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Contractors or employees? Full Federal Court clarifies sham contracting

27 March 2015


The so-called ‘Odco system’ of contracting is a method of engaging workers via commercial contracts (contracts for service) rather than employment contracts. Under the system, there is an interposed corporate entity and therefore no direct contractual relationship between the principal and the worker. Such arrangements are being used increasingly in Australia as a means to increase workforce flexibility and reduce labour costs.

Companies promoting the Odco system of contracting usually point to cases where the system has been examined by courts and upheld as a valid independent contract arrangement, not an employment relationship between principal and worker. However, the cases usually referred to were handed down before the introduction of the stricter ‘sham contracting’ provisions in the Fair Work Act 2009 (Cth) (FW Act). Those provisions prohibit misrepresenting an employment relationship as an independent contractor arrangement (sections 357 and 359) and dismissing employees in order to re-engage them as independent contractors (section 358).

The Full Federal Court Case

The case of Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd is the first to examine the Odco system in the context of the sham contracting provisions.

The case considered actions taken by Quest South Perth in dismissing its employees and then engaging Contracting Solutions Pty Ltd (CS) to engage those same workers as independent contractors and provide their services back to Quest. Quest contracted with CS for the services of the newly converted independent contractors, and in return CS proposed to meet all of the relevant legislative requirements including superannuation and workers compensation insurance.

At first instance, McKerracher J found that one of the employees had been threatened with dismissal if they did not enter into an independent contract, and therefore Quest had contravened section 358 of the FW Act. However, he found that there had been no misrepresentation by Quest in contravention of section 357 because all Quest had done was deny that it had any direct contractual relationship with the workers. It was CS that had held discussions with the employees about becoming independent contractors and it was CS that was party to the contract section 357 applied to.

The Fair Work Ombudsman (FWO) appealed the decision in relation to section 357 on the basis that the section should be read widely so as to apply to tripartite arrangements. The Full Court rejected this and upheld the decision at first instance. It found Quest had not misrepresented to the workers that its relationship with them was one of independent contract rather than employment.

Importantly however, the Full Court then went on to consider the true nature of the relationship between Quest and the workers following their engagement by CS. The Full Court found that notwithstanding the ‘lip service’ paid by Quest and CS to the key indicators of an independent contractor relationship, there was no hiding the substance of the arrangement between the workers and Quest.

The Full Court looked at recent decisions on independent contractor relationships which have put considerable emphasis on whether or not the worker is carrying on their own business. The Full Court refined this further, holding that for a worker to be a genuine ‘independent contractor’ there must be a ‘pursuit of profit’ by that contractor. The Full Court said:

“A commercial enterprise, no matter how small, is an undertaking in which time, money, and effort are risked in the hope of making a profit. Unlike the employee, who will be content to be remunerated with a wage which reflects the value of the personal services provided, the entrepreneur providing commercial services will want to be remunerated by making a profit.”

The Full Court held that as the workers were not genuinely trying to make a profit for their own business, the nature of the relationship between Quest and the workers could not be said to be one of genuine ‘independent contractor’.

In making its decision the Full Court noted that the workers:

  • performed all their work using Quest’s facilities;
  • performed work exclusively for Quest;
  • worked under the direction and control of Quest;
  • wore Quest’s uniforms and were portrayed as part of Quest’s business;
  • had no capacity to delegate their work to other personnel within their business; and
  • had a level of remuneration consistent with the level of pay for an employee performing the same work.

Accordingly, the Full Court found that although the claim of sham contracting had not been proven, the true nature of the relationship between Quest and the workers was one of employment.

As a result of this decision, Quest will be liable for superannuation, leave entitlements, income and payroll tax on behalf of or in relation to the workers.

Key take-away points

This case is a continuation of a line of recent authorities which give considerable emphasis to whether a purported independent contractor can be said to be running their own business. Previous tests such as the ‘control’ or ‘multi-factorial’ tests are still relevant, but appear to have become secondary to the analysis.

While the Full Court found that the FWO had not raised an actionable claim for sham contracting, other employers using similar arrangements may not be so lucky in the future. In particular, great care needs to be taken by a principal when discussing an independent contracting arrangement with a worker.

In the current economic climate, there is increasing pressure for businesses to explore different options for engaging workers. If the proposed solution is to engage workers as independent contractors, we strongly recommend that legal and tax advice be sought before proceeding.

Click here to download pdf. 

Contacts: Kathy Reid, Principal; Craig Boyle, Principal.


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