Risky business of sham contracting

  • 11 Sep 2016
  • High Court closes loophole in the Fair Work Act, putting employers on notice.
  • Employers need to take care when engaging independent contractors, either directly or when using a triangular/Odco arrangement with a labour hire company.
  • Engaging workers through a labour hire company will not necessarily prevent employers from breaching the sham contracting provisions of the FW Act.
  • Each engagement needs to be assessed to determine whether it is a genuine independent contractor arrangement or one of employment.
  • If an employment relationship is found to exist, employers risk pecuniary penalties under the sham contracting provisions.

While some employers have escaped paying employee entitlements by using triangular contracting arrangements, the law has now been tightened and employers need to be aware of the heavy punishments available if they breach the provisions of the Fair Work Act.

“Triangular contracting” or “Odco” style contracting came under scrutiny in the High Court case of Fair Work Ombudsman v Quest South Perth Holding Pty Ltd [2015] HCA 45 and, as a result, a loophole in the Fair Work Act was closed to eradicate the illegitimate employment practice.

Whether a person is legally a contractor or an employee is now clearer and businesses that try to avoid paying superannuation, leave entitlements or payroll tax risk breaching section 357 of the Fair Work Act.

To read more about this case CLICK herehttp://eresources.hcourt.gov.au/showCase/2015/HCA/45


Sham contracting is prohibited under the Fair Work Act (FW Act) in circumstances where it is used by an employer to avoid paying employee entitlements such as annual, personal and long service leave, workers’ compensation premiums, superannuation and payroll tax.

Quest South Perth Holding Pty Ltd (Quest) operated a business providing serviced apartments. Contracting Solutions Pty Ltd (Contracting Solutions) operated a labour hire business. But in 2009 two housekeepers employed by Quest were moved into a triangular contracting arrangement whereby Contracting Solutions purported to engage them as independent contractors and then provide their services to Quest under a labour hire agreement.

The employees were told they would be independent contractors to Quest rather than employees. There would be no changes in roster or shifts and they would be paid a flat rate by Contracting Solutions, which would be higher than the base rate they were receiving as Quest employees.

The Fair Work Ombudsman (FWO) commenced proceedings in the Federal Court claiming Quest breached section 357(1) of the FW Act which prohibits a person from misrepresenting employment as an independent contractor arrangement (sham contracting). The FWO alleged that Quest made use of the triangular contracting arrangement to portray to the housekeepers they were independent contractors, despite the fact they were doing the same work in the same way for Quest as they were before the new arrangements.

At first instance the Federal Court found that the Odco style arrangements were not a sham under section 357(1).The FWO appealed to the Full Bench of the Federal Court which dismissed the appeal maintaining that section 357(1) did not cover a representation by an employer about a contract, or future contract, with another person, stating:

“a representation made by an employer to its employee that he or she is providing work as an independent contractor under a contract for service made with another person is not actionable”

This was despite the Full Court finding that at all relevant times the housekeepers wore Quest uniforms, used Quest supplies and worked entirely at the direction of Quest -usually indicators of an employment relationship. Importantly, there was also no evidence that the housekeepers were in any way profiting from their purported engagement as independent contractors.

High Court decision

The FWO was granted special leave to appeal to the High Court. The FWO argued that the Full Federal Court’s interpretation of section 357 was too restrictive and was “contrary to its obvious purpose and is plainly wrong”.

The High Court unanimously agreed that section 357(1) prohibited the misrepresentation of an employment contract as a contract for services including in circumstances where a third party is involved. As a result the High Court closed the loophole left open by the Full Federal Court which permitted employers to avoid obligations to employees by using triangular contracting arrangements.

Implications for employers

This decision makes it clear that employers need to be very careful when engaging independent contractors to ensure the arrangement is not an attempt to avoid employee obligations. This is the case whether the independent contractors are engaged directly or using a triangular or Odco contracting arrangement with a third party such as a labour hire company.

The High Court ruling has made it clear that engaging workers through a labour hire company will not necessarily prevent employers from breaching the sham contracting provisions of the FW Act. Each such engagement needs to be assessed to determine whether it is a genuine independent contractor arrangement or whether there is a risk the relationship will be found to be one of employment which could not only expose the employer to employee entitlements but also pecuniary penalties under the sham contracting provisions.

Hicksons can assist you in analysing and managing the risks associated with engaging independent contractors or labour hire workers.

Post by Sarah Jones

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