2. Re-Characterisation of Independent Contractors as Employees
a. Laws and Guiding Principles
As described above, the re-characterization as employee depends on several criteria, which have been developed by German federal courts based on the few scattered law provisions on this issue.
With regard to employee protection rights, the German labor courts usually decide on the legal status of a contractual relationship within the scope of a legal dispute over the application of a specific regulation or benefit that applies to employees only.
The social security authorities decide on the status of a contractor with respect to the question whether the principal/employer has complied with its legal obligation to pay social security contributions for every employee. For this purpose, the authorities audit employers regularly check for any unregistered employees, for whom social security contributions are due.
b. The Legal Consequences of a Re-Characterisation
The legal consequences of a re-characterization are broad and entail comprehensive risks for the employer.
In case of a re-characterization, the pseudo-contractor may claim employment with the principal/employer, thus gaining the status of an employee including the applicable level of protection. Specifically, the re-characterized employee may claim dismissal protection under the German Act on Protection Against Unfair Dismissal. This means that a termination requires a specific reason in order to be valid, and that the applicable notice period has to be observed. The employer may no longer terminate the contractual relationship without a valid reason.
Furthermore, the employer is, pursuant to German Social Code, obligated to retroactively pay social security contributions for the re-characterized employment relationship. In this regard, the employer is liable for the aggregate amount of the social security contributions without being allowed to deduct the employee’s contribution from his/her salary in full. This obligation for payment of social security contribution arrears generally covers the entire duration of the re-characterized employment relationship and is thus only limited by the applicable statute of limitation. This means that the employer may have to pay social security contributions for almost up to four years (in case of intent for up to thirty years) in arrears.
The employer’s managing director/legal representative in charge may be held liable under criminal law for wrongful non-payment of the employee’s social security contributions pursuant to the German Criminal Code. The legal representative may be sentenced to up to five years of imprisonment or charged with a fine, although this is rare in practice.
c. Judicial Remedies Available to Persons Seeking ‘Employee’ Status
Persons seeking the status of an employee may address the competent labor court by lodging a declaratory action. If the claimant prevails, the court will declare that an employment relationship is in place and/or has been concluded at some particular point of time in the past between the claimant/employee and the defendant/employer.
As the employee status is sine qua non for some particular benefits or protective regulations to apply, a court will have to impliedly decide on a claimant’s labor status if he/she sues the principal/employer for one of these particular benefits or protective measures. In practice, this commonly occurs following the termination of the contractual relationship by the principal/employer where the claimant would enjoy dismissal protection if qualified as an employee.
As previously mentioned above, principal and contractor may, either jointly or alone, also address the competent German authority and initiate a declaratory procedure about the contractor’s social status. The authority’s decision may be challenged by either party in court.
d. Legal or Administrative Penalties or Damages for the Employers in the Event of Re-Characterisation
In the event of re-characterization, the employer must pay the outstanding social security contributions for up to almost four years (in case of intent for up to thirty years) in arrears, plus a late payment fine (generally one percent of the due amount per month).
Furthermore, penalties from a criminal conviction are possible and may include a sentence to imprisonment or a fine, whose amount depends on the income of the convicted employer/employer’s legal representative. Any such penalties are imposed on the legal representative of the employer. The likeliness of such conviction is, of course, subject to an assessment on a case-by-case basis and rare in practice. Any form of criminal intent would necessarily be involved when misjudging the social status of an employee in order to justify a conviction.
If convicted, the employer/employer’s legal representative may also be personally liable for the outstanding employee’s social security contributions. This will particularly become relevant if the employing entity has filed for bankruptcy.