Compliance & Investigations
Is compliance still possible when using independent contractors? – New developments in the Federal Social Court and their impact on practice
Using independent contractors for a longer period of time in such a way that they are not regarded as falsely self-employed is becoming more and more of a gamble. Social security institutions have recently intensified their audit work considerably; the Main Customs Office is more and more likely to be found knocking at the door. Based on one of its more recent decisions, the Federal Social Court (Bundessozialgericht) seems to be narrowing the discretion even further. However, a decision from March provides hope.
I. Judgment of the Federal Social Court of 18 November 2015
After the 12th senate of the Federal Social Court initially regarded a rack jobber as an independent contractor in its judgment of 31 March 2015 (B 12 KR 17/13 R), it changed its mind roughly six months later, namely on 18 November 2015 (B 12 KR 16/13 R), and found that an employment relationship existed. The latter decision caused a bit of a stir, with good reason, since the Federal Social Court seemed to be departing from some key principles for making distinctions:
1. Employment requiring social security contributions
At least the Federal Social Court concedes that the contracting parties’ intent - which is documented in the agreement - not to want to establish an employment relationship requiring social security contributions can be seen as an indication of self-employment; it can "tip the scales" in the overall assessment. For this reason, a corresponding provision should not be left out in any contract with self-employed persons.
2. Continued payment of remuneration in the event of illness or vacation
However, the senate does not attach any additional significance to provisions according to which there is no continued payment of remuneration in the event of illness or vacation/no vacation allowance is paid, and the contractor himself is obliged to pay tax on his income and to make his own social security and health insurance payments. This, too, is only intended to express the same intent of the contracting parties. But it is therefore still a good idea to include these provisions as well.
3. Secondary employment and refusal of offers for work
What is confusing is the senate’s statement that the contractor’s right to refuse offers for work and to also work for other customers is of little importance. Previously, these were key arguments in support of a freelance activity; the tried and tested arrangement with a framework agreement and related individual contracts that the contractor can freely accept or refuse was also based on these arguments. As grounds for its view, the senate claims that, ultimately, the situation prior to accepting work is essentially the same as it is for a job-seeker, who is likewise free to accept or refuse a job offered to him. The comparison is clearly inappropriate, given that job-seekers are not employees. The right to refuse work should still be included and cited as an argument against employment status.
4. Freely organised work activities
Work activities that are essentially freely organised shall only indicate self-employment if they are in fact an expression of a freedom from instructions and not just a "consequence of assigning greater personal responsibility to the individual employee in order to have tasks performed where, otherwise, there is continued proper participation in the work process". In this case, the core criterion of freedom from instructions is devalued even though it is not clear what case the senate actually has in mind. When it comes to organisation, it is still important that the work activities be more or less free from instructions.
If the contractor is not bound by instructions with respect to the place of work and/or working hours, but instead these follow from the nature of the work, this lack of a duty to follow instructions shall not serve as an argument against employment status. Even if the activities are augmented by additional tasks entailing greater responsibility, and include more options for independently organising the work, these aspects shall not militate against employment status as long as the contractor cannot use them to increase his earnings potential.
5. Use of third parties as vicarious agents
Previously, the right of the contractor to also use third parties as vicarious agents in order to carry out work was a strong indication of a freelance activity. However, the senate now regards this as just one of several indicators against the assumption of an employment relationship to be considered within the framework of an overall assessment; the delegation of the owed performance to third parties must, in the individual case, be characteristic of an independent activity and, in particular, the contractor must be able to realistically make use of this. Thus, from the customer’s point of view, it can also consider expressly encouraging contractors to utilise third parties when carrying out the work. Of course this should also be expressly permitted in the contract itself.
6. Entrepreneurial risk and resulting opportunities
Entrepreneurial risk and resulting opportunities have always been a strong argument for assuming a freelance relationship. According to the senate, however, the mere risk that - apart from the performance of individual contracts - one occasionally might not be able to utilise his own work capacity is not sufficient. Employees are also granted more and more freedom when it comes to determining their place of work and structuring their working hours. For this reason the senate is considering stipulating in the future that freedom with respect to determining the volume of one’s work and how one’s working hours are structured can only be regarded as an indication of self-employment if such freedom, in particular, results in increased earnings potential. However, there are already considerable doubts about whether the senate’s observations on the modern working world - for which it refers to the Green Paper Work 4.0 (Grünbuch Arbeiten 4.0) – are accurate. Moreover, increased freedom within individual employment relationships cannot lead to self-employed persons being considered employees for this reason only. In spite of these statements by the senate, freedom from instructions must continue to be ensured when drafting the contract and when implementing it.
The use of his car, PC, fax machine and mobile phone for work shall only create an entrepreneurial risk on the part of the contractor if these items - which have been purchased specifically with a view to the work carried out - are used for this and if the capital spent in this manner would have to be considered lost if the contract was lost and/or additional contracts were not awarded. According to the senate, this can in any case not be assumed - for items that are nowadays also regularly present anyway, for private use, in most households of employed or non-working persons - without a special related finding of facts. Thus, it is helpful in practice if the contractor uses software or apps, or also certain office equipment or vehicles especially designed for work.
Remunerating for the contractor based on the work result and success (e.g. on turnover and sales figures, graduated commission, etc.) has advantages regarding self employment - and this is consistent with current case law. On the other hand, remunerating the contractor primarily on the basis of the duration of the work performed has disadvantages. This aspect also plays a major role when the German Pension Fund carries out checks, which means that this must also be considered when deciding on the respective arrangements.
II. Judgment of the Federal Social Court of 31 March 2017
Following this decision, more than a few have wondered if there is any room left at all for self-employment. Here, the judgment of the 12th senate – the composition of which had changed in the meantime – of 31 March 2017 (B 12 R7/15 R) indicates a return to standards that are easier to implement in practice. The decision concerned a social worker in accordance with section 30 Social Security Code VIII whose self-employed status was attested to by the senate. Even though this is certainly a special case, many of the senate’s statements go far beyond it in their generality:
1. Entrepreneurial risk
There is now a different emphasis with respect to entrepreneurial risk: where a person merely provides services which essentially only require know-how, time and effort, entrepreneurial activities are not associated with significant investments in tools, work equipment or materials. Where such services are concerned, a lack of these investments is therefore not regarded as a sign of employment status or as an indication speaking against entrepreneurial activities. Thus, a freelance relationship can also exist without such investments.
Maintaining one’s own place of business can also form part of the entrepreneurial risk. The senate also clarifies in this respect: if such a place of business is to be expected and/or is necessary for the type of activity in question, this may well be the case. On the other hand, it does not matter either if, in the case of a person providing services only, no such establishment exists. Thus, one can also be self-employed without having such a place of business.
If, based on the decision of 18 November 2015, the impression was created that the use of a car, PC and mobile telephone, insofar as this also takes place privately, speaks against an entrepreneurial risk, the senate now states that it does not speak against self-employment if these items were not purchased specifically for and in connection with work; it is simply irrelevant.
2. Use of third parties as vicarious agents
If the decision of 18 November 2015 made it sound like the obligation to personally render services establishes an employment relationship, the senate now asserts that such an obligation must only be regarded as a significant indication of employment status - and against self-employment - if it is not due to the particularities and special requirements of the contractual service: "In particular with respect to activities the success of which requires a special trust over a - potentially - longer period of time or a special expertise, the rendering of services by a specific person can often be regarded as part of a contract." Therefore, a contractor can also be regarded as self-employed even if he is obliged to personally render services (!). This could have a significant impact on practice when it comes to using IT service providers. Nevertheless, it is of course advisable - as stated above - to stipulate in the contract that third parties are entitled to render services and, in addition, to encourage this in practice.
Whereas the decision of 18 November 2015 meant that the agreement of a fixed hourly rate generally established a basis for employment, the senate now says that even the agreement of a fixed hourly rate does not necessarily indicate that this is the case. According to the senate, this is because, where only services are provided, performance-based remuneration cannot be expected due to the specific characteristics of the work to be performed.
In addition to these statements, which cast a somewhat different light on the decision of 18 November 2015, the judgment of 31 March 2017 also contains remarks on aspects that have not yet been clarified but are important in practice:
For example, in its questionnaires the German Statutory Pension Insurance Scheme regularly asks whether the respective remuneration is freely negotiated. According to the recent decision, this does not necessarily matter anymore: If a customer has a certain degree of market and bargaining power, it is not unusual for that customer to outsource services at terms and conditions unilaterally determined by it. On the other hand, according to the senate the remuneration amount can also be freely negotiated outside of the scope of collective agreements on remuneration or other legal requirements when establishing employment relationships.
4. Short notice period
Some already derive an indirect right to give instructions from the fact that a contract only provides for a short - for example, 14-day - period of notice: the reason being that the contractor will likely follow all of the customer’s instructions if the contract can be terminated at any time on short notice. The senate has a different – and correct – view: the possibility of disregarding the notice periods set forth in section 622 German Civil Code is, in particular, a consequence of agreeing on a freelance contract instead of an employment contract. Therefore, interpreting every freelance contract that can be terminated on short notice as an employment contract would constitute circular reasoning.
5. Reports and meetings with customer
The contractor’s duty to provide a written report every six months on the achievement of the agreed targets did not matter either, from the senate’s point of view.
The same goes for regular meetings between the contractor and the customer, as long as the contractor is not obliged to participate, and in particular if the specific contractor actually did not participate in the meetings either.
6. Reimbursement of expenses
The reimbursement of expenses is in some cases regarded as an indication of an employment relationship since the employee has corresponding claims. However, since flat rates for travel time are quite common, also in the case of self-employed tradesmen, the reimbursement of travel costs should not matter, including in the case of independent contractors.
7. Amount of income
Previously, the amount of income was not important for the question of status. Now the senate regards it as a material indication of self-employment if the agreed fee is greater than the remuneration of a similarly utilised employee for whom social security contributions must be paid and, as a result, allows the self-employed person to insure himself. This is an entirely new consideration which, in the case of highly paid specialists – for example in the IT sector – reduces the risk of a freelancer being regarded as an employee.
8. Non-compete covenant
However, it is becoming increasingly advisable to exercise caution when agreeing on non-compete covenants: Although the absence of such a covenant is not evidence of self-employment, an existing non-compete covenant can be an indication of an employment relationship. Therefore, it is now advisable to avoid such covenants; it can also be stipulated that the contractor is allowed to work for competitors as well.
Should the trend marked by the decision of 31 March 2017 take hold, this would be an important step towards more predictability when drafting and implementing contracts with self-employed persons, making it easier for the parties involved to be compliant in this regard as well.