Does Minnesota’s New Subcontractor Classification Law Ban Time & Materials Subcontracts?

Summer: perfect for trips to the cabin, relaxing at the lake, and—for contractors—packing an entire year’s worth of work into a few short months! As jobs pick up for the year, more and more contractors are finding themselves caught in the wave of Minnesota’s new Independent Contractor law (Minn. Stat. § 181.723) which took full effect this year.

The law provides a fourteen-factor test that subcontractors must pass to be considered Independent Contractors. Stricter than the previous nine-factor test, all fourteen elements must be met—or higher-tier contractors could face serious penalties, even potentially becoming responsible for wages, benefits, and insurance for their subcontractor’s workers.

The risks are high. The statute is untested. Many questions are still unanswered. For example, are Time and Material (T&M) subcontracts still permitted under the new statute?

T&M Subcontracts

T&M is a common compensation method where subcontractors can earn payment at specified rates for the hours of labor and materials required to complete the work, instead of setting a lump sum or unit price at bid time. T&M subcontracts are especially useful when the overall scope is unknown.

Minnesota’s new Independent Contractor law (Minn. Stat. § 181.723) does not directly address T&M subcontracts. It does, however, require that all subcontracts

The language begs the question: are T&M subcontracts still permitted? While untested, this statute should not be interpreted to have such far-reaching and unintended consequences.

T&M subcontracts should not be banned implicitly

T&M subcontracts are incredibly common and banning them would be drastic. If that were the legislature’s intent, one would expect it to be addressed far more clearly.

First, the previous version of this law included a similar list of three permissible subcontract structures, yet the Minnesota Department of Employment and Economic Development continued to recognize T&M subcontracts.[1]

Second, when the new law was announced, the Minnesota Department of Labor and Industry released a list of FAQs, including #25, which allows cost-plus and T&M subcontracts so long as the subcontractor assumes risk of profit or loss:

Determination of whether a contract meets the requirements of the independent contractor test requires a case-by-case analysis. The test requires that under the contract the hired person may realize additional profit or suffer a loss if the costs and expenses to provide or perform the contracted services are less than or greater than the compensation provided under the contract. If this requirement is not met, the contract does not satisfy the independent contractor test.

While not binding authority, it is encouraging that public agencies seem to recognize that such a common subcontracting method should not be banned implicitly.

T&M subcontracts are possible under a “per-job” compensation basis

While T&M is not explicitly listed as one of the three permitted compensation bases, it can fall into the “per-job” category by setting rates for each specific job. In other words, T&M rates can (and now must) be provided on a per-job basis to ensure compliance with the plain language of the statute.

T&M subcontracts can still meet the “profit or loss” requirement

The new law requires subcontractors to assume risk. This requirement is possible in a T&M subcontract if time and material rates are set independent of the costs. That way, subcontractors bear the risk of cost escalation, whether in labor or materials.

The result may be different with other payment methods, such as cost-plus or price escalation clauses. In those scenarios, it may be more difficult to meet the “profit or loss” requirement without adding some significant risks to the subcontractors. These and similar subcontract clauses should be closely scrutinized for compliance with the new statute.

Conclusion

The new law sets out to protect workers yet creates new uncertainty in the industry. The legislature should work with industry experts to avoid such confusion, including clarifying the statute to avoid potentially unintended industry-wide consequences.

T&M subcontracts should continue to be permitted. However, the law is untested, and courts may disagree. In the meantime, the best practice for contractors is to ensure they have job-specific T&M rates that are independent of costs in any Minnesota-based T&M subcontract.

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[1] “An independent contractor is often paid a flat fee or on a time and materials basis for a job.”

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