Close Scrutiny Required to Determine If Worker's Waiver of ERISA Benefits is Valid

Close Scrutiny Required to Determine If Worker's Waiver of ERISA Benefits is Valid

The U.S. Court of Appeals for the Second Circuit has held that when ERISA benefits are at issue, the employment status (employee vs. independent contractor) of an individual is not determined solely by the label used in the contract between the parties. A court's review of a waiver of ERISA benefits requires close scrutiny and not the lesser scrutiny given to general contract waivers. Yak v. Bank Brussels Lambert, 252 F.3d 127 (2nd Cir. 2001)

Facts
In 1997, Patricia Yak, an attorney, entered into a consulting agreement with BBL Holding (BBL). The agreement specified that Yak would work for BBL as an independent contractor and would not be entitled to any employee benefits. The agreement was renewed at the beginning of 1998 and again at the end of 1998. The clauses that discussed Yak's employment status and lack of employee benefits remained the same in all the agreements.

Yak provided legal consultant services on any matters requested by BBL. Yak was paid a specified hourly rate. Originally, Yak worked a maximum of 27 hours per week. After a subsequent agreement, Yak began working at a fixed weekly rate of pay for 40 hours per week. Yak was paid for all of BBL's holidays and received supplemental payments for three weeks of vacation pay.

Yak performed her assignments on BBL's premises because she was not permitted to take files off the premises. Yak was assigned a desk, a computer, and a telephone with her own extension. Also, Yak was provided with an administrative assistant employed by BBL. The assistant pulled files for Yak and helped with typing. Yak always used BBL's stationary for correspondence.

Yak submitted time sheets, which had to be approved by BBL's vice president. The vice president provided Yak with assignments and oversaw her work. Yak was required to provide the vice president with oral status reports on her work every eight to ten days and the vice president prioritized Yak's work.

At least once, the vice president called Yak at home to find out why she had not reported to work by 9 a.m. Yak was informed that she had to call the vice president if she was not going to report to the office for any given reason. Also, Yak was asked to coordinate any vacation days around the vice president's schedule so that one of them would always be in the office.

When Yak's employment with BBL ended, she sought unemployment benefits. The New York State Department of Labor (NYDOL) held that Yak was an employee and awarded her unemployment benefits. Also, the IRS determined that for federal withholding tax purposes, Yak's status was that of an employee and not an independent contractor.

NYDOL Administrative Decision on Employment Status
The NYDOL issued a determination holding BBL liable for additional unemployment contributions based on amounts paid to Yak and to all other similarly situated attorneys. The initial determination held Yak eligible to receive unemployment benefits. BBL objected to the decision and requested a hearing. At the hearing before an administrative law judge, BBL contended that Yak and all other similarly situated persons were independent contractors and not employees.

In order to determine if there was an employment relationship, the NYDOL looked at the amount of control exhibited over important aspects of the services performed, including:

Who located clients?
Were work hours regularly scheduled or occasional and sporadic?
Who fixed the fees for the services?
Where were the services rendered?
Whose equipment and facilities were used?
Who took care of the billing and collection?
Who kept the essential records?

The administrative law judge held that the determination of whether an employer-employee relationship exists must rest upon evidence that there is control exercised by the purported employer over the results produced or the means used to achieve the results. The administrative law judge concluded that the bank exercised a sufficient amount of direction, supervision, and control over Yak to establish an employer/employee relationship. Thus, BBL was liable for additional contributions and Yak was eligible for unemployment benefits.

IRS Decision on Employment Status
Yak submitted a Form SS-8 for a determination of her employment status for Federal employment tax purposes. Reg. Sec. 31.3121(d)-1(c)(2) provides that an employer/employee relationship exists when the person having the services performed has the right to control and direct the individual performing the services, not just to the end result, but to the extent that the employer controls how the work should be done. An individual is determined to be an employee or independent contractor under common law by considering all of the facts and circumstances.

Reg. Sec. 31.3121(d)-1(a)(3) provides that if an employer/employee relationship exists, the designation or description of the parties as anything other than that of employer and employee is immaterial. If an employer/employee relationship exists-even if the employee was designated as an independent contractor-that designation must be disregarded.

In the determination, the IRS stated that the following factors are considered when determining whether an employer/employee relationship exists:

The degree that the individual becomes integrated into the employing organization. Integration includes the manner in which the professional is paid for the services, i.e., a percentage basis, salary, or a guaranteed minimum. Integration also includes whether the professional is permitted to employ associates or to engage substitutes when absent from work, and if so, whether the professional is responsible for remuneration to any associate, and whether the professional is permitted to engage in a private practice or perform professional services for others. Workers are assumed to be employees if they are guaranteed a minimum salary. See Rev. Rul. 74-389.
The substantial nature, regularity, and continuity of the work for the employing organization. This factor exists when the parties agree to a schedule of definite and fixed hours that is followed without substantial deviation. A worker who is required to comply with instructions about when, where, and how work is performed is ordinarily an employee. See Rev. Rul. 68-598 and Rev. Rul. 68-381.
The authority vested in or reserved by the employing person or firm to require compliance with its general policies. This factor is indicated by whether or not the individual professional is subject to the direction and control of some other authority.
The degree to which the individual has been given the rights and privileges which the employing organization has created or established for its employees. Rights and privileges include vacation and sick leave with pay, pay for holidays, severance pay, increments for length of service, and life and accident insurance.

The IRS looked to Rev. Rul. 68-324 for additional guidance on the treatment of an attorney as an employee. In Rev. Rul. 68-324, the IRS held that an attorney who was engaged by a law firm and was furnished a place to work, performed services for the firm under its direction, and was required to work certain hours each day was an employee for federal employment tax purposes.

In this instance, the IRS looked at the difference between the "intent" of the consulting agreement and the way that Yak was actually treated by BBL, such as BBL asking for full-time work and paying her a weekly salary. Based on the facts, the IRS held that it was clear that Yak performed services in a manner consistent with an employer/employee relationship. Thus, for federal employment tax purposes, the IRS concluded that Yak was an employee and not an independent contractor

District Court
With the support of these two administrative decisions, Yak requested restitution from BBL for a variety of benefits, including health, life and disability insurance, sick leave, savings and pension plans, as well as bonuses and severance pay. BBL refused to pay, and Yak sued in district court.

In district court, BBL argued that even if Yak had acted as an employee and not as an independent contractor, she had waived her rights to any employee benefits under the terms of her consulting agreement. The district court held Yak had unambiguously waived her right to employee benefits in the consulting agreement, and thus the administrative decisions deeming Yak to be an employee were irrelevant. The district court dismissed Yak's lawsuit.

Second Circuit
On appeal, Yak argued that the consulting agreements were voided by the administrative decisions, and that the district court erred in finding her employment status irrelevant to the benefits waiver issue.

The appeals court held that neither the NYDOL decision nor the IRS decision determined that the consulting agreements were void. These two decisions simply held that for purpose of unemployment insurance and federal income tax withholding, Yak was an employee despite the consulting agreements.

The court held, however, that ERISA waivers require closer scrutiny by the district court than general contract claim waivers. The court held that when ERISA benefits are at issue, the employment status of an individual is not determined solely by the label used by the parties in the contract. In a prior case, the court upheld the waiver of ERISA benefits because it was determined that the plaintiff knew that he may be covered by the ERISA benefits when he relinquished his benefits. See Finz v. Schlesinger, 957 F.2d 78 (2d Cir. 1992)

The appeals court held that the district court erred in dismissing Yak's complaint and that Yak's employment status was relevant to an analysis of a waiver of ERISA employee benefits.

The court remanded the case back to district court for a determination as to (1) whether any of the benefits Yak was seeking were governed by ERISA, (2) Yak's employment status, and (3) the circumstances surrounding the execution of the release. Further, the court held that the district court must subject the waiver to close scrutiny.

Effect on Companies
It is important for companies to remember that employees cannot merely be classified as independent contractors as a means to avoid federal employment tax withholding and contributions for unemployment insurance. The waiver of benefits by an independent contractor may not be upheld if the worker is determined to be an employee and the waiver was not a sufficient waiver for ERISA purposes. Thus, it is important that companies be aware of the various factors examined in determining if an independent contractor is in fact an employee.

To avoid unexpectedly covering certain workers in benefit plans, the plans should be drafted in such a manner (consistent with the overall nondiscrimination and other limitations placed on benefit plans) as to exclude workers by job classification or contractor status, even if these workers are found to be employees. Thus, employers can avoid having their benefit plans cover workers that are later found to be employees and not independent contractors.