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Microsoft Temps Win Another Round

June 1, 1999

Adding a new chapter to a long-running dispute, a Ninth Circuit panel ruled in Vizcaino v. U.S. District Court for the Western District of Washington, 1999 U.S. App. LEXIS 9057 (9th Cir., May 12, 1999) that the class of workers potentially eligible for benefits under Microsoft's employee stock purchase plan was improperly limited by the trial court. The opinion exposes Microsoft to claims for benefits from several thousand additional workers. Claims from the expanded class could cost Microsoft upwards of $15 to $20 million.

Prior to 1990, Microsoft relied extensively on a pool of "freelancers" to staff certain projects. Microsoft characterized the freelancers as independent contractors and informed them from the outset that they were not eligible for benefits provided to Microsoft's regular employees. The freelancers signed non-disclosure agreements specifically acknowledging that they were not employees of Microsoft.

During an employment tax audit of Microsoft for 1989 and 1990, the IRS challenged Microsoft's characterization of the freelancers as independent contractors, relying on a common law test of employment status. During negotiations to resolve the audit, Microsoft agreed to recharacterize the freelancers as employees. Microsoft then reorganized its freelance program, offering some of the affected freelancers jobs as regular employees. Others were converted to temporary employee status or left Microsoft entirely.

The Litigation -- Chapter One

Microsoft's decision to recharacterize the freelancers as employees with respect to employment taxes had unexpected and far-reaching implications. A group of former freelancers sued Microsoft in federal district court in 1993 for failing to provide them with benefits available to regular employees, including the right to participate in Microsoft's employee stock purchase plan. Under this plan, participants could periodically purchase Microsoft stock at a discount, using funds set aside through payroll deductions. Given the spectacular rise in value of Microsoft stock over the time period at issue, this benefit was of particular interest.

The district court certified a class comprising "all persons employed by Microsoft in the United States who are denied employee benefits because they are considered independent contractors or employees of third-party employment agencies, but who meet the definition of employees of Microsoft Corporation under the common law." Microsoft did not object to the class certification at the time, but reserved the question of whether specific individuals fell within the class.

In its motion for summary judgment, Microsoft argued that the plaintiffs were ineligible for benefits on the basis that they contractually waived their rights in their non-disclosure agreements and because they were not regular employees eligible for coverage under the terms of the plan. The district court ruled in Microsoft's favor.

On appeal to the Ninth Circuit, that decision was reversed. With respect to the stock purchase plan, the appellate court stated that the plan was established with the expectation that it would meet the requirements of Internal Revenue Code Section 423, which provides tax advantages to plans covering all common law employees. Thus, because Microsoft intended its plan to meet Code Section 423, coverage under the plan should have been provided to all of its common law employees. Accordingly, the court held that the plaintiffs had an enforceable cause of action for breach of contract. The Ninth Circuit panel further observed that the terms of the non-disclosure agreements signed by the freelancers did not control their employment status for these purposes, nor were the terms of the non-disclosure agreements necessarily inconsistent with coverage under the stock purchase plan, since employees, rather than Microsoft, pay for stock acquired under the plan.

Back to the Trial Court

Microsoft appealed this decision to the full Ninth Circuit, and then to the Supreme Court. After the Supreme Court denied certiorari, the case was remanded to the district court. At that point, Microsoft requested that the class certification be amended. Microsoft argued that the definition used in defining the class incorrectly encompassed groups of workers who should not be represented by the named plaintiffs consistent with Rule 23 of the Federal Rules of Civil Procedure. Although the district court denied Microsoft's motion to amend the class, it ultimately held that the class should be clarified to include only the named plaintiffs and those workers who were "similarly situated." This new definition excluded from the class other groups of workers who were not reclassified by Microsoft following the IRS audit, including temporaries hired after the conversion into reclassified or converted positions and others who were in fact common law employees, irrespective of their treatment by Microsoft. The new definition specifically excluded workers who had been transferred by Microsoft to temporary employment agencies.

The Latest Chapter

This decision led to the most recent Ninth Circuit panel opinion. The court of appeals granted plaintiffs' petition for mandamus to compel the district court to comply with the mandate issued by the appellate court. The court of appeals ordered the district court to allow into the class all workers who meet the common law definition of employee, whether or not Microsoft characterized them as independent contractors or employees of temporary agencies. The court of appeals stated that the lower court's clarification of the class improperly excluded other groups of workers who were neither reclassified by the IRS nor converted to temporary status or regular employees by Microsoft. As a result, all temporary workers hired by Microsoft are potentially members of the class, to the extent they meet the common law definition of employee.

The panel remanded the case to the district court with a recommendation that the lower court look to the factors relied upon in Nationwide Insurance Company v. Darden, 503 U.S. 315 (1992) to determine the common law employment status of the disputed workers. Darden held that the familiar "right of control" test, based on common law principles of agency law and applicable to several other federal labor and employment law statutes, should be used in determining whether an individual is an employee for ERISA purposes. Microsoft has not yet publicly indicated whether it will appeal the decision.

In what may be the most significant aspect of the latest opinion, the Ninth Circuit panel observed that workers who had been transferred to employment agencies and who thus became employees of those agencies could nonetheless also be deemed employees of Microsoft, at least for purposes of participating in the stock purchase plan. The court stated: "Even if for some purposes a worker is considered an employee of the agency, that would not preclude his status of common law employee of Microsoft. The two are not mutually exclusive." On this issue, the appellate court relied on the Ninth Circuit's earlier opinion in Burrey v. Pacific Gas and Elec. Co., 159 F.3d 388 (9th Cir. 1998), which, according to the panel, "is based on the premise that workers leased from an employment agency could be the common law employees of the recipient of their services; their status with respect to the latter must be determined using the Darden factors."

Implications for Employers

Many companies have implemented significant changes in their staffing model due to globalization and other market pressures, including workers' demands for increased job flexibility. The Ninth Circuit's latest decision in Vizcaino v. Microsoft reinforces the importance of a careful review of contingent workforce arrangements. Whether the workforce includes temporary workers, contract workers, leased employees, or other variations devised to address specific business demands and workplace issues, employers should consider their possible exposure for employee benefits, employment taxes and other liabilities associated with workers who may be found to meet the common law test for employees articulated in Darden. The "right of control" test endorsed in Darden is a multi-factor test that is inevitably fact-specific. The language in relevant employee benefit plans and employment contracts should also be reviewed. In addressing these issues, companies should recognize that their classification decisions for payroll, benefits and other purposes will not necessarily establish workers' status, from the standpoint of the IRS or the courts. Vizcaino demonstrates that even generally-accepted classifications that have evolved on an industry-wide basis are potentially subject to challenge. In light of the court's conclusion that workers such as leased employees can be common law employees of both the employment agency and the client, prudent employers should take a closer look at existing relationships with employment agencies and contractors providing various sorts of labor services.

For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

Thomas P. Gies
Partner – Washington, D.C.
Phone: +1.202.624.2690