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Small Employers Beware: Employee Misclassification and Increased Identification and Prosecution of Non-Insured Employers by the North Carolina Industrial Commission

by: Richard T. Granowsky, J.D.

August 11, 2017

Three is a magic number in NC Workers’ Compensation. For most businesses, three is the number of employees that means you need to buy and maintain workers’ compensation insurance. Unfortunately, it is not always clear who counts as an employee under the NC Workers’ Compensation Act (“the Act”). Many years ago I had a conversation with the Deputy Commissioner who was handling the Industrial Commission’s non-insured docket at the time. I was explaining to him how there seemed to be a mistake because my client had fewer than three employees. His response got my attention. As I recall it, he said, “I’ve been trying these cases for 10 years and I haven’t seen an employer with less than three employees yet.” We worked that case out quietly and got it settled and approved without any penalties assessed against my client. Times have changed and a business (and its owner) who finds itself on the wrong side of the non-insured docket at the Industrial Commission is much less likely to escape the encounter without fines, civil penalties and possible criminal charges. Businesses operating in North Carolina that do not carry workers’ compensation insurance should consult with legal counsel to confirm that they are not required to be insured under the Act.

On December 18, 2015, former Governor McCrory signed Executive Order No. 83, entitled, “Employee and Employer Fairness Initiative.” The Executive Order established the Employee Classification Section within the Industrial Commission, established liaisons between the NC Department of Revenue, the Industrial Commission, and the Division of Employment Security, and mandated processes to receive employee complaints of misclassification and for the sharing of information between State agencies for the purpose of identifying misclassified employees, enforcing compliance, and prosecuting violations. The dangers of employee misclassification have been widely discussed over the past few years in the contexts of potential tax and wage and hour consequences. Less attention has been paid to the potential consequences under the Workers’ Compensation Act.

The Industrial Commission has established a Compliance and Fraud Investigation Section, which is composed of a Compliance Unit and a Criminal Investigation Unit. The Compliance Unit handles civil cases involving employers who are operating as non-insured employers in violation of N.C. Gen. Stat. §97-93 and §97-94. The Compliance Unit uses a database known as the Noncompliant Employer Tracking System (NETS), which uses data from various state agencies to identify potentially noncompliant employers. In addition, non-insured employers are identified by direct employee complaints and as the result of workers’ compensation claims by injured workers made against non-insured employers. Completed investigations and gathered evidence from the Compliance Unit is presented by the Office of the Attorney General during the Industrial Commission’s non-insured penalty hearings. According to the NC Industrial Commission’s 2015-2016 annual report, from fiscal year 2010-2011 to 2015-2016 the annual fines and penalties it collected for noncompliance with the workers’ compensation insurance requirement increased from $0 to $1,495,963.00.

The Commission’s Criminal Investigation Unit operates as a law enforcement agency. Between fiscal years 2012-2013 to 2015-2016, criminal charges filed against noncompliant employers increased from 10 to 150. Willfully failing to comply with the obligation to obtain and maintain workers’ compensation insurance is a Class H Felony. Neglecting to maintain workers’ compensation insurance is a Class 1 misdemeanor.

The financial consequences to a business and its owner(s) of failing to comply with the insurance requirement can be severe. A minimum fine of $50.00 a day (maximum fine of $100 a day) is imposed for each day that the employer was required to maintain insurance, but failed to be insured. The business is also liable for the payment of compensation due to any injured employee during the uninsured period (both indemnity and medical compensation). Finally, any person who had the ability and authority to bring the employer into compliance with the insurance requirement and fails to do so may be assessed a civil penalty up to 100% of the amount of compensation due to employees injured during the uninsured period. A review of recent Industrial Commission decisions shows that in cases involving injured workers, the Commission is routinely assessing both a $50.00 per day fine for the uninsured period and imposing a civil penalty of 100% of the combined indemnity and medical compensation awarded to the worker against the owner of the non-insured employer.

There are multiple reasons for employers to mistakenly believe they are not required to maintain workers’ compensation insurance. The misclassification of employees as independent contractors is at the top of the list. However, employers also get into trouble when they fail to count corporate officers as employees, misconstrue the meaning of “casual employment”, or subcontract work out to uninsured subcontractors in certain contexts.

In determining whether on not a worker is an employee or an independent contractor, the Industrial Commission uses the common law test set out in Hayes v. Elon College, 224 N.C. 11, 29 S.E.2d 127 (1944). Under this test, an independent contractor:

  1. Is engaged in an independent business, calling or occupation;
  2. Is to have the independent use of his special skill, knowledge, or training in the execution of the work;
  3. Is doing a specified piece of work at a fixed price or for a lump sum or upon a quantitative basis;
  4. Is not subject to discharge because he adopts one method of doing the work rather than another;
  5. Is not in the regular employ of the other contracted party;
  6. Is free to use such assistants as he may think proper;
  7. Has full control over such assistants; and
  8. Selects his own time.

No one factor is controlling and not all factors have to be met to make the determination. The Commission makes its determination based on a preponderance of the evidence standard. Suffice it to say that while reasonable minds may differ on the application of the test to specific facts, the Industrial Commission’s determination, if supported by some competent evidence, is the determination that matters.

A quirk in the Act that can catch businesses unawares is that corporate officers of for profit corporations are counted as employees. However, sole proprietors, members of LLCs, and partners are not automatically counted as employees. Consequently, a sole proprietor with two employees is not required to maintain workers’ compensation insurance. However, everything else being equal, if that sole proprietor incorporates his or her business and becomes a corporate officer, the business is now counted as having three employees and is subject to the insurance requirement.

N.C. Gen. Stat. §97-13(b) excludes from the Act employers that have regularly in service less than three employees in the same business within the state. The phrase “regularly in service” opens the door to arguments that some employees should be excluded from the count because they are not “regularly in service”. The phrase “regularly in service” is not defined in the Act, but has been interpreted to mean “employment of the same number of persons throughout the period with some constancy.” Patterson v. L. M. Parker & Co., 2 NC App. 43, 48-49, 162 S.E.2d 571, 575 (1968). The number of employees on the date of a workplace injury is not determinative. Nor does the Act define the period during which the number of regularly employed persons should be determined. Employing the statutory number of employees during a two month period preceding a workplace accident was enough to require coverage in Hunter v. Peirson, 229 N.C. 356, 49 S.E.2d 653 (1948), but where for the six weeks preceding an injury the employer had less than the statutory number, coverage was not required in Patterson, supra, 2 NC App. at 48-49, 162 S.E.2d at 575. Employers who periodically work three or more employees in the course of a year, but not throughout the year, are placed in an uncertain position and are exposed to some degree of risk if they choose to not to purchase workers’ compensation insurance.

Principal contractors, intermediate contractors and subcontractors who sublet work have special obligations as statutory employers of their uninsured subcontractors and their employees. See N.C. Gen. Stat. §97-19. With the exception of contractors who contract with individuals in the interstate or intrastate carrier industry who operate a truck, tractor or truck tractor trailer licensed by the U.S. Department of Transportation, contractors who obtain a certificate of insurance from their subcontractors establishing compliance with 97-93, are protected from liability. However, a higher level contractor who fails to obtain such a certificate from a subcontractor is liable for compensation to the injured workers of an uninsured subcontractor on the project. This is true whether or not the subcontractor regularly employs three employees and is obligated to maintain insurance under 97-93. Notwithstanding being insured itself, a higher level contractor who fails to ensure that a subcontractor is properly insured may be held liable for a civil penalty up to 100% of the compensation (indemnity and medical) due to the subcontractor’s injured employee under 97-94(d). See Putman v. Alexander, 194 N.C. App. 578, 670 S.E.2d 610 (2009).

Contractors who contract with individuals in the interstate or intrastate carrier industry who operate a truck, tractor or truck tractor trailer licensed by the U.S. Department of Transportation, regardless of whether or not they employee three or more employees, are obligated to obtain insurance under 97-93 to cover themselves personally and for their employees and subcontractors and are liable as the employer under the Act on account of injury or death of the independent contractors and their employees and subcontractors due to an accident arising out of and in the course of work covered by the contract. N.C. Gen. Stat. §97-19.1. The only exception from liability in this context is if the person contracted with is an independent contractor individually licensed by US DOT and that individual is personally operating the vehicle solely pursuant to that license.

In addition to the situations discussed above, there is another set of non-insured situations that arise as the result of workers’ compensation renewal and cancellations problems between employers and their respective carriers, and miscommunications between and among co-employers and their carriers. These situations are outside of the scope of this article, but employers should be mindful that the obligation under 97-93 is to both obtain and maintain proper workers’ compensation coverage.

There is every reason to believe that the state and the North Carolina Industrial Commission will continue to apply resources to increase its capacity to detect non-insured employers, force compliance, assess civil penalties and pursue criminal prosecution of non-insured employers. Smaller employers and employers that rely on independent contractors and casual labor who do not maintain workers’ compensation insurance should review their situations with competent counsel to evaluate their risk of being found to be non-insured employers in violation of N.C. Gen. Stat. §97-93 and §97-94.

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