Mason Pokorny, Benjamin Briggs, and Phillip Lane
While having a third-party handle your human resource and employee benefit needs may sound attractive, particularly if you are a small business, be sure to read between the lines when researching your options. Growing in popularity over the last decade, Professional Employer Organizations (PEOs) seem to be, at least on the surface, the solution for which all small businesses have been looking. But is this “solution” right for you?
PEOs combine staffing and employee benefits to “help” the little guy. The role of PEOs is to offer benefits, such as human resources, payroll, and workers’ compensation, to small businesses by having the businesses enter into a co-employment contract with the PEO. As a result of this contract, the PEO effectively becomes the employer of record for tax and insurance purposes and the businesses
lease their employees back from the PEO. This business structure can pose problems in several areas.
Under the co-employment contract, your business retains control and oversight over the workplace productivity and direction for the employees the PEO leases back to the business. However, by entering into a co-employment contract with a PEO, small businesses relinquish control over certain aspects of the business, including administrative tasks of HR, payroll, and workers’ compensation. Now, you may be thinking: “Well, I don’t want to deal with that part of my business, anyway... that’s why I entered into this contract.” However, while on the surface this arrangement may seem ideal, relinquishing control of these areas poses unforeseen issues to your business. For instance, if the PEO fails to provide proper compensation, benefits, or insurance coverage to the leased employees, your business may be liable even though the PEO had control over these administrative tasks. This potential liability is discussed in greater detail in the following sections.
Various employment laws acknowledge the concept of “joint employment,” meaning that a single employee may have two (or more) employers in the eyes of the law. This is often the case in the employee leasing scenario, where both the PEO and the business leasing the employees from the PEO are considered joint employers of the leased employees. Even though the PEO pays the employee and is the employee’s employer of record for tax and insurance purposes, the employee may still bring an employment or
wage-and-hour lawsuit against the business as the employee’s joint employer. This means that while a business may relinquish control to a PEO regarding various aspects of the business, the business may still be liable for those aspects that are now outside their direct control.
One of the main reasons businesses choose to enter into co-employment contracts with PEOs is to outsource workers’ compensation compliance. In other words, rather than obtaining a workers’ compensation policy directly and handling coverage internally, businesses run their employees through a PEO so that the PEO handles workers’ compensation coverage for those employees. While this arrangement may be appealing, it again exposes the business to potential liability.
Utilizing a PEO to provide workers’ compensation coverage for a business’ employees can often lead to a “coverage gap,” which is a period during which the employee is working for the business without having workers’ compensation coverage. Businesses may not realize that the leased employees do not become official employees of the PEO—and come under the PEO’s workers’ compensation policy—until the PEO fully processes the employment paperwork the business is required to submit for the leased employees. This arrangement can lead to a lapse in time during which the employee is not on the PEO’s payroll or covered by workers’ compensation insurance.
This coverage gap may occur when a business hires a new employee but does not submit all the necessary paperwork to the PEO in a timely manner; or the coverage gap may arise from the PEO taking several days to fully process the employee and add him or her to the policy.
Example: A business hires a new employee Friday morning and the new employee starts working the following Monday at 8:00 a.m. The PEO does not fully process the new employee's paperwork until the following Wednesday. As a result, the new employee works for the business for several days without the required workers’ compensation coverage.
This coverage gap could be due to the business not submitting the necessary information and records to the PEO right away or the PEO simply taking a while to process the paperwork. Either way, this coverage gap exposes the business to liability. If the new employee is unlucky enough to suffer a workplace injury during the coverage gap, the PEO will likely deny the new employee’s claim, which will likely prompt the employee to come after the business for his or her medical bills and lost wages. Moreover, if the Division of Workers’ Compensation visits the jobsite during the new employee’s coverage gap, ultimately the business – not the PEO – would be found in violation of Florida’s workers’ compensation laws. Such a violation will lead to a stop-work order, a full audit of the business going back two years, and an eventual monetary penalty.
Another problem that may arise when businesses utilize PEOs for workers’ compensation coverage is lack of notice regarding policy cancellations. While an insurance carrier has certain notice requirements when canceling a policy, those notice requirements are owed to the company contracting with the carrier to provide coverage. In the PEO context, the insurance carrier only owes notice to the PEO, not the business for which the covered employee’s actually work. The carrier may choose to cancel its policies with the PEO after providing sufficient notice to the PEO; but the PEO may not be contractually obligated to notify the business of this development, which would leave the business temporarily uninsured with no knowledge of the situation.
Furthermore, PEOs are not “technically” insurance providers to the business and are not subject to the same cancellation notice requirements that apply to traditional insurance companies. Unlike an insurance carrier, a PEO can give immediate notice to the business that it is canceling the employee leasing contract, which also cancels the business’ workers’ compensation insurance. It may take the business a while to obtain a workers’ compensation policy directly from a carrier or enter into a new contract with a different PEO. Therefore, a PEOs sudden cancellation creates a coverage gap during which the business either must cease operations or continue operations without the required coverage and, thus, expose itself to significant liability.
An additional issue may arise if the PEOs workers’ compensation insurance carrier wrongfully denies an injured employee’s workers’ compensation claim. When an insurance carrier denies a workers’ compensation claim, the injured worker may opt to pursue a civil claim for negligence against the business for which he or she worked. If the business is not listed as an “additional insured” on the PEO’s insurance policy, the workers’ compensation carrier may refuse to pick up defense of the claims and indemnify the business for any damages incurred because the carrier does not technically insure the business (it only insures the PEO).
Even if you do not use a PEO, you should still be aware and wary of other companies that do use them. Contractors who sub out work to subcontractors that receive workers’ compensation insurance through a PEO are also subject to risk. Under Florida law, a contractor has an obligation to ensure that not only its own employees are covered under an active workers’ compensation policy, but also verify that all downstream contractors’ employees are covered under an active policy.
When a subcontractor produces a Certificate of Insurance that shows coverage through a PEO, Florida law requires that the prime contractor obtain an updated employee roster from the PEO to verify that every worker the subcontractor may have on the project is listed on the updated employee roster. If the prime contractor does not take this extra step to verify that all its subcontractor’s employees have coverage, the prime contractor would be exposed to potential workers’ compensation claims or a penalty through the Division of Workers’ Compensation.
Moreover, a downstream contractor that utilizes a PEO may be subject to the coverage gaps discussed in this article. The downstream contractor’s coverage gaps expose the prime contractor to liability because, again, the upstream contractor is obligated to ensure every worker for a downstream contractor is covered while working on the project.
Prime contractors often seek to obtain gap coverage in their workers’ compensation policy to ensure that they are not exposed to any uninsured claims from any subcontractor’s employees or a potential penalty from the Division of Workers’ Compensation. However, if the prime contractor utilizes a PEO rather than a traditional insurance carrier, the PEO does not offer this gap insurance and the prime contractor may have liability exposure.
For some businesses, utilizing a PEO makes sense. Just be sure to read between the lines and do your due diligence before you decide to outsource your employees to a PEO. Take the time to fully consider and weigh the potential benefits against the potential risks and costs. Additionally, be sure to conduct the same due diligence when deciding whether to work with a subcontractor that uses a PEO. If you choose to work with a subcontractor that relies on a PEO for workers’ compensation coverage, be sure to regularly get updated employee rosters and verify that all the workers the subcontractor brings on the job are listed on the employee roster. Your business should also make sure that its subcontract includes language requiring the subcontractor to comply with workers’ compensation obligations, and fully indemnifying your business for any costs or damages it may incur if the subcontractor does not fully comply with its workers’ compensation obligations.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.
Cotney Construction Law is an advocate for the roofing industry, General Counsel of FRSA, NWIR, TARC, TRI, RT3, WSRCA, and several other local roofing associations. For more information, contact the author at 866-303-5868 or go to www.cotneycl.com.