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The law treats employees and contractors differently, so it’s important employers correctly classify their workers to meet their obligations. 

A ‘sham contract‘ describes the practice of an employer passing off an employment relationship as a contractor arrangement rather than an employee. Sham contracting commonly arises when:

  • the employment relationship ends, and the contractor believes the employer owes them entitlements; or
  • the worker believes they are an employee and wants to receive entitlements.

As a business owner, you should understand the difference between contractors and employees and your risks in setting up a sham relationship. 

What Makes Sham Contracting Illegal?

An employer will face penalties under the Fair Work Act 2009 (the Fair Work Act) if they attempt to disguise an employment relationship.

Even if your worker signs a contractor agreement, they may still be considered an employee under the law. Employee status attracts certain rights and entitlements such as superannuation, leave and workers’ compensation. An employer by requiring a worker enter into an independent contractor arrangement rather than employee contract denies the employee their rights.

Sham contracting requires the employer to either:

  • intentionally set up the relationship so as to avoid their obligations; or
  • be reckless as not to check whether the worker was in fact, an employee.

If an employer can prove they did not know the employee was not a contractor and they were not reckless, they will not be in breach of the Act.

Risk of Using Third Parties to Avoid Sham Contracting

The High Court discussed sham contracting in Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] HCA 45.

In this case, Quest had for a number of years employed two housekeepers. Quest then attempted to enter into an arrangement involving the housekeepers and a labour hire business. Labour hire is when a company provides workers to their client, but remains the hirer or employer. The substance of the housekeepers’ services, however, remained the same under the new agreement.

The Fair Work Ombudsman brought a case against Quest for misrepresenting that the housekeepers were independent contractors rather than employees. This classification was considered a breach of the Fair Work Act.

The Court’s decision highlights that employers cannot hide behind a labour hire agreement or another third party to avoid an employee’s rights under Australia’s workplace laws.

What Should You Do as an Employer?

We have set out some practical steps employers can take to ensure they comply with their workplace obligations. 

Conduct Research 

Employers should research the differences between an employee and contractor before bringing on workers. Many employers automatically assume contractors will best suit their business model. This is not always the case and depends on the industry in which you operate as well as the services you provide. If you prefer to have control over the conduct and performance of your workers, an employee relationship may be better.

Confirm That the Contractor is Aware of Their Working Relationship

Ensure that your worker understands the difference between a contractor and employee as well as the nature of the contract they have entered into. 

Use the Right Contracts

It’s crucial to have written contracts in place and provide the correct information to your workers about their employment status. Regardless of whether an individual agreed to enter into a contractor’s agreement, if they meet the criteria of an employee, the agreement can be considered a sham arrangement. An employment lawyer can help you to review the situation and determine the appropriate contract.

Bargain and Negotiate

Employers should provide contractors with the option to negotiate their contract. This is important to demonstrate that an individual understands the terms of the agreement.

Check that a Contractor’s Relationship is Permitted

Confirm whether your industry permits subcontracting before setting up your business and bringing on board workers.

Key Takeaways

An employer may not engage an employee under the false representation that they are an independent contractor. Many businesses fall foul of this section in the Fair Work Act when they fail to evaluate their hiring practices or the structure of their business model.

To avoid sham contracting, ensure you undertake a due diligence process. Confirm that both you and your prospective workers understand the nature of their work status and draft your contracts to reflect this. If you have any questions or need help drafting your worker’s contracts, get in touch on 1300 544 755 or fill out the form on this page.


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