Industrious Conversations: How Closing the Loopholes affects contractors

Elissa:

Hello and welcome to Ashurst Legal Outlook. This is our podcast in our new series, bringing you insights into industrial relations developments in Australia from our leading Employment team at Ashurst. My name is Elissa Speight, and I'm a partner in the Employment team in Canberra. I'm joined today by Jane Harvey, who's a partner in our Employment team in Melbourne.

If you've listened to the other podcasts in this series, you might've noticed that there are two key themes in relation to the Closing the Loopholes changes that emerge. One is strengthening the protections for and regulation of workers, including workers who aren't employees, and the other is extending the scope of the Fair Work Commission to intervene in workforce matters. Today, we'll be discussing how the Closing the Loopholes reforms impact independent contractor arrangements, and we see those two themes coming through in this topic too.

Jane:

That's right, Elissa. We're going to be talking about three particular changes impacting independent contractor arrangements. The first is changes relating to the classification of a worker as an employee or a contractor.

The second is the introduction of a new unfair contract terms jurisdiction for contractors. And lastly, we're just going to be touching briefly on some changes to the defences that are available where a sham contracting claim is made.

Elissa:

So let's start with the changes that impact how workers are classified and, in particular, whether or not they are an employee for the purposes of the Fair Work Act. This is obviously a fundamental question because it determines which protections and obligations in the Fair Work Act will apply to that person. For the most part, the Fair Work Act provides that the words "employer" and "employee" are given their ordinary meanings.

That's still the case, but one of the most significant changes in the Closing the Loopholes amendments is the insertion of Section 15AA. That section changes the way in which the ordinary meaning of those terms is to be determined. In particular, the new section requires that the ordinary meanings of "employer" and "employee" are now to be determined by reference to the real substance, practical reality, and true nature of the relationship between the parties.

So this really requires the totality of the relationship between the parties to be considered in characterising the relationship as one of employment or one of principal and contractor. And that includes looking not only at the terms of the contract governing the relationship, but also the manner of performance of that contract.

So Jane, before we talk about the implications of this change, maybe you can take us back to what the approach was to determining whether a worker was an employee or a contractor before the Closing the Loopholes amendments.

Jane:

Thanks, Elissa. Well, you might recall that prior to the Closing the Loopholes amendments being made, the High Court back in 2022 had held in two separate decisions, one was CFMMEU v Personnel Contracting, that where a comprehensive written contract exists, the question of whether an individual is an employee of a person is to be determined solely by reference to the rights and obligations found in the terms of that contract and that it's not necessary or appropriate to engage in a wide-ranging review of the parties' conduct in performing their obligations under that contract.

So, in other words, contract is king for working out whether a worker is an employee or a contractor. So the new Section 15AA that Elissa has just explained to us effectively overturns the High Court's decisions and reintroduces the multifactorial test for determining whether a person is an employee or an independent contractor. So while the terms of the contract are still going to be relevant to that classification, a business that engages natural persons as independent contractors can no longer rely on the primacy of those contractual terms to defend a claim that a person is, in fact, an employee for the purposes of the Fair Work Act.

Instead, how the contract is performed in practice and any changes that might occur in those arrangements over time can now influence the assessment of whether an individual is an employee or a contractor. So the multifactorial test returns. Elissa, do you want to give us a bit of a refresher on what the relevant factors are?

Elissa:

Thanks, Jane. So there are a considerable number of case authorities which identify the factors that are relevant in the characterisation of a relationship as one of employment or one of contractor and principal. I'm not going to go through them all in detail, but at a high level, the factors include the actual terms and terminology that's used in the contract, the degree of control that the principal can exercise over the worker, including the way in which the work is carried out and the nature of the worker's entitlements. That includes things like the way in which they're remunerated for their services and whether there are any leave entitlements, whether the worker provides exclusive services to the principal or whether they're also providing their services elsewhere, and whether the worker provides and maintains their own equipment or whether that's provided by the principal. It's important to remember that these factors aren't exhaustive. I haven't covered all of them, and they also may be weighted differently depending on the particular circumstances.

So there is an inherent uncertainty in determining whether a worker is an employee or an independent contractor. In a minute, we'll talk a little bit about some practical guidance for principals in light of these changes. But first, it's important to briefly touch on why correctly classifying workers as employees or independent contractors actually matters. So basically, it's important to get this right because if an independent contractor is found to be an employee, then the employer will be liable to remediate that worker for any unpaid minimal employment entitlements.

So that would include things like wages, overtime, or allowances. The employer will also have to credit leave entitlements that have been accrued during the relationship, and the employer would also have to pay taxes and make superannuation contributions that hadn't been made during the course of the contract. The employer could also be exposed to potential penalties and other compensation for its failure to provide these entitlements. So noting those risks, Jane, what are some practical steps that can be taken by a company to ensure that the contractors in their business are less susceptible to being characterised as being an employee?

Jane:

Thanks, Elissa. The first one is hopefully obvious. You should only be entering into contractor arrangements where the facts support the arrangement being a contractor arrangement by reference to those indicia that Elissa has taken us through. If you're then satisfied that the relationship can be properly characterised as an independent contractor arrangement, you need to set things up in a way that ensures that the factors which support that characterisation are reflected in the arrangements both in the written contract, and we would definitely recommend having a written contract, but also in practice.

So it's not going to be very helpful, for example, if the contract says that the contractor is going to need to issue invoices in order to be paid, but that doesn't actually happen, and the principal instead just regularly pays the contractor the same amount each month, for example. The next thing to do is to ensure that the contractor is actually performing the services that have been agreed in the contract. I think that if the contractor starts straying into providing other services, particularly if they are services that might otherwise be performed regularly by employees, that can give rise to some issues. You should also make sure that contractors are not being treated like employees in practice.

So again, an example of this is that the contractor is going to be held to, and accountable for, the particular deliverables that are referenced in the contract. So if the contractor is not meeting those deliverables, don't go and put them on a performance improvement plan as you would in the case of an employee who is not performing their duties to the level required. And I think, finally, you just need to be making sure that you're regularly reviewing your contractor arrangements and continuing to assess whether those arrangements, as they're transpiring in practice, continue to reflect a relationship which is genuinely one of principal and independent contractor.

Elissa:

Another feature of the Closing the Loopholes amendments in relation to contractors is that there's now this ability for individuals to opt out of the application of Section 15AA. Can you explain the opt-out regime for us?

Jane:

This is one that I must say I only came to a bit late, noticing that this was actually a feature of the Closing the Loopholes changes, and I still find it a slightly odd kind of regime. In essence, what individuals can do is that if they earn over the high-income contractor threshold, then they can essentially issue an opt-out notice. We're going to come back in a minute to talk more about that high-income threshold, but it has been set at the moment to be $175,000.

That, interestingly enough, aligns with the employee high-income threshold. So if a contractor who earns above that threshold issues an opt-out notice, the effect is that Section 15AA in the Fair Work Act won't apply, and instead, you revert back to that High Court position in Jamsek v Personnel Contracting for the purposes of determining the status of the relationship. So that is provided that the arrangement is not a sham arrangement, the contractual terms will determine whether it is an independent contractor relationship or not.

Now, the contractor can give that opt-out notice at any time, but it is also possible for the principal to invite the contractor to issue an opt-out notice if the contractor hasn't already done so. And the principal can do that in circumstances where, as I've said, the contractor earns over the high-income threshold but also where the principal considers that if the totality of the relationship is considered, the relationship may be deemed one of employment. Once the principal issues that invitation, the individual then has 21 days to issue that opt-out notice.

One of the really important things to note about the opt-out notice scheme is that the contractor can actually revoke an opt-out notice at any time. What happens then is that you're back to having to apply the definition of "employee" in the Act, so that's section 15AA that Elissa talked about at the top of the podcast. And so, rather than having certainty that the nature of the relationship will be determined by reference to the contractual terms only, you would need to look at the totality of the relationship. So that means the written contractual terms, but also what is happening in practice.

Elissa:

So it sounds like opt-out notices aren't a complete answer to managing the risks of misclassification in this space. So what are some things that the principal can do to manage the risks that you've just described arising from the opt-out regime?

Jane:

I think that what it essentially means is that companies need to be ensuring that both the contractual terms and the arrangements in practice are consistent with the person being classified as an independent contractor so that even if the opt-out notice is revoked, the individual would not be classified as an employee. That's not to say I don't think that there isn't any utility at all in an opt-out notice.

I think that it is sensible for companies to review the kinds of contractor cohorts they have and identify those contractors where the use of an opt-out notice would be prudent and straightforward. And I think in many cases, it's likely to be in the interests of the contractor to actually issue the opt-out notice and have certainty as well about the characterisation of the arrangement.

So I think what companies need to be doing is doing that identification of where they might sensibly be using opt-out notices and then develop a framework around that. So what are the circumstances in which you're going to request or possibly require a contractor to provide an opt-out notice. I think, though, like many aspects of the Closing the Loopholes, we're going to have to just watch this space and see how the law develops in this area.

Elissa:

So one point that you've touched on there is the high-income threshold for contractors. And it's really interesting that this is the same as the employee high-income threshold.

The threshold relates to the individual's earnings for work performed under the relationship, but "earnings" aren't defined for this purpose. So it's another area where there is some potential complexity. Jane, is the contractor high-income threshold relevant for any other purpose in addition to the opt-out notice?

Jane:

It is indeed Elissa. I'm glad you asked. I mentioned right at the beginning that the second topic we're going to look at was a new jurisdiction that has been introduced as a result of the Closing the Loopholes changes, which is an unfair contracts jurisdiction. So that new jurisdiction is intended to provide a low-cost and accessible dispute resolution avenue for what's been described, at least in the Explanatory Memorandum, as "low-leveraged independent contractors" being essentially, independent contractors who earn below the high-income threshold, who otherwise lack the means to apply to a court for dispute resolution. So under this new jurisdiction, independent contractors who earn less than the high-income threshold can now bring a claim in the Fair Work Commission in respect of any unfair term in their contract, provided that the term, if it was an employment relationship, would relate to a workplace relations matter.

Elissa:

So what are "workplace relations" matters? How broad are we talking?

Jane:

Well, "workplace relations" matters could include remuneration or allowances, leave entitlements, hours of work, rights to enforce or terminate the contract, disputes and dispute resolution, industrial action, and any other sort of substantially similar matters. What it wouldn't include are things like discrimination, superannuation, workers compensation, or health and safety, just to name a few.

Elissa:

So Jane, how does the Commission then go about determining whether the terms of the contract are unfair?

Jane:

So the Fair Work Act's criteria for assessing whether a term of a services contract is unfair broadly replicates the terms in the Independent Contractors Act.

When dealing with an unfair contract application, the Fair Work Commission can consider any relevant matters, and that includes the relative bargaining power of the parties, whether the contract as a whole displays a significant imbalance between the rights and obligations of the parties, whether the term is reasonably necessary to protect one's legitimate interests, whether the term in question imposes a harsh, unjust or unreasonable requirement on a party to the contract, and whether the remuneration payable under the contract is lower than what would be payable to an employee.

Elissa:

So if the Commission does decide that a term in a contract is unfair, what happens next?

Jane:

So if a term is considered to be unfair, the Fair Work Commission can amend, vary or set aside all or part of the contract, and a person would then be liable for a civil penalty if they don't comply with the contract as amended by the Commission. To be clear, though, it's not actually an offence simply to include in a contract a term that is ultimately considered to be unfair.

Elissa:

So in order to manage these risks that we've just talked about, I imagine that companies that need to engage independent contractors should be reviewing all the templates that they use for engaging independent contractors with a view to identifying any clauses which may be considered unfair, and then when they're entering into contracts, considering the circumstances of that particular individual contractor and making any necessary adjustments to the template terms where appropriate for that contractor.

Jane:

Yes, that's exactly right, Elissa. And maybe just before we move on from this topic, one final point is that I've mentioned that this jurisdiction is only available for contractors who earn below the high-income threshold.

For contractors who earn above that threshold, they can still utilise that unfair contracts regime that is in the Independent Contractors Act 2006 that I've already mentioned. And finally, the new regime can only be used for contracts that were entered into after 26 August 2024.

Elissa:

Another change arising from the Closing the Loopholes amendments relates to sham contracting. The Fair Work Act provides that an employer must not represent to an individual that the contract is a contract for services or an independent contractor arrangement when, in fact, it's a contract of employment. So in other words, these provisions protect against employers misrepresenting the true nature of the arrangement.

The defence to misrepresenting employment as an independent contracting arrangement has now changed, and it's gone from a test of recklessness to one of reasonableness. So previously, it was enough to establish that the employer believed that they were not reckless in that belief in relation to the nature of the relationship. Under the new test, an employer will need to establish that they reasonably believed that the contract was a contract for services rather than an employment contract.

So the test has changed from one of recklessness to reasonableness. So what that means is that while the previous defence considered the employer's subjective belief, what they actually believed, and then applied an objective standard of recklessness, the new defence assesses the employer's belief against a more objective and lower standard of whether that belief was reasonable.

The reasonableness of the employer's belief will be assessed with regard to the size and nature of its business, as well as any other relevant matters. For example, if the employer was acting on external advice. The more sophisticated the business, the higher the standard that it will be held to.

Jane:

Thanks, Elissa. So what happens if an employee successfully argues that the contract is a sham, and what should employers be thinking about in trying to manage that particular risk?

Elissa:

So where an employer is found to have engaged in sham contracting, then they'll be potentially liable for a civil penalty. They could also face liabilities from any consequences of misclassification, which have arisen from the representation. And I talked about those a bit earlier, the sorts of liabilities that arise where a person hasn't been paid the minimum employment entitlements during the relationship and where they are then later classified as an employee.

The higher bar of successfully defending a sham contracting claim increases the need for companies to conduct, and in particular, to document, a robust assessment of the anticipated nature of each arrangement before engaging a contractor. Employers should also consider other ways of managing this risk, such as by requiring the contractor to be engaged via an incorporated entity.

Jane:

Well, thanks so much, Elissa. It's been really great talking to you today about independent contractors.

Elissa:

Thanks very much, Jane.

Jane:

To bring all of that together, there's a lot of things for companies to be thinking about when engaging independent contractors following these changes as a result of the Closing the Loopholes amendments. So just quickly to recap, companies should be thoroughly considering the nature of each engagement with an independent contractor before offering a contract. You should also think about whether and when opt-out notices might be utilised. You should review and update standard form documents for engaging contractors.

Really importantly, given the importance of making sure that the practical arrangements reflect contracting arrangements, make sure that your managers understand these changes, and when a worker will be an independent contractor and how those arrangements should be managed in practice so as to ensure they are not in fact employment arrangements. And finally, regularly review arrangements with contractors to make sure that if challenged, they will withstand scrutiny.

Well, that's it for us today. Thank you so much for listening. To hear more Ashurst podcasts and to ensure that you don't miss any future episodes in a series, just subscribe now on Apple Podcasts, Spotify, or your favourite podcast platform.

Also, please do reach out to our Employment team if you'd like to discuss this topic more. It's one that we are following closely and we have a keen interest in. We're really waiting to see how it all unfolds. We hope that you can join us next time to gain insights from other members of our leading Employment team here at Ashurst as we continue to explore key developments in industrial relations in Australia. Until then, thank you for listening, and goodbye for now.

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