From the March 2001 issue of Entrepreneur

Interwest Insulation of Seattle had 16 employees-enough to require a raft of paperwork but not enough to justify a human resources manager to take care of it all. And like many small businesses, Interwest couldn't afford to offer its employees big-league benefits. So Interwest turned to an employee leasing company.

Owner Scott Sonners entered into a contract with Barrett Business Services Inc. in which Barrett hired almost all of Interwest's employees, including Sonners himself, then leased them back to Interwest. The two companies became joint employers. The employee leasing agreement stated that the workers would be employees of Barrett for certain purposes, including hiring, discipline and firing, payroll, benefits, and workers' compensation insurance. Interwest would retain control of the business side of employee issues and follow Barrett's instructions on such matters as workplace safety. Under the new arrangement, safety improved and so did employee benefits. Sonners was able to concentrate on the business of his company rather than on keeping track of employee paperwork.

Although such industries as building security have leased employees for decades, leasing of general employees has been commonplace for only about 15 years. "The law is still catching up," says Miami attorney Norman Davis of Steel, Hector & Davis LLP, who has represented some of Florida's largest employee leasing companies. Davis contends that leasing employees can be ideal for entrepreneurs because it frees them to focus on their businesses. "They're entering these arrangements so they can get all the paperwork off their backs," he says. But because the field is regulated by state laws that vary widely, it's easy to trip over legal stumbling blocks.

Complicating the matter is the fact that "employee leasing" can refer to a whole spectrum of arrangements. At one end is the traditional temporary worker, employed by a temp agency and dispatched to clients to help with seasonal overloads, employee vacations and such. Large corporations have expanded this concept into the usage of long-term temps, often highly skilled people working on contract to complete a particular project, sometimes for years. Typically, long-term temps receive no benefits. Indeed, many large companies use long-term temps to avoid paying benefits. (That backfired a few years ago for Microsoft when a court ruled that long-term temporary computer programmers working side by side with the company's regular em-ployees, doing the same work year after year, should be entitled to the same stock options as its regular employees.)

At the other end of the spectrum stand thousands of small businesses leasing employees for the opposite reason: They want their employees to have health insurance and other benefits, which leasing companies can offer at affordable rates because they're pooling thousands of employees. Typically, a business will turn its entire work force over to the leasing company for purposes of payroll, taxes, benefits and so on. Many leasing companies now prefer to be called "professional employer organizations" (PEOs) to distinguish themselves from temporary agencies.

In the early days, some leasing companies insisted that they were the sole employers, and that the workers were merely leased to client companies that were to be absolved of all liability for employment-related lawsuits. Few make that claim anymore because off-site companies can't exercise control over such matters as sexual harassment. Indeed, leasing companies in Florida recently persuaded the state legislature to pass a statute declaring that the parties in leasing arrangements are considered co-employers.

In any state, it's up to the parties involved to decide who should be responsible for what. Typically, the client company is responsible for matters involving the business and the direct supervision of employees, while the PEO is responsible for all other matters related to employment. The distinction is spelled out in an extensive employee leasing agreement. "If it's clear in the agreement," Davis says, "courts tend to recognize it."


Steven C. Bahls, dean of Capital University Law School in Columbus, Ohio, teaches entrepreneurship law. Freelance writer Jane Easter Bahls specializes in business and legal topics.


Stating The Case

But not always. Back in Seattle, Interwest Insulation was getting along just fine-until the Washington State Department of Labor and Industries decided to conduct an audit. The auditors learned Interwest had not been paying state workers' compensation premiums, and they didn't buy the explanation that the firm's employees were covered by Barrett, which met state standards for self-insurance. An administrative law judge determined that Interwest was the sole employer, liable for $38,453 in unpaid industrial insurance premiums. After the Board of Industrial Insurance Appeals affirmed that ruling, Sonners took it to court and lost. Last June, after five years of legal wrangling, the Court of Appeals of Washington affirmed again. The appeals court noted that under state law, the employer is the one who exercises control over the employees. Co-employers must both exercise control, and Barrett did not. Interwest was in charge of hiring and firing employees, sending workers to job sites, providing materials and directing jobs to be done. State law overruled the contract between the companies. (Although Sonners has since sold the business's assets, he plans to appeal to the Washington Supreme Court.)

Attorney James Harward, who just completed a term as chairman of Utah's professional licensing board for PEOs, notes that state laws in this area are often quirky. "Some states require that the PEO takes some role in hiring and firing," he says. "A lot of states are not up to speed-for instance, they're stuck on who issues the W-2 form." For example, Nevada requires three workers' compensation policies-one for each co-employer and one for both. Utah, on the other hand, requires a master policy and two subpolicies.

So if you're thinking of signing on with a PEO or employee leasing company, have your attorney draft the contract or go over it carefully to make sure all relevant state laws are addressed. And be aware that state laws in this area are still evolving, so you may need periodic updates.

Other Points To Consider

Be aware of other legal issues that might crop up if you work with a PEO or leasing company:

1. Financial instability: In a typical arrangement, the PEO collects money from clients for payroll, taxes, benefits and the like, then distributes it to the employees. If several clients fail to pay their bills, the PEO may have trouble meeting its obligations. Make sure the PEO is financially strong enough to weather the storm.

2. Thresholds: Many state and federal employment laws, including the Title VII discrimination laws, the Americans With Disabilities Act and the Age Discrimination in Employment Act, apply to firms with 15 or more employees. If your 10 employees are now co-employed by a company with 15,000 others, your company might be subject to those laws. While that provides legal protection your employees might value, it opens your business- to serious liability if an employee gets mad and sues. Make sure you have enough insurance.

3. Liability issues: Although early leasing companies claimed that they could protect client companies from employment-related liability, that's not likely. "There's not much case law on whether leasing companies will exonerate the client," says employment litigation attorney Anthony J. Carriuolo of Berger, Davis & Singerman in Fort Lauderdale, Florida. "But I expect that it will not. If you control the situation, you ought to be held liable." Indeed, the new Florida statute gets the leasing company off the hook for discrimination, harassment and other civil wrongs if it exercised no control over the day-to-day job, didn't authorize the wrongdoing and didn't know about it.

4. Workers' comp rating: Over the years, your company builds a reputation for safety that can reduce workers' compensation premiums. One of Carriuolo's clients who had an excellent record used an employee leasing company for several years, then terminated the relationship. The company then got rated by the state as a new employer, and therefore was charged a more expensive rate. While the risk of that happening might be worth the benefits of leasing, be aware of the possibility.

5. Fuzzy contracts: Most PEOs and employee leasing companies have stand-ard contracts. As an entrepreneurial firm, you may not have the leverage to change your agreement. But make sure your attorney examines it carefully to make sure it addresses every issue, clarifying who's responsible for what, with an eye to your state's law.


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