Legal Insights with Klein Law: Dangers of Disguising Employees as Contractors; The Blackmailer. Part 2

As with most countries, it is very tempting for both employer and contractor (employee) to disguise an employment relationship as something else.

This is the second article relating to Disguising Employees as Contractors from the desk of our Legal Columnist, American Intellectual Property expert, Daniel Klein, who is based in Tbilisi and Armenia. It is a follow-up to our recent article relating to tax rates. (See The Dangers of Disguising Employees as Contractors. Part 1).

As with most countries, it is very tempting for both employer and contractor (employee) to disguise an employment relationship as something else.

For IT companies that are relying on work-for-hire contracts with the creators of Intellectual Property (IP), it is mission critical that the contract in question is air tight and duly and legally transfers from contractor to the company any potential source code, software development, or other IP created.

However, if the contractor is in fact an employee, such a contract could be deemed invalid by a Georgian Court, null and void, meaning that its as if the parties were working without any documentation of the relationship.

As per our Part 1 article, these contracts are created by the company and for the company. Courts in general have little sympathy for large corporations when it comes to employee law suits. In that regard, if the employer is trying to save on taxes and in case of a foreign counter agent, save on legalizing the immigration status of a worker (See our eye opening discussion on that in Part 3 next week), courts rarely blame the employee for tax evasion or possible immigration violations if they are foreign workers.

According to Managing Counsel to America’s Align Technologies, Eugene Vlasov, “a work-for-hire contract is a rather straightforward agreement with a contractor, whereas if the contractor is actually an employee, a whole ecosystem of documents and procedures are required in order to secure the valid transfer of IP to the company.” Mr Vlasov further insists that “appropriate documentation of IP transfers, Internal Working Rules, Royalty payments, and air-tight detailed employment agreements are just of few of the elements for a valid and sometimes sophisticated ecosystem.”

In that regard, international IT companies that rely on templates or procedures that are used in the West may fail in the secure IP transfer to the extent they are not localized for Georgia, Armenia or other relevant jurisdictions.

What makes matters potentially worse is that if the IT workers are digital nomads in other jurisdictions, and actually are really a company worker, the jurisdiction of the country where the nomad resides in certain circumstances could be the jurisdiction in terms of applicable employment law. This is too complicated for a legal column, so we won’t elaborate further.

A disgruntled contractor/employee (ex or otherwise) may approach a company with their/their lawyer’s claims (correctly or not) and ask for:
• Past royalties due for part of the software created;
• A possible injunction, depending on the jurisdiction that the software is used; in other words, a court order for the company to discontinue using said software or other IP.

Of course, especially in Georgia, to get such a judgement could take a very long time, and the company might find it better both from a publicity/internal reputational issues/economic perspective to just settle with the blackmailer. Blackmailers can set dangerous precedents for potential other disgruntled employees.

We have had of several Georgian subsidiaries seeking assistance in that regard, especially since late last year.

VC funds, Private Equity funds, banks and other financiers of US or European companies often require detailed due diligence of the companies’ HQ, as well as its worldwide subsidiaries. That means at the granular level they might review all contractor contracts as well as the employee ecosystem just mentioned. For many IT companies, the main (and in some cases the only significant) asset is the employee/contractor-created IP. If it is flawed, it can and often does impact evaluations and the decision to provide the next round of funding or the like.

In conclusion, it is Mission Critical to have in place effective, valid and user friendly systems and documents in order for IT companies to survive and thrive.