SI Review: July 2011


Don't Get Burned

Don't Get Burned

6 legal issues that could land staffing firms in hot water

By Eric H. Rumbaugh and Mark Lotito

The legal issues that could land a staffing firm in trouble are many and varied.

With the various state and federal laws that govern employment relationships, staffing firms face a seemingly endless number of legal pitfalls. The legal landscape continues to change, and agency enforcement priorities have increasingly targeted issues that are particularly significant to staffing firms. Some, such as worker classification or wage and hour violations, are well-known and often discussed; others, such as immigration, might not be relevant for every staffing agency.

Staffing firms can often provide good solutions for client companies seeking to manage legal risks associated with their workforces, but in some situations, such as potential workplace discrimination or harassment, staffing firms and their clients face risk. The issues discussed in this article are either recurring problems for staffing firms or less prevalent problems that have attained a higher profile in recent years. These topics, however, are only a sampling of significant legal issues that might confront a staffing firm.

SUTA Issues

State unemployment insurance programs rely on employer contributions to fund their reserves. Those reserves have dropped precipitously because of the recent recession, and state agencies have come under increasing pressure to increase contributions. States want workers to be employees, not independent contractors, so they can collect unemployment taxes. States can generate contributions if an “independent contractor” is reclassified as an “employee,” and new state laws governing worker classification have the potential to help states find new sources of contributions. The overall issue of worker classification is addressed more fully later in this article.

Another enforcement priority of relevance to staffing firms is a practice called “SUTA dumping.” SUTA dumping is the practice of manipulating the unemployment insurance rating process to reduce an employer’s unemployment insurance tax rate. If an employer’s payroll is subject to a high unemployment insurance tax rate, the employer might try to reduce that rate by shifting its payroll to an entity with a lower unemployment insurance tax rate. After the shift is completed, the entity with the high unemployment insurance tax rate is “dumped.” The federal government addressed this issue with the SUTA Dumping Prevention Act of 2004; since then, states have enacted their own laws to prevent SUTA dumping.

A recent example of litigation involving SUTA dumping is the case of Employment Dev. Dep’t v. Cal. Unemployment Ins. Appeals Bd. In that case, two companies, Screaming Eagle and Payday, provided payroll services to entertainment business clients. The companies were run by the same person, and they had the same officers, offices, staff members, addresses and accounting systems. After Screaming Eagle was assigned a higher unemployment insurance tax rate, its payroll was shifted to Payday, which had a significantly lower rate.

An auditor at the California Employment Development Department, however, determined that the two companies were a single employing unit. The department discontinued Payday’s account and assessed contributions at the higher rate. The department also imposed penalties with interest. The companies challenged the determination, but the California Court of Appeal agreed with the position of the Employment Development Department, upholding the assessment at the higher unemployment insurance tax rate.

Discrimination and Background Checks

Discrimination complaints filed with the Equal Employment Opportunity Commission can lead to expensive litigation or costly settlements for a staffing firm. Indeed, the EEOC Web page dedicated to its Eradicating Racism and Colorism from Employment (“E-RACE”) initiative contains a long list of recent cases. In this context, more attention is now also being focused on employer practices related to background checks. Businesses can face individual or class litigation suits if their hiring tests and background checks result in screening out protected classes, such as minorities, at a higher rate than other groups. The EEOC has renewed its emphasis on this enforcement area, and individuals also continue to bring suits based on background check screening.

A leading example of the EEOC’s increased attention to background check screening is the ongoing case of EEOC v. Freeman. In that case, the EEOC has alleged that a company engaged in a nationwide pattern of unlawfully discriminating against African-American applicants by using poor credit history as a hiring criterion and against African-American, Hispanic and white male applicants by using criminal history as a hiring criterion. The EEOC investigation into the company’s screening practices and the subsequent litigation were triggered by a complaint from an African-American woman, who alleged that the company discriminated against her by rejecting her employment application because of credit history.

Staffing firms are sometimes used by their clients as a way to outsource tests or screening devices that would create EEOC scrutiny for the client. Often, if the screening test is problematic, both the staffing company and its client will face liability. In any case, staffing companies must resist client pressure to apply screening that creates liability.

Worker Misclassification

Staffing firms sometimes face complex compliance issues related to worker classification, and the risks associated with misclassification have increased dramatically. No national definition of “independent contractor” or “employee” exists, and employer-employee relationships are tested differently under different legal provisions and in different states. In recent years, worker classification has received increasing attention at both the state and federal levels. Many states have either adopted or considered new worker classification laws that impose stricter classification and reporting requirements. Congress has likewise considered, but not passed, several legislative measures that would address worker classification; and high-profile litigation and settlements continue to draw attention to the issue.

Worker classification has also become an increasingly important enforcement priority for state and federal government agencies. Generally, government agencies consider independent contractor classifications to be less reliable for generating revenue than employee classifications, meaning they believe many independent contractors are not paying their self-employment taxes. Therefore, as budget crises have put pressure on state and federal agencies to increase revenue, worker classification practices have received greater scrutiny.

Worker classification audits can be triggered in many ways. An independent contractor might file an application for unemployment benefits or fail to properly report income taxes. Workers might also challenge their classification if other similarly situated employees received higher compensation or better benefits. Despite years of high-profile litigation, clear guidance is still lacking on many aspects of worker classification, and the issue continues to pose risks for staffing firms and their client companies. Staffing firms must work to classify workers correctly, and avoid client (or worker) pressure to misclassify workers.

Wage and Hour

Clients sometimes pressure staffing firms to classify workers as “exempt” from overtime pay. Staffing firms must resist this pressure; clients are not served well by wage and hour misclassification either, as they can also face liability. Wage and hour classification is an issue for staffing firms’ internal employees as well as the contingent staff they place.

In Betancourt v. Maxim Healthcare Services Inc., for instance, the district court in April conditionally certified a class of recruiters who had worked for Maxim Healthcare Services Inc.’s Staffing Solutions division (“Maxim Staffing”). The recruiters argued that Maxim Staffing misclassified them as administratively exempt from the Fair Labor Standards Act (FLSA) and had failed to pay overtime. The recruiters claimed that they regularly worked more than 40 hours per week and that they lacked discretion to make decisions about hiring, job placements, discipline or termination.


Many staffing firms rely mostly, or even exclusively, on U.S. citizens and residents for their workforce. Some staffing firms, however, engage significant numbers of foreign nationals to meet the staffing needs of their client companies. In any situation involving a foreign national, the staffing firm needs to address government immigration requirements carefully, because violations, even unintentional violations, can have costly repercussions. In some cases violations might even endanger the staffing firm’s ability to maintain its business model.

For example, in Cyberworld Enterprise Technologies Inc. v. Napolitano, a staffing firm [Cyberworld] relied primarily on foreign nationals for the workers it supplied to client companies. As the “placing employer,” Cyberworld was required to confirm with the “secondary employer” that hiring a foreign national, known as an H-1B employee, would not displace a “United States worker” employed by the secondary employer.

The Department of Labor’s Wage and Hour Division received a complaint regarding Cyberworld’s compliance with the immigration requirement. Ultimately, the administrator of the Wage and Hour Division found that Cyberworld had failed to make the required displacement inquiry. The administrator not only assessed a $3,400 penalty but also imposed a one-year debarment on Cyberworld, meaning that Cyberworld would not be able to submit H-1B visa petitions for a year. The Court of Appeals for the Third Circuit upheld the one-year debarment, noting that the immigration law at issue did not require that the violation be knowing or intentional.


Sometimes staffing firms send workers to interview with client companies before the worker is assigned to the client. In this context, a recurring problem is who should bear the cost of the interview. State laws vary on this issue, so a staffing firm will need to determine if it is legally required to compensate a worker for interview time. The staffing firm will also need to assess whether associated time, such as preparation time and post-interview review, should be compensated. Likewise, the staffing firm will need to determine if travel costs should be reimbursed. Factors such as degree of control may affect the determination of what compensation, if any, is due; and staffing firms should review the legal requirements of the relevant jurisdiction to determine the applicable standard.

In 2010, a class action was filed in California under the state’s wage payment law for the failure of a staffing firm to pay temporary employees for time spent interviewing with clients. The suit was brought in a state court by a group of current and former temporary employees of staffing firms. This suit was similar to an earlier case (now on appeal), where a federal judge in California ruled that temporary employees’ client interview time (but not their commuting expenses or time for preparation and travel) was time worked for which wages must be paid under California law.

Historically, not many staffing firms have paid their temporary employees for client interviews. While the final answer is not yet in on whether interview time must be compensated for, more staffing companies are moving to pay for this time, at least on a state-by-state basis; and the coming year promises more challenges and developments in this area.


Staffing firms regularly confront legal issues that are common to the business community, but they also face legal concerns that are unique to the staffing industry. Worker reclassification concerns are perhaps the most well-known of these legal risks, but others, such as immigration, might be equally important to a staffing firm’s business model. The legal considerations discussed here can give rise to significant problems for staffing firms, but they are only an introduction to the legal issues that might land a staffing firm in trouble.

Eric H. Rumbaugh is a partner and Mark Lotito is an associate with the law firm of Michael Best & Friedrich LLP, headquartered in Milwaukee ( They represent employers in labor, employment and employee benefits law matters.


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Ashley08/05/2013 04:35 pm

Great article. Staffing firms are often held liable for mistakes made by the employees they place. Healthcare firms are often presented with even more risks due to HIPAA guidelines. This piece highlights the precautions staffing firms should take to avoid lawsuits:

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