and the IRS has a 20-point test to determine the existence of an employer/employee relationship. An employer that fails to follow the standards is subject to fines, can be shut down or faces additional workers’ comp premiums.

If the worker is successful in establishing an employer/employee relationship, then the workers’ comp policy of the established employer will respond, and the user would owe additional premium. If an employee leasing company is involved, its workers’ comp coverage will not respond in a number of states — unless the worker has been reported to it as an employee prior to the loss. Otherwise, the user of the worker who is found as the employer must pay the benefits.

If the employer has a workers’ comp policy in its name, that policy would respond. If such a policy doesn’t exist, then the injured worker could look beyond the user if the user is working for someone else.

At least 40 states require the principal employer (general contractor or user of the subcontractors) to pay workers’ comp benefits if any subcontractor fails to carry workers’ comp coverage. Clients of employee leasing companies that do not have a workers’ comp policy in their own name (which is difficult to obtain) must ensure that when using laborers in an employee leasing arrangement that the workforce of the subcontractor has all workers listed by the employee leasing company.

Recovery Under Tort Liability

The injured worker may state that he or she was not an employee or may have been unsuccessful in establishing an employer/employee relationship. In either case, the injured party can sue for damages, alleging the business was negligent. The worker could sue for much more than any benefits available under workers’ comp coverage. The business owner’s standard, unendorsed commercial general liability policy would respond. This leaves the business’ total assets exposed, if the claim is beyond the policy’s general liability limits.

Steps to Lessen Exposure

To reduce exposure, anyone who uses subcontractors has two options:

1. Make all workers “employees,” pay the extra premium and gain protection from potential lawsuits under state workers’ comp laws.
2. Or, if the contractor wants to be independent, establish procedures in which the user of such subcontractors is protected.

If a company decides to use option two, it should clearly establish that subcontractors are not employees by using a proper subcontractor agreement. The contract should conform with state criteria for establishing a contractor/subcontractor agreement, contain indemnification and hold harmless agreements, and include insurance requirements. All subcontractors conducting work for the business should be required to sign such a contract.

Subcontractors should carry their own workers’ comp and GL coverages. The contractor’s CGL and the workers’ comp policies are both subject to audit. When the user of the worker has not retained valid certificates of insurance for each subcontractor or not at the required limits, the CGL and workers’ comp carriers will add the subcontractor’s exposure to theirs for premium development.

Most state workers’ comp laws require the principal contractor to pay workers’ comp benefits when a subcontractor fails to provide coverage. Often, contractor “B” will act as a subcontractor for contractor “A,” a developer or general contractor. Contractor B may subcontract some activities to “C,” who does not carry workers’ comp coverage. In an accident, the liability flows upward from C through B to A.

If A’s workers’ comp carrier has to respond, contractor A can seek recovery from the subcontractor, if the subcontractor has any money. If a claim is presented under A’s workers’ comp policy, or when the policy is audited, the additional developed exposure would be added to the “payroll” of A.

Risks that typically use independent contractors usually have high rates. Therefore, paying for a subcontractor’s workers’ comp exposure is expensive, and is an additional, unforeseen cost of doing business. Contractor A is in fact subsidizing the subcontractor’s operation.

The rationale for using subcontractors should not be saving money. Subcontractors should be responsible for their own expenses. The quoted contract price by the subcontractor usually includes all labor and materials, and should always include adequate general liability and workers’ comp coverage. Transferring the liability exposures and/or costs of insurance to the principal contractor defeats the purpose of using subcontractors.

The contractor relationship established in the written agreement between the user of the subcontractor and the subcontractor should contain a hold harmless and indemnity agreement, where the subcontractor holds the user harmless for any claim. That includes “injury or death to employees or other workers” the subcontractor would use to complete the work required in the contract.

If the subcontractor does not have workers’ comp insurance, does not have GL insurance or will not sign the hold harmless agreement, then the contractor should then find someone who does. Or, the contractor could make the worker an employee, pay the premium for the worker’s activities, which for the most part protects the general contractor from the injured worker in a lawsuit.

If the subcontractor wants to be his or her own business, then he or she should be willing to provide the necessary insurance and sign the hold harmless agreement, so that the user of the subcontractor limits its exposure for using the subcontractor.

With this procedure in place, if the worker the subcontractor uses is injured, the injury will be addressed by the subcontractor’s workers’ comp coverage. If the worker sues the user in an attempt to collect more than the workers’ comp benefits, the user can look to the signed contract and invoke the hold harmless agreement, asking the subcontractor to honor the agreement. The subcontractor then would present the claim to its GL carrier, and the standard coverage not limited by endorsements would respond to any lawsuit, because the contract between the contractor and the subcontractor is included in the definition of “insured contract.”

The proper management of the risks associated with using subcontractors includes:

1. Developing and using a standard subcontractor’s contract that includes hold harmless agreements in favor of the user, including protection against lawsuits from injured workers.
2. Workers’ comp and GL coverage requirements.
3. Obtain and retain workers’ comp certificates of insurance from every subcontractor.
4. Obtain and retain GL certificates of insurance with adequate limits from every subcontractor. A guideline would be the limits the principal contractor is required to carry for a particular project.
5. If a subcontractor uses workers’ who are leased, maintain a procedure to assume all workers are leased, and the employer leasing company’s coverage will respond.

Managing subcontracting exposures has two goals: to protecting assets from uncovered exposures and to make subcontractors responsible for their own insurance costs and additional exposure if they want to be independent contractors.

Topics Lawsuits Carriers Workers' Compensation Contractors Construction