'Employees vs Contractors’: Misclassification risks for Start-ups

‘Employees vs Contractors’: Misclassification risks for Start-ups

The recent Californian Labour Commissioner’s finding against ‘Uber’[1] highlights the difficulty that many start-ups face when classifying the employment status of workers. A similar case is unlikely to arise for companies in the traditional retail sector, whose shopfront assistants are clearly hired as employees. Retail start-ups, particularly online ones, wishing to expand their back office capabilities in IT, administration and marketing face the same dilemma of correctly classifying staff as employees or contractors. This article outlines the distinction in Australian law, and what is at stake for start-ups that apply the wrong label.

Business Rationale

Hiring contractors is strategically beneficial for a start-up. Firstly, various ‘workplace relations matters’[2] – superannuation entitlements,[3] occupational health and safety compliance[4] and taxation requirements[5] – need not be included in employment agreements with contractors. Employees are entitled to these benefits, which can add to employment costs and administrative hassle. Secondly, a contractor usually bills a business for the work done, whereas an employee is entitled to an ongoing wage. The flexibility in only paying for tasks commenced is valuable for start-ups that have minimal financial ability to pay workers in quieter business periods. Whilst the ability to control the quality of output is diminished under a contractor arrangement, the financial constraints on a start-up places a greater emphasis on less capital intensive solutions for expansion.

Points of Law

The Legal Distinction

The Fair Work Act governs workplace relations in Australia, but leaves the definition of ‘employee’ to the common law.[6] The majority of the High Court in Hollis v Vabu[7] applied the ‘multi-factor’ approach to determine the working relationship between a courier and his employer. The Court looked to the totality of the circumstances and then balanced the indicators that pointed one way or another. The contractual terms were not determinative of the employment relationship.[8]

Factors that pointed towards an employment relationship were:

  • Employer’s degree of control over the way work was performed[9]
  • Worker uniforms with employer’s logo emblazoned[10]
  • Employer deducted payments from worker’s salaries[11]

Factors that pointed towards a contractor relationship were:

  • Worker provided skilled labour[12]
  • If worker supplied and maintained tools or equipment, particularly if they are expensive[13]
  • Worker paid per unit of work, not per time period engaged[14]
  • No annual leave entitlements paid[15]

A court is unlikely to re-characterise a back office function that has been contracted out by a retail-start up. A service provider normally has control over the their tasks and equipment used. Moreover, these services require specialised expertise. As long as these contractors are paid on a project-by-project basis, it is likely that the contract for services will be correctly classified.

Consequences for Misclassification

Sham Contracting’

The Fair Work Act prohibits an employer misrepresenting to an individual that their employment contract is for work as a contractor.[16] The Fair Work Ombudsman will be responsible for investigating these contracts.[17] A breaching employer could be subject to an injunction,[18] compensatory award,[19] or pecuniary penalty order.[20] An injunction may indirectly increase legal expenses, as a start-up is obliged to amend its employment arrangements if it intends to maintain its contracts for services. The latter two remedies are direct financial consequences. Negative media attention may also be attracted if the misclassification is publicised.[21] In this way, a start-up is likely to face financial and reputational repercussions from misclassification.


A business will be excused from liability if it did not know,[22] or was not reckless as to whether the contract for services was actually for employment.[23] This acts as a presumptive burden on the employer to prove the defence, not for the Ombudsman to negative it.[24] The test for knowledge is subjective and goes to the employer’s ‘state of mind’.[25] It has seldom attempted to be employed by breaching defendants, and consequently has received little judicial attention.[26]

In FWO v Quest, the Federal Court held that s 357 only applies to mischaracterisations of the actual contract of employment, not merely misrepresentations that an employee is an independent contractor.[27] This strict reading of the language of the statute draws attention to the terms of the contract for employment rather than any auxiliary statements made about it. Legal advice is needed to ensure that these contracts are tailored specifically to a start-up’s needs.

Other Consequences

Consequences for misclassification are not limited to the Fair Work Act. A negligent act by an employee performed in the course of their employment will hold the employer vicariously liable.[28] Any professional negligence by an employee mislabelled as a contractor would likely impose liability on a start-up. Moreover, there may be obligations to back pay the worker’s full employee benefits[29]. This lump sum remedy is burdensome on a start-up’s financial planning. These legal consequences may be unexpected for start-ups engaging the services of contractors.


There is a strong business case for retail start-ups to expand back office functions with contractors, but the legal consequences from mischaracterisation can be significant. Firms should not be content that classifying a worker as a contractor is enough to satisfy the ‘multi-factor’ approach. Whether a contractor is an employee will depend on each individual agreement and the unique working relationship. In this way, legal assistance should be sought to ensure that the status of a worker is aligned with the start-up’s intended purpose. A review of existing workers’ agreements is advised.

If you are unsure about the way you have classified your employees, contact Gladwin Legal at , or call 1300 033 934 for a free chat.



[1] Berwick v Uber Technologies, Inc [Superior Court of California, San Francisco County] No CGC-15-546378, 16 June, 2015.

[2] Independent Contractors Act 2006 (Cth).

[3] Ibid s 8(b).

[4] Ibid s 8(d).

[5] Ibid s 8(l).

[6] Fair Work Act 2009 (Cth), s 11.

[7] (2001) 207 CLR 21, per Gleeson CJ, Gaudron, Gummow, Kirby and Hayne JJ; affirmed in Ace Insurance Ltd v Trifunovski (2013) 209 FCR 146.

[8] Ibid 33 [24].

[9] Ibid 40 [43].

[10] Ibid 42 [50].

[11] Ibid 44 [54].

[12] Ibid 42 [48].

[13] Ibid 41 [47].

[14] Ibid 44 [54].

[15] Ibid 44, [55].

[16] Fair Work Act 2009 (Cth), s 357(1).

[17] Evidence to Senate Education and Employment Legislation Committee, Employment, Parliament of Australia, Canberra, 21 November 2013, 72 (Eric Abetz).

[18] Ibid s 545(2)(a).

[19] Ibid s 545(2)(b).

[20] Ibid s 546(1).

[21] ‘Burger Chain Grill’d Ordered to Temporarily Reinstate Sacked Employee’, The Guardian (online), 27 July 2015 <http://www.theguardian.com/australia-news/2015/jul/27/burger-chain-grilld-ordered-to-temporarily-reinstate-sacked-employee>.

[22] Fair Work Act 2009 (Cth), s 357(2)(a).

[23] Ibid s 357(2)(b).

[24] Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd (2015) 228 FCR 346, 402 [241]-[242] (North and Bromberg JJ), 416 [337] (Barker J) (‘FWO v Quest’).

[25] Ibid 404 [257] (North and Bromberg JJ), 416 [338] (Barker J).

[26] See, eg, Linkhill Pty Ltd v Director, Office of Fair Work Building Industry Inspectorate [2015] FCAFC 99 (22 July 2015); Tattsbet Ltd v Morrow (2015) 321 ALR 20.

[27] FWO v Quest, 366 [77] (North and Bromberg JJ), 411 [308] (Barker J).

[28] Bugge v Brown (1919) 26 CLR 110, 119 (Isaacs J); affirmed in Ffrench v Sestili (2007) 98 SASR 28, 37 [33] (Debelle J).

[29] Fair Work Act 2009 (Cth), s 545(1).