June 24, 2022Client Alert

Co-Employment and Direct Sourcing

Myth, Fact, and Legend

Enterprises use direct sourcing to recruit top talent, improve hiring and retention, shorten onboarding time, decrease talent acquisition costs, and increase talent satisfaction. Fortunately, organizations can design and implement scalable talent programs to directly source talent without reinventing the wheel or developing costly internal processes or systems. Instead, enterprises may leverage a workforce management vendor or technology platform to dramatically increase their direct sourcing effectiveness and mitigate risks.

Some business leaders fear that engaging a workforce management vendor to build a contingent workforce may create co-employment risks. Below we address the myths associated with co-employment to see just how much of this concern is rooted in fact.

What is Direct Sourcing?

Direct sourcing
is a strategy or method that organizations use to identify suitable candidates in the labor market to fill open roles or projects to hire contingent, temporary, or full-time talent, rather than outsourcing the recruitment and hiring functions to recruiters or headhunters.

There are myriad options for direct sourcing, often including leveraging a business’s existing workforce to identify potential candidates, referral programs, and human resources’ networks. In many cases, businesses engage a workforce management vendor or platform that provides enterprises with a recruiting team to source contingent talent for the enterprise, and allows the enterprise to source, manage, and engage talent directly. The vendor's recruiting team may use the enterprise business's logo or brand to attract candidates and create a talent pool from which the business can draw. Talent is often engaged directly by the vendor to provide services to the business on a project basis or for a limited period.   Some enterprises in this chain have tried to manage how the direct sourcing recruitment process is conducted in order to manage co-employment.   As discussed below, for the most part, these efforts have little if any impact.   Whether an enterprise end-client is leveraged in the recruitment process (or not) is largely irrelevant in determining employment or co-employment status.

What is Co-Employment?

The term co-employment refers to situations in which two or more businesses both qualify as “employers” of the same person(s). In a typical contingent workforce situation, the business provides the workspace and supervises and directs the employee’s day-to-day work, while the vendor pays the employee, withholds payroll taxes, provides benefits, maintains workers’ compensation insurance, and manages many personnel-related functions. In many contingent labor situations, the business and vendor are co-employers. The key question is typically whether an enterprise exercises sufficient control over a worker to be a co-employer.

What's the Difference Between Co-Employment and Joint Employment?

The terms co-employment and joint employment are often used interchangeably. The term “co-employment” is used more commonly in the industry.

Am I an Employer or Not?

For there to be co-employment, there must first be employment. Whether a worker is an employee (as opposed to an independent contractor) of one or more businesses is usually determined by applying various employment status “tests”.  There are too many tests to list here, but most tests are similar and use common elements. Some of the most frequently applied tests include the IRS test (used for tax purposes) and the economic realities test, which is the most common federal test used for wage and hour purposes.  The best known and perhaps the most widely used test was articulated by the United States Supreme Court in Nationwide Mut. Ins. Co. v. Darden, 503 US 318 (1992).  The Court said that the primary factor for determining if a worker is an employee is whether the business controls the manner and means by which the work is performed. Other relevant factors weighed by courts include:

  • The skill required
  • Who provides the instrumentalities and tools for the job
  • The location of the work
  • The duration of the relationship between the parties
  • Whether the business has the right to assign additional projects to the hired party
  • The extent of the business's discretion over when and how long to work
  • The method of payment
  • The business's role in hiring and paying assistants
  • Whether the work is part of the enterprise’s regular business
  • Whether the business provides employee benefits
  • How the business treats the worker from a tax perspective

Co-Employer or Not?

Once a worker qualifies as an employee, the question becomes who is the worker’s employer? Contingent workers often qualify as employees of the vendor, the enterprise end-client to whom they are assigned, or both. Regulatory agencies provide different standards for determining whether a co-employer or joint employer relationship exists, but each agency’s standard relates to the level of control exercised by a vendor or enterprise over a particular worker. For instance:

The Equal Employment Opportunity Commission (EEOC) and Department of Labor (DOL) advise that the entire working relationship must be assessed and no single criterion is determinative. The EEOC says the most important consideration is whether “the right to control the means and manner of her work performance rests with the [vendor] and/or its client [enterprise] rather than with the worker herself."

The DOL and Medical Leave Act (FMLA) say that "[w]here two or more businesses exercise some control over the work or working conditions of the employee, the businesses may be joint employers. For example, joint employment will ordinarily be found to exist when a temporary placement agency supplies employees to a second employer." 29 C.F.R. § 825.106.

For a long time, the DOL advised that two entities were joint employers when "employment by one employer is not completely disassociated from employment by the other employer(s)." 29 C.F.R. § 791. The Trump-era DOL rule narrowed the circumstances in which a business would be a joint employer to when it actually exercised control over a worker—it was not enough that the business had the right to exercise control. Multiple district courts held the Trump-era rule conflicted with the FLSA and the Biden DOL rescinded the Trump-era rule but has not proposed a new rule yet.

The National Labor Relations Board (NLRB) historically considered businesses to be "joint employers" if they shared or co-determined the essential terms and conditions of employment and exercised the right to control. The NLRB consists of five (5) members appointed by the President and its approach often changes when the administration changes. For example, the NLRB eliminated the requirement that a business exercise actual control in 2015 but reverted to the actual control standard in 2017. Many commentators expect the NLRB under President Biden to adopt a more expansive standard that will make it more likely that a business is considered a joint employer.

Direct Sourcing is Largely Irrelevant

Businesses today must be nimble, continually responding to market demands and adapting their workforce accordingly. In many contingent labor situations, the client enterprise controls the workplace, supplies the equipment, and manages and directs the work in a way which suggests employment.   In these cases, co-employment is all but unavoidable.   But there is no need to avoid it.  Contrary to conventional wisdom, co-employment relationships in and of themselves do not create liability.   In fact, co-employment is lawful, very common, and often beneficial to all parties involved.   Direct sourcing, and how it is conducted, is not an element in determining employment or co-employment status.   How talent is recruited is not a factor, and whether the worker is told where they will ultimately be working, are not factors, and neither is the use (or non-use) of the ultimate enterprise end-client’s logo or name in the recruitment process.   The method and manner of the enterprise end-client’s control are the most important factors.   Recruitment vendors and their enterprise end-clients need to accurately understand co-employment, but they should not fear it.

The Benefits of Co-Employment

Employees Create It, Employers Own It

Aside from its people, an organization’s intellectual property is often its greatest asset. Copyright law protects a “work” from the time it is created in a fixed form and immediately becomes the property of its author or creator. But an important exception to this principle exists in the employment context in that “works made for hire” are generally attributed to and owned by the employer.

The United States Supreme Court and the Copyright Office have interpreted the Copyright Act’s “work made for hire” principle to mean “a work prepared by an employee within the scope of his or her employment” or “a work specially ordered or commissioned for use.”

An important best practice for businesses is to have a signed, written agreement between the business and the worker (regardless of classification or co-employment) in which the parties expressly agree that the work will be considered a work made for hire. Where no such agreement exists, courts will apply a similar “control” test to the employer-employee relationship as in the co-employment context. To determine whether the work was made for hire, courts will assess the 1) control by the employer over the work, 2) control by the employer over the employee, and 3) status and conduct of the employer. Id. The closer the employer-employee relationship resembles a traditional, salaried employee relationship, the more likely the work will be considered a “work made for hire” and the rights to that intellectual property belong to the business.

Proper Worker Classification Mitigates Risk

When an enterprise engages a worker via a qualified workforce management vendor or platform, the vendor evaluates and determines the appropriate worker classification status to maintain compliance. Proper classification mitigates risks for both the vendor and enterprise that are associated with worker misclassification, which can result in damage to the employer’s brand, monetary fines, and legal penalties.

Workers' Compensation is an Employee's Exclusive Remedy For Workplace Injuries.

If a worker is injured at a business's workplace, the worker may be able to sue the business under various tort laws, unless the worker is an employee, in which case the worker typically is limited to making a claim under workers' compensation. Employees in most cases are barred from suing either co-employer for most tort claims.

Discrimination, Harassment, and Hostile Work Environment Claims.

Anti-discrimination and anti-harassment laws apply to employees and non-employees alike. For instance, in many cases, discrimination against non-employees is just as unlawful as discrimination against employees.   The best risk-mitigation tool is to “not discriminate” – re-labelling a person does not reduce risk, and might lead a business to short-circuit common sense risk mitigation steps that would normally prevent discrimination (and liability) in the first place.   In the case of workplace harassment, an “employer will be liable for harassment by non-supervisory employees or non-employees over whom it has control (e.g., independent contractors or customers on the premises), if it knew, or should have known about the harassment and failed to take prompt and appropriate corrective action.” Harassment | U.S. Equal Employment Opportunity Commission ( Risk management tip for any business: do not permit harassment.  Risk management tip number two: if it does happen, don’t ignore it - fix it.  While employers can avoid liability for hostile environment-type harassment that does occur in most cases by acting on it, an “employer is automatically liable for harassment by a supervisor that results in a negative employment action such as termination, failure to promote or hire, and loss of wages.” Harassment | U.S. Equal Employment Opportunity Commission ( Employers may avoid liability for hostile environment-type harassment by maintaining strict anti-harassment policies and procedures, promptly investigating all claims, and taking appropriate corrective action where harassment occurs. Non-employers do not have the ability to use this safe harbor.

A Business Controls Its Co-Employment Destiny

A business controls its co-employment status—whether it is co-employer or not—for the most part based on the amount of control it exercises over a worker. Fortunately, whether an enterprise utilizes a workforce management vendor or permits use of its logo or brand to recruit workers will not typically factor into a court’s co-employment determination analysis.

Direct Sourcing and Co-Employment Myths: Busted

In many contingent labor settings, co-employment exists from inception. This is normal and lawful, and there is no need to avoid it.  Indeed, in many cases, there is no practical way to avoid co-employment.  Co-employment, itself, is not a risk.  Misunderstanding co-employment, however, can create risks.

About The Authors

Eric Rumbaugh is a Partner at Michael Best, where he leads a recognized practice in the area of contingent labor and regularly prepares and reviews policies, procedures and contracts and litigates contested matters for users and providers of temporary employees, consultants, independent contractors, and other contingent talent.

Eric is a prominent national speaker and writer and regularly presents and writes on employment law topics. He also teaches a course on co-employment for Staffing Industry Analysts.

Alexius O’Malley is an Attorney at Michael Best, and a top-rated employment litigator selected by Illinois Super Lawyers as a 2021 & 2022 Rising Star. In addition to her litigation practice, Alex focuses on counseling public and private employers on all aspects of employment and workplace practices, including hiring, EEO compliance, accommodations, wage and hour issues, and non-compete/non-disclosure agreements.

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