Reducing Independent Contractor Risk From Your Franchise Business

June 26, 2012

I’ve been on the franchise annual-convention circuit for the past couple months and it’s been interesting to hear about franchisees’ concerns. This year, no matter the franchise system, three issues of concern have consistently popped up:

  1. The use of independent contractors,
  2. Social media and the management of employees; and
  3. Data Privacy/Cyber Liability concerns.

I’ll address each of these in separate posts going forward, though for now, let’s look at the question of using independent contractors first, and how this can affect both the franchisees and the franchisor.

Independent Contractor vs Employee 
Independent contractors have been used by business for probably as long as business has been around. They can be an effective tool to help manage labor costs and many independent contractors like the flexibility that comes with this type of employment.

But over the past several years, case law and government agency regulations have increased the scrutiny on independent contractor employment arrangements. The federal government estimates that over 50% of independent contractors are misclassified; these workers should actually be classified as employees.

The state and federal governments are really looking at the issue of control when defining an employment arrangement. In other words, where, how and what control do you exert over the independent contractors and how they do their job. You can read more detail on this how the IRS determines whether the relationship between a business and its workers is an employer-employee or business-independent contractor one here.

You should consult with your legal and tax advisors to ensure your employment arrangements are proper and compliant with your local legal and regulatory requirements.

Independent Contractor Insurance Can Reduce Risk 
Given the increased scrutiny on employer-contractor relationships nowadays, it’s more important than ever how you structure your insurance coverage, and what you should require from your independent contractors in order to effectively and legally help reduce your risk.

If you are a franchisor and your franchisees are using independent contractors, it is important that you put guidelines in place regarding the proper insurance coverage required. These should be consistent and clear throughout your franchise system. If not, your franchisees—and possibly you—could end up holding additional liability.

Some key things to consider as you weigh your insurance options:

  • If your franchisees are primarily sole proprietors but occasionally use independent contractors to help them when needed, you should require both your franchisees and their independent contractors to carry the proper insurance coverages. Here’s why: If an independent contractor working on behalf of a franchisee causes damage at a client site (home, store, building, etc) and/or their property and they do not carry insurance, this claim will in all probability fall on the franchisee. The franchisor will most likely be named as well, so it’s important make sure the franchisor is listed as Additional Insured on all appropriate coverages.
  • Sole proprietors and independent contractors should carry their own workers’ compensation insurance and verify their coverage for you by providing you with a certificate of insurance. Additionally, while this is only one step in the model the IRS uses to distinguish between contractors and employees, it will help protect you in a few ways:
    • First, it will indemnify the injured person if they cannot work, and workers comp provides first dollar medical coverage.
    • Second, this reduces the likelihood that they would come back to you looking for coverage.
    • Third, it reduces the risk that you might have to pay back taxes and fines related to workers’ compensation taxes. 
  • Auto coverage: Some carriers limit non-owned only coverage to be in excess of employees coverage and will exclude independent contractors. Again, this can significantly put your franchise brand at risk

Let me stop here before I get carried away even further on the technical components of franchise insurance requirements. Just remember you can, and will, be involved in settling any claim that arises from the use of an independent contractor, especially if you have not verified they have the proper insurance in place.

For these reasons, and more, it is critical that you work with professional services firms—CPAs, attorneys and insurance brokers—that have experience with independent contractors and franchising.