Hiring an employee through a pay slip or as a freelancer – which is better?

Hiring an employee through a pay slip or as a freelancer – which is better?

September 26, 2021

A CEO of a business pays his salary for years against an invoice. After the business is sold and the new owners decided to terminate his engagement, the CEO files a lawsuit against the company, contending that in fact he was an employee and even demanded retroactive payments that the business (actually, he as the CEO) should have paid him during his employment. Is this illogical case possible?

In the case described above, as part of the due diligence for the transaction, the CEO confirmed to the purchaser that he is self-employed, he received payments against tax invoices and paid the required VAT and defined the relationship between the parties, both at the beginning and near their termination, as an independent contractor, and thus the Court dismissed the claim. However, not all such lawsuits ends in a similar way.

An employer-employee relationship is a matter of status and therefore, the way the parties define it in an agreement is not the only test to determine whether this relationship exists, in the same manner that as an agreement between an employee and an employer for remuneration lower than the minimum set by law will not be recognized. In a precedent-setting holding of the Israeli National Labor Court in April 2021, the Court established a new caselaw that changed the rules of the game, regarding the engagement against an invoice (a.k.a. freelancer or self-employed contractor): If the freelancer integrated into the business and the employer fails to show that if the same freelancer was employed as an employee he would have earned less, the employee may be entitled to retroactive payment of social benefits for the entire period of work and to damages. In addition, conduct in bad faith by a service provider who contends to have an employee-employer relationship, after being the one who demanded to work as a freelancer, may prevent recognition of an employee-employer relationship.

That case dealt with three joined appeals. One was a folk-dance instructor who entered into an agreement with a municipality to provide dance lessons in schools and it was held that there no employee-employer relationship existed. In another case, a person was employed as a freelancer for nearly 8 years, as a director of the Israeli Corporations Authority, but the Court held that employee-employer relationship existed, but the social benefits element was absorbed in the higher remuneration he received. The third case concerned a freelancer who was engaged as such for more than 12 years but the Court held that no employee-employer relationship existed because the freelancer is the one who demanded to be engaged as such for his economic reasons.

As in other cases, in employment relationship, including due to the holdings in such caselaw, it is advisable to take the high road and prefer to employ the work force through pay slips and full employee-employer relations and not to employ them in an artificial way to circumvent the payment of social benefits, all in order to minimize the risk of employee claims that may end in paying high compensation. If there is a real reason to hire the work force via an invoice as an independent contractor, it is vital that the agreement be drafted with the assistance of a lawyer with expertise in the field, in order to avoid future legal disputes, which may involve costs that can be saved or reduced.