April 18, 1994

John Duncan
Paul Lynd
(415) 703-4590
Rick Rice (L.A.)
(714) 935-2812

DIR Cracks Down on Workers' Compensation Coverage Schemes; Cautions Employers About Employee Leasing Companies

SAN FRANCISCO -- On the heels of a favorable decision by the Ninth U.S. Circuit Court of Appeals, the Department of Industrial Relations will continue to enforce vigorously requirements that employers hold valid workers' compensation coverage and cautions employers about the validity of employee benefit plans offered through employee leasing companies, Director Lloyd W. Aubry, Jr. announced.

Since 1913, California law has required that employers carry workers' compensation insurance. In Employee Staffing Services v. Aubry, the Ninth Circuit ruled April 5 that state laws requiring workers' compensation coverage from a carrier admitted in California or through self insurance are not preempted by the federal Employee Retirement Income Security Act (ERISA).

The case before the Ninth Circuit involved Stafcor, a subsidiary of Employee Staffing Services, which hired employees and "leased" them to its client employers in the garment industry. Stafcor, which has since ceased operation, provided benefits to its employees under its ERISA plan, but did not carry a workers' compensation insurance policy as required by state law. Rather, Stafcor guaranteed benefits through a trust fund subsidized by employer clients and employees. The State Labor Commissioner issued a "Stop Notice and Penalty Assessment" against Stafcor, requiring the employee leasing company to stop using any employee labor until it secured valid workers' compensation coverage.

In response, Stafcor filed suit in federal court, asserting that the federal ERISA law preempted California's requirement that employers carry a separate workers' compensation policy. In its ruling, the Ninth Circuit held that "the obligations of California workers' compensation insurance cannot be avoided by substituting an ERISA plan's coverage for worker-related injuries."

Aubry praised the decision, noting that it represents the tenth case in which DIR has gone to court against employee leasing firms offering workers' compensation coverage to their employer clients. DIR has won every case.

"We feel gratified and vindicated by the decision of the court," he said. "We had received some criticism for proceeding against these companies that were trying to lower their workers' compensation costs. But Stafcor's method was clearly not the way as can be seen from the experience of many other ERISA plans. The court's decision protects the benefits of injured workers as well as the taxpayer of the state who has to pay for workers' compensation benefits when these ERISA plans become insolvent."

In recent years, the number of employee leasing companies has grown dramatically. Employer clients frequently turn to employee leasing companies in order to reduce their health and worker' compensation insurance costs. Aubry cautioned that any client employing services from an employee leasing firm or considering using such services should do so carefully.

"While we understand business' desire to reduce workers' compensation costs," he said, "the ways to reduce costs are through legislative reform as was accomplished last year and through emphasis on prevention and safety -- not through inventive schemes.

"Clients or potential clients of employee leasing companies should verify that services really are what they are purported to be," Aubry continued. "Unfortunately, the growth in employee leasing has spurred schemes, as in the Stafcor case. In this case, and in others we have seen, the workers' compensation coverage is not valid under state law. In such cases, the employer clients could be unwittingly exposing themselves and taxpayers to significant liability."

Under state law, firms not carrying valid workers' compensation coverage are considered uninsured and face a "Stop Notice and Penalty Assessment" from the Labor Commissioner and fines of $1,000 per employee, up to $100,000. If an injury occurs, the fine increases to $10,000 per employee. A worker injured while working for an uninsured employer can sue for damages and the employer is presumed negligent in such cases.

The cost of injuries to employees of uninsured employers is borne by the Uninsured Employers Fund (UEF), a program managed by DIR and funded mostly by General Fund tax revenues. The UEF pays costs such as medical treatment, disability benefits, and vocational rehabilitation. In such cases, DIR files liens against an employer's property and attempts to recover costs and reimburse taxpayers. However, costs to taxpayers because of uninsured employers have grown from $14 million in the 1988-89 fiscal year to $18.6 million in fiscal year 1992-93.

"It is important to note that, despite its promises to its employer clients, Stafcor also reneged on paying on some workers' compensation claims," Aubry said. "In order to protect employees, law-abiding employers, and taxpayers from the schemes offered by some employee leasing companies, we must and will continue our vigorous enforcement in this area. Although the federal government recently filed lawsuits under ERISA concerning health benefits and employee leasing firms, California has led the way in enforcement."

Other states engaged in similar litigation have requested and received assistance from DIR. Oklahoma, Virginia, Arizona, Texas, Michigan, New York, and Maine either have requested and been provided copies of California's court filings or received support from California as amicus curiae.


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