Employee or Independent Contractor?

Employment Law Issues to Consider Before Including Work Made for Hire Clauses in Contractor Agreements

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From JDSupra, Chandra Andrade, Nate Garhart, and Rebecca Stephens provide a terrific summary of the risks of including a “work made for hire” clause in an independent contractor agreement in California. Chandra, Nate, and Rebecca write:

For most employers, it is important to own the intellectual property rights in written and/or graphic work commissioned from independent contractors.  But including a Work Made for Hire Clause (“WMFH Clause”) in an independent contractor agreement will cause a California-based independent contractor to be considered a “statutory employee” under California’s workers’ compensation, unemployment insurance, and disability insurance laws. Companies engaging California-based independent contractors must therefore decide whether to include a WMFH Clause in the agreement – weighing such factors as the type of work product the contractor will be delivering and how the company intends to use it.  Given the state’s heightened focus on companies’ relationships with their contractors over the last few years – from Dynamex in 2018, to AB 5 in 2019, to Proposition 22 in 2020 – there is also an increasing risk that a contractor may claim to be an “employee” for purposes of other Labor Code benefits, such as overtime and break periods.  This article explains WMFH Clauses, the pros and cons of including them in contractor agreements, and how to minimize the risk that a contractor will claim the myriad employee benefits that often underlie the desire to hire contractors in the first place.

Ownership of the Work of Independent Contractors

Independent contractors provide an important source of labor for many companies needing specialized, discrete work that is outside the usual scope of their business.  Usually, the parties will enter into an independent contractor agreement that governs the relationship, including the ownership of the materials created by the contractor in providing the requested services.

Under the United States Copyright Act of 1976, 17 U.S.C. § 101 et seq. (“the Act”), where the agreement is silent as to ownership of such created materials (or no such written agreement exists), ownership will vest in the contractor and not transfer to the employer.  17 U.S.C. § 203.  All is not lost in such situations, as controlling case law makes clear that the employer would still be able to use the materials under a non-exclusive implied license, and that the license would be irrevocable since it was supported by consideration.  Asset Marketing Systems, Inc. v. Gagnon, 542 F.3d 748, 754-757 (9th Cir. 2008).  That said, the lack of exclusivity, as well as the lack of clarity concerning the scope of the employer’s use permitted under the license, weigh against reliance on such rights.

For this reason, employers are wise to include language positing rights in the contractor’s work product in the employer.  There are two main mechanisms to do so: (i) a WMFH Clause and (ii) an assignment.

  1. Works Made for Hire

Under U.S. copyright law, works made for hire are automatically owned by the employer. As such, the employer is deemed the author and there are no additional concerns about ownership or use.  That said, not all works by independent contractors qualify to be deemed works made for hire.  Indeed, the Act provides that only the following types of works by independent contractors qualify:

  • contributions to collective works;
  • portions of audiovisual works;
  • translations;
  • supplementary works;
  • compilations;
  • instructional texts;
  • tests;
  • answer materials for tests; and
  • atlases.

17 U.S.C. § 101.  To be sure, very few of the works for which independent contractors are hired fall into one of these enumerated categories.  Where rights are purportedly transferred using a WMFH Clause, ownership of a work that does not qualify as a WMFH would thus remain with the independent contractor.  In such situations, the second mechanism – assignment – is required to shift ownership to the employer.

  1. Assignments

Copyright is freely transferable so long as the transfer is in writing and signed by the owner of the rights conveyed.  17 U.S.C. §§ 201, 204.  Although the employer would not be deemed the “author” under such a transfer, it would gain all of the rights under copyright law.  There is, however, one twist that differentiates an assignment from the ownership resulting from a WMFH: the author (or the author’s heirs) may terminate any assignment at any time during the five-year period beginning at the end of the thirty-fifth year after the transfer.  17 U.S.C. § 203.  This right to terminate may not be contracted away or waived in advance.  Id.

The practical implications of this termination right are tempered by the fact that it is effective only as to rights in the originally transferred work, and the assignee would still be permitted to use new works it created based on or otherwise using the assigned work (though no new “derivative works” could be created after termination).  Additionally, many works will not have a useful life of greater than 35 years.  Moreover, the termination requires action by the contractor.  Very few such individuals are likely to have any interest in terminating the assignment after 35 years, and even fewer would be familiar with the Act’s provisions regarding termination rights.

Because the associated risk of using an assignment rather than a WMFH Clause is thus limited, assignment is the employer’s best option for taking ownership of the rights it needs. Yet, to maximize their intellectual property rights and options, many employers draft independent contractor agreements to include both a WMFH Clause and an assignment clause, the latter being triggered where the work at issue is deemed not to be a work made for hire.  This approach ignores a significant downside to using the term “work made for hire” that can create unexpected issues for employers.

Implications of Using WMFH Clauses in Contractor Agreements

Multiple California statutes provide that using a WMFH Clause in an independent contractor agreement transforms the contractor into a “statutory employee.” First, for purposes of the state Workers’ Compensation law:

Employee includes … [a]ny person while engaged by contract for the creation of a specially ordered or commissioned work of authorship in which the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire, as defined in Section 101 of Title 17 of the United States Code, and the ordering or commissioning party obtains ownership of all the rights comprised in the copyright in the work.

Cal. Lab. Code § 3351.5(c).  Further, under the California Unemployment Insurance Code (governing entitlement to both unemployment and disability insurance benefits):

“Employer” … means any person contracting for the creation of a specially ordered or commissioned work of authorship when the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire, as defined in Section 101 of Title 17 of the United States Code, and the ordering or commissioning party obtains ownership of all of the rights comprised in the copyright in the work. The ordering or commissioning party shall be the employer of the author of the work for the purposes of this part.

Cal. Unemp. Ins. Code § 686.  And under the same code, “Employee” includes “[a]ny individual who is an employee pursuant to Section … 686.”  Id. § 621(d).

The upshot is that employers must obtain workers’ compensation, disability, and unemployment insurance for their independent contractors who have signed an agreement with a WMFH Clause.  Failure to do so subjects the employer to criminal and civil penalties.  Cal. Lab. Code § 3700.5; Cal. Unemp. Ins. Code § 2122.  As with other misclassification claims, whether the agreement refers to the worker as an independent contractor does not matter – the status can still be legally challenged.

Are Statutory Employees Entitled to Any Other Employee Rights and Benefits?

Another question that arises is whether this conversion to “statutory employee” triggers rights to any other employee benefits (e.g., overtime protections, meal and rest breaks, compliant wage statements).  Surprisingly, while law journal articles have long raised that possibility, there is practically no case law on the subject.  The only mention of the concept occurs in an unreported California appellate court decision, Barry v. Twentieth Century Fox Film Corp., No. B221785, 2011 WL 4360994, at *8 (Cal. Ct. App. Sept. 20, 2011).  The Barry court refused to consider the legal merits of the “statutory employee theory under section 3351.5” because appellants first raised the argument on appeal.  The trial court below had briefly considered the theory, but ruled that “defendants fail to present any authority to support their position that, when a person signs such an agreement, the agreement overrides any evidence that the person was actually an independent contractor.”  The trial court thus disagreed with Barry’s argument that an independent contractor could transform into an employee purely by signing a WMFH Clause.

The trial court’s reasoning seems consistent with the plain meaning of the California statutes, which specially define “employee” and “employer” for purposes of the respective workers’ compensation, disability, and unemployment insurance sections.  It seems unlikely that the legislature intended a federal copyright principle to automatically transform workers into employees for all state-law purposes; if it did so intend, the legislature likely would have said so. This idea that workers can be statutory employees for certain rights and benefits but not others is also consistent with IRS guidance on Statutory Employees, which states that workers can be both independent contractors under the common law and “treated as . . . statutory employees . . . for certain employment tax purposes” if they meet a set of listed requirements, thus requiring that businesses withhold Social Security and Medicare taxes from only certain statutory employees’ wages.

Yet, given the dearth of case law and increasing focus on the classification of independent contractors versus employees in the gig economy, plaintiffs and/or state agencies involved in administering and enforcing proper worker classification may spring into action.  In 2018, the California Supreme Court adopted the “ABC” test to determine proper worker classification under California’s Wage Orders, a significantly more stringent standard than the former Borello test.  See Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (2018).  With AB 5, the California legislature codified the ABC test and expanded its application to the entire California Labor Code (while exempting specified occupations, which remain subject to the Borello test).  Cal. Lab. Code § 2775.  To classify a worker as an independent contractor under the ABC test, a hiring entity must demonstrate (among other things) that the worker is “free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.”  Cal. Lab. Code § 2775(b)(1)(A).  Thus, in addition to claiming that “statutory employees” are entitled to employment benefits beyond workers’ compensation, disability, and unemployment insurance, plaintiffs’ attorneys may argue that WMFH Clauses (or other broad intellectual property assignments) reflect a significant level of control over the worker, thereby evidencing that the worker should be classified as an employee.

Employers’ Options for Minimizing Risks of Employee Claims

Notwithstanding the aforementioned risks and the absence of case law on this topic, employers have several options for maintaining intellectual property ownership without undermining independent contractor classification.  One obvious option is to abstain from including WMFH Clauses in independent contractor agreements, instead requiring the contractor to assign ownership of all deliverables to the creator.  The risk of this strategy, as discussed above, is that the creator can terminate the assignment after 35 years.  But this risk is less of an issue for works to be used for a limited period and/or those commissioned from entities (which would logically not qualify for the benefits available to statutory employees) rather than individuals.

Where working with an individual, the company can include a WMFH Clause but add language specifying that the creator is a statutory employee only for workers’ compensation, disability, and unemployment insurance purposes, and is not otherwise an “employee.”  While not dispositive, this would be one factor a court or agency would consider in determining employee status for other purposes.  Additionally, the company could specify that the contractor retains some limited rights in and to the copyright interest, as a way to avoid triggering Section 3351.5(c) and Cal. Unemp. Ins. Code § 686 – both of which purport to apply if the commissioning party obtains ownership of all the rights comprised in the copyright. For example, if the contractor retains some level of ownership in the work (e.g., a license to reproduce the commissioned work for non-commercial promotional purposes), arguably Sections 3351.5(c) and 686 would not apply.

Of course, whether or not a company includes a WMFH Clause, it should always ensure that other features of the agreement (and actual practice) are consistent with contractor treatment under the ABC test (or, for occupations exempted by AB 5, the Borello test).  Whichever approach companies take, they should do so after careful balancing of the above considerations on a case-by-case basis, rather than (as many companies do) using the same template agreement across the board.

Source: Employment Law Issues to Consider Before Including Work Made for Hire Clauses in Contractor Agreements | Farella Braun + Martel LLP – JDSupra

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