By Nancy Kawano and Merrili L. Escue , DLA Piper
This post is a condensed version of a two-part series originally published by DLA Piper. See Costly Employment Mistakes Emerging Companies Should Avoid, Part One and Part Two for the complete articles.
Most startup businesses are faced with the challenge of making the most efficient use of every dollar of their financing. As a result, creative cost-cutting measures are essential to increase available working capital.
For the unwary employer, however, cutting the wrong corners can be financially disastrous and may crush the life out of a new venture with enormous penalties, possible double damages, expensive litigation and potential individual liability for officers and directors. What follows are four costly employment mistakes companies can make, and how to avoid them.
- Deferring payment of wages until the company has more cash. The first employees of a company are typically the founders and/or individuals with a significant personal interest in the company. To conserve capital, these individuals are often willing to forego cash compensation for their services, typically for equity or an understanding that they will be paid at some later, undetermined date. Unfortunately, such arrangements violate the wage and hour laws in every state. In addition, such violations can trigger investigations by government enforcement agencies, including the tax authorities. Any agreement to waive these legal requirements, and avoid or delay payment of wages that are due to an employee, is invalid and unenforceable.
Avoiding legal liability for this problem is very simple: know and understand the applicable wage and hour requirements, including those for minimum wage and overtime pay; establish proper employee pay procedures; and establish regular paydays.
- Assuming payment by salary avoids overtime pay.Many startups pay all of their employees a fixed salary to simplify their payroll and because the company believes that if employees receive a salary they are not required to track the employee’s work hours or pay extra for working overtime. Unfortunately, this belief is false. Payment by salary is only one part of a two-part test for exemption from the overtime requirement. The second, and most critical, part of the test requires an analysis of the nature of the employee’s position and duties. Furthermore, the exemptions from overtime are very limited. Any company in which all or most employees are classified as exempt from overtime will be suspect.
To avoid this problem, companies must not assume an employee is exempt from overtime merely because the employee is paid by salary. Rather, companies should classify employees only after proper analysis and application of the appropriate two-part test for exempt status.
- Improperly classifying employees as contractors.In another misplaced effort to cut costs and avoid having to establish payroll and other infrastructure, companies sometimes classify persons who provide services – including its executive officers – as independent contractors, when they are truly employees. The company pays the contractor a fee that may not comply with the minimum wage and overtime requirements for employees and does not withhold or pay any employment taxes. When the relationship ends, however, a dissatisfied service provider may claim to have been an employee who was not properly paid. If that is proven to be true, there will be liability for unpaid wages, including overtime, and the resulting derivative violations and penalties mentioned above, as well as liability for failure to properly withhold and pay employment taxes.
The determination of independent contractor status requires analysis of multiple factors, and legal tests vary by government agency. To avoid issues, a company should act conservatively when determining independent contractor status. If the person truly is an independent contractor, a written agreement documenting the relationship is essential.
- Not maintaining proper documents and records. Creating proper documentation and maintaining appropriate records are concepts that sound simple and mundane. But their simplicity causes many employers to either forget to document, or just choose not to document, because they don’t think it is very important. This is potentially one of the biggest mistakes an employer can make, as many state and federal laws require that employers document certain aspects of the employment relationship. Additionally, failure to document certain policies, and terms and conditions of employment can create ambiguity that will play out in favor of an employee in most disputes because the burden of proof is almost always with the employer.
To avoid improper assumptions and misunderstandings, some key types of documentation should be maintained, including (but not limited to): offer letters, disclosure and authorization for background checking, confidentiality and nondisclosure/invention assignment agreements, job descriptions, wage notices, wage statements, timesheets, bonus/commission plans, performance issues/management, leave of absence administration, handbooks, documentation of rationale behind employee termination, exit interview, change-in-status documents.
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