WHAT IS A PEO?

A PEO is an entity that contractually assumes various employer rights and human resources responsibilities through the undertaking of an “employer relationship” with workers either assigned to or hired by its clients (employers).  In short, the PEO and the employer/client share an employment relationship that allows the PEO to handle and manage employee-related matters such as payroll, benefits, tax matters and, in many cases, workers' compensation programs, thus allowing the employer to concentrate on the operation and revenue producing aspects of its business. This relationship has become so commonplace that various states actually recognize PEOs and their clients as “co-employers.” 

This co-employment relationship has been summarized by NAPEO, in part, as a contractual relationship whereby the PEO:

• Co-employs workers at the client locations and assumes responsibility as an employer for specified purposes;
• Reserves a right to direct and control these employees;
• Pays wages and employment taxes of the employee out of its own accounts;
• Reports, collects and deposits employment taxes with the state and federal authorities;
• Establishes and maintains an employment relationship with its employees that is intended to be long-term and not temporary; and
• Retains the right to hire, re-assign and fire the employees.

Recognizing the potential for fraud that could arise from the co-employer shared relationship, some states have enacted legislation that further defines a PEO relationship and undertakes management protocols for these entities.  The majority of states, however, have failed to enact or enforce legislation that would protect employers from PEO fraud or misrepresentation.

POTENTIAL FRAUD ISSUES

When an employer outsources its workers' compensation coverage responsibility to a PEO, it is entrusting that all insurance requirements will be fulfilled by the PEO.  This means that the PEO will be responsible for classifying employees, communicating payroll to insurers, selecting appropriate coverage and paying premiums. This also presupposes that the PEO is familiar with the local workers' compensation statutes and regulations. Unknowingly, some employers may willingly shift this burden to the PEO without securing contractual evidence of the PEO's rights and duties. What's worse, these same employers may rely on an ambiguous contract drafted by the PEO which does nothing to protect the employer's interests. Unfortunately, the lack of a clearly defined, written contract between the PEO and employer can not only lead to fraud or misrepresentation by the PEO, but also can negate the existence of a valid PEO relationship in states that require a written PEO contract. 

When an employer is contracted with a PEO and a workers' compensation claim is filed, questions often arise as to whether appropriate insurance has been maintained, if there is documentary evidence available to support the PEO's responsibility to defend the workers' compensation claim and even, sometimes, whether the PEO is fiscally solvent. There have been cases where a “fly by night” PEO is saddled with liability by a workers' compensation judge and simply fails to pay benefits. Under such circumstances the employer would likely be liable for the injury and could be put into a situation where no insurance exists, thus exposing employers to criminal liability in certain states.

The fact that the PEO and its employer-client are viewed as co-employers in the workers' compensation system has a perceived advantage. From a theoretical standpoint, an employer can farm out its workers' compensation coverage while keeping the protection of tort immunity. It follows that in the PEO relationship, where the PEO and the employer both share the right to control the employee, both technically possess the right to assert tort immunity. However, this has not stopped a number of lawsuits naming the employer as a third party tortfeasor after a workers' compensation injury, which has led some states to create specific statutes related to workers' compensation that govern PEO contracts and tort immunity.  If an employer is unaware of these statutes and if the PEO does not strictly adhere to the provisions of the statute, the alleged “PEO relationship” may not be binding and the employer could face expensive litigation to prove that tort immunity applies or that a PEO co-employer relationship even exists.

PROACTIVE RISK MANAGEMENT

The emergence of incidents of PEO fraud in relation to workers' compensation matters provides a cautionary tale for employers considering entering into the PEO arrangement. Employers should be aware of statutes in certain states that require a PEO to define its contractual obligations and the protocols by which the PEO is to be managed through a “Professional Employer Agreement.” For employers operating in states without such legislation, it is important to insist on a written contractual agreement with the PEO, drafted in unambiguous language that is understood and agreed upon by both parties at the start of the co-employment relationship.  Within this contract, a  provision as to the allocation of workers' compensation coverage must  be included. Further, the employer must have the contractual ability to request and secure proof of workers' compensation coverage from the PEO. The contract should also provide employers with access to the loss history and total wages paid for covered employees. Operating in this fashion will ensure that the employer is engaging in an environment that is free from potential PEO fraud.

Anthony Natale III is a shareholder in the Workers' Compensation Department at civil defense litigation firm, Marshall Dennehey Warner Coleman & Goggin. Resident in the Philadelphia office, Natale has exclusively focused on the defense of workers' compensation claims since 1995. He may be reached at 215-575-2745 or [email protected].