Independent Contractors

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Everybody loves independent contractors. They can be cost saving because the company won't have to pay benefits, worker's compensation insurance, social security, Medicare, or unemployment tax. Using independent contractors can also help a company manage burn (monthly cash outflow) between projects.

There are two major risks to manage when using independent contractors:

Preventing the contractor from being reclassified by the IRS as an employee (resulting in a major tax hit)
Assuring adequate control of intellectual property and proprietary information

Successful Use of the Independent Contractor, Part One: Is the Worker an Employee or an Independent Contractor?

The IRS uses two main principles in classifying workers: independent contractors will generally :

Have control over the outcome of the work and ownership of the tools to create it; AND
Offer and provide services to more than one company.

A court determining a worker's status will apply a test looking to the following factors:

Independent Contractor or Employee?

Factor	More likely to be classified as employee if	More likely to be classified as independent contractor if
Employer supervision and control of work product	Employer has high degree of supervision and control	Worker is largely unsupervised and controls work product
Kind of occupation	Unskilled position	Highly skilled worker
Permanence and duration of employment	Long- term and open -ended	Short-term with a clear end date
Social security taxes	Employer pays	Worker pays
Retirement and Health benefits	Employer provides	Worker provides
Ownership of facilities and equipment used in work	Employer-owned	Worker-owned
Is the work performed by worker integral to the company's business	Yes	No
How payment is calculated	Hourly/time based	Per job/work-based
Worker's opportunity for profit/loss?	Low	High
Skill, initiative, judgment required for successful performance of work	Low	High
Worker receives sick leave or vacation time	Yes	No
Parties have a written agreement stipulating that worker is an independent contractor	No	Yes

To get the gestalt of what the IRS is looking at, keep in mind that a major goal of the law distinguishing between employees and independent contractors is to prevent the exploitation of workers by companies looking to avoid paying the taxes, insurance, and benefits attached to employee status. The law is looking to establish that any persons classified as independent contractors do so voluntarily as part of a scheme to offer services to several entities, with adequate negotiating leverage to make the decision to be an independent contractor from preference and not necessity.

Successful Use of the Independent Contractor, Part Two: The Contract

While a written agreement will not necessarily protect a company from the reclassification of independent contractors, it is a necessary part of any independent contractor relationship.

The independent contractor agreement should be signed before the contractor begins work and should detail:

The work to be performed.
The reporting relationship.
That the contractor will be working without supervision, on his own schedule, and has the option of working at the company office or not, and may use the company equipment or not, as the contractor prefers.
Responsibility and any personnel reporting to the independent contractor.
Milestones and time frame for completion of work.
Fees and timing of payments (which should be tied to successful milestone completion).
Provision of resources and equipment for completion of work.
Where work is to be performed.
Reimbursable expenses.
That the work is to be done on an independent contractor basis, and that the contractor will be responsible for paying all taxes, insurance, and benefits.
Representation and warranty that no work submitted by the contractor will violate the rights of any third party (e.g. intellectual property right infringement).

Successful Use of the Independent Contractor, Part Three: Intellectual Property and Information Control Concerns

A company has three basic nightmare scenarios:

The independent contractor claims intellectual property ownership of the work product.
The independent contractor uses confidential information gleaned during the engagement in a subsequent product.
The independent contractor contributes infringing content (someone else's code or art) and the infringed property owner proceeds to sue the company.

To guard against an independent contractor retaining any ownership rights in the product, the parties must sign an agreement setting forth the relationship of the parties and containing language that:

Defines the "work product" and any interim deliverables. Defines the work product broadly as including but not limited to all inventions , artworks, trademarks, copyrights, patents, and know-how created during the engagement.
Catalogs pre-existing property. If the contractor will be using a pre-existing IP, such as an engine or a tool set, these need to be named and described with specificity. Furthermore, the contractor must grant the company a license to use that IP. Whenever pre-existing IP is incorporated into the work product, the company will want an irrevocable, non-exclusive, permanent, sub-licensable, royalty-free license to use the contractor's IP so that the company will not have to negotiate with the contractor every time it sells or changes the work product.
Sets up invention disclosure parameters. The contractor should promptly and fully disclose all intellectual property created during the engagement and as a result of work performed during the engagement.
Assigns all IP to the client. The company will want to own all intellectual property created by a contractor as a work made for hire. The contractor should irrevocably assign to the company all rights that do not qualify as a work made for hire. The contractor should also agree to execute all documents and provide any other assistance required to establish the client's ownership.
No Contest. Contractor should agree not to contest ownership of the IP.

NOTE

A company's license to the pre existing property is only for the par ticular manifestation created for the company, i.e. the company can't break out the engine and sub-license it to someone else. It can only be sublicensed as part of the game.

To maintain good information hygiene, the independent contractor agreement should prohibit the contractor from disclosing confidential information to any third parties. The agreement should also:

Define confidential information broadly, including information given to the client by third parties.
State that the contractor has no existing conflict of interest and will not accept any engagement giving rise to such conflict during the course of work for the company.

To guard against being the unwitting recipient of work violating a third party's rights (stolen code or artwork that could be deemed to defame an existing personan ex-girlfriend, for example), the agreement should contain:

Contractor's representations that no element of the work product will contain any materials that infringe a third party's rights; and
Contractor's agreement to indemnify and hold the company harmless against any claims, losses, etc. resulting from a breach of the contractor's representation. In other words, if the contractor provides artwork that turns out to have been stolen from a third party, the contractor will be liable for attorney's fees or settlement costs, the costs of swapping out the artwork, and so on.

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