Underground Economy

A DECADE AGO, Executive Management Services of Indianapolis purchased a Florida-based cleaning company, inheriting its employees. It wasn't long before President Dave Bego discovered that the workers that company had hired had all signed agreements stating that they were independent contractors. The problem? There is no way that a typical janitorial worker can meet the Internal Revenue Service's criteria to be classified as an independent contractor. Clearly, those janitors had been part of an illegal scheme to misclassify workers.

Bego immediately started switching those workers to employees, but was shaken by the experience, which taught him just how rampant illegal subcontracting is.

"In every business, in every industry, there are people who try and circumvent and cheat the system, and this is a big deal because in our industry, labor is the biggest percentage of our cost," Bego says.

A huge underground economy is thriving, thanks to employer avoidance of payroll taxes, insurance payments and workers' comp premiums through misclassification of janitorial employees as independent contractors, also known as illegal subcontracting. It is a blemish on the reputation of the cleaning industry, yet it continues to be a common practice among janitorial companies and subcontractors because it's easy to get away with: there's a labor pool, most often of illegal immigrant workers who will work, off the books, for less than minimum wage; customers are willing to turn a blind eye as long as they're getting a low price; and federal and state enforcement of wage and hour laws, taxation laws and insurance fraud is, by most accounts, nowhere near sufficient to even make a dent in the problem.

While unscrupulous building service contractors are making major profits off of illegal contracting schemes, those who are doing business to the letter of the law are wringing their hands in frustration.

"It's a frustrating situation," Bego says. "From our perspective, we look for customers who want to do business legally and want to do it the right way."

How it Works

Illegal subcontracting schemes can involve a prime contractor who is misclassifying employees as independent contractors, or they can involve multiple layers of subcontracting.

"It happens at two levels: one is where a cleaning contractor will go out and hire his people as independent contractors and have a set wage per day for the work; and then the second scenario is where a primary contractor goes out and gets the job, and then he goes to a subcontractor who then hires his people as independent contractors," says Bego.

At the heart of why worker misclassification in the janitorial industry is so blatantly illegal, is the fact that it is not possible for janitorial work to be defined as independent contracting. Independent contractors have to be able to dictate their own hours, provide their own cleaning supplies, have the ability to make a profit, not be paid based on hours worked, and cannot receive training or instruction from the company they subcontract for.

"There's 22 criteria that the IRS has set up as hurdles you have to clear in order to be considered a legitimate subcontractor and it's impossible for a night cleaning worker to meet that criteria," says Don Dyer, CEO of Austin-based PJS of Texas.

Worker misclassification hurts the entire country because it robs the government of tax revenues, it hurts basic wage rates, Bego says, and it hurts illegal immigrants, a population that largely wants to work but does not have proper documentation to fill out I-9 forms. As these jobs are completely off the books, illegal immigrant workers are perfect targets for employers, who, in turn, are getting away with paying up to 30 percent less for labor than their competitors.

"So it's easy for these contractors that do that to hire these people and take advantage of them because they can pay them cheaply," Bego says. "Personally, I believe it's an unethical practice, that contractors in our industry should wake up and do business with character and integrity."

However, in an industry that has suffered cuts due to the recession, more and more contractors are facing a tough choice: continue to do business ethically, at higher prices, and risk losing business, or break the law in order to compete with unscrupulous contractors. But that choice can seem like a lose-lose proposition.

Dyer says his company completely ceased doing business in Dallas, where average prices for janitorial work are an estimated 20 to 30 percent cheaper than elsewhere. They just can't compete there, he says.

"It's an insurance issue, it's a tax issue — federal and state, it's an unemployment issue; they don't have to pay any of those costs, so they're charging 20 percent less and making more money," Dyer says.

All sources interviewed for this article confirmed that Dallas and Atlanta are two hotbeds for illegal subcontracting.

Fighting the Problem

Bego and other BSCs claim a large contingency of contractors, large and small, utilize these illegal practices. And many BSCs feel powerless to do much — after all, they can't enforce labor laws themselves, they can't convince workers that being paid under the table is wrong, and they can't prevent customers from going after the low bids.

Many BSCs are taking it personally that they have to compete with companies that are intentionally misclassifying workers.

"If someone is practicing illegal subcontracting, they obviously have a huge cost advantage over us who are legitimately complying with all the labor laws," says John Ezzo, president of New Image Building Services, Mount Clemens, Mich. "That advantage has been a minimum of about 20 percent."

Having served for years as an officer and board member, and in 2007, president, of Building Service Contractors Association International (BSCAI), Ezzo was being approached by other members, asking what can be done about the problem of illegal subcontracting. Though BSCAI does some lobbying for government assistance, he says, it is not an enforcement agency.

So, he made the decision to be proactive in reducing illegal subcontracting. Not only did he travel to Washington, D.C., and Michigan's capital many times to lobby on behalf of the industry, but he also personally partnered with state agencies and the attorney general to address the issue.

"I got the feds and state to go after this operation in Michigan, but I devoted a lot of time to it and called in a lot of favors," he says. "I mean, I spent years working on it before I got any traction with it at all. You've got to keep barking, get far enough up that tree, to get the right person's attention to do something about it."

It is potentially risky business to personally champion such a cause, but to Ezzo it was worth it to help root out competitors who were essentially cheating their way to winning contracts.

"Would most people do that? Probably not," Ezzo says. "But it definitely has helped the situation in my market, it's brought awareness to clients that they need to hire legitimate contractors. For me, it's working and it's paying off."

There's no global or federal solution to ridding the market of illegal subcontracting — so it needs to be done by individuals and at the state level, in the attorney general's office, Ezzo says. Enforcement at the state level is necessary to root out companies who are engaging in these schemes.

"My argument was, 'I'm proving to you that you're missing millions of dollars in tax revenue, so all you have to do is enforce the laws that you currently have and you'll eventually collect,'" Ezzo says.

BSCs' best allies when it comes to enforcement are state attorneys general, says Rex Gore, president of PJS of Texas.

"If more states' attorney general offices would go after these guys, and the real estate owners would understand because they have some liability, I think that would be pretty instrumental," says Rex Gore. "Because right now, it's a see-no-evil, hear-no-evil response."

In California, an effort similar to Ezzo's is happening — but on a much bigger scale.

In 1999, three Los Angeles-area BSCs got together to fund a watchdog group that essentially serves as a policing and investigatory entity for the cleaning industry in California, with the goal to ferret out illegal subcontracting and misclassification.

"The objective of the group is to level the playing field so that a responsible operator can compete," says Dick Dotts, president of DMS Facility Services in Monrovia, Calif., a funding member of the organization.

The organization is funded by Service Employees International Union (SEIU) contracts, through which union contractors contribute one to four cents per hour worked for each employee to the trust, which is called the Maintenance Cooperation Trust Fund (MCTF). Now, there are about 50 BSCs involved in the fund.

MCTF is modeled after similar compliance programs in the building trades, says Executive Director, Lilia Garcia.

"We're the first one in the service industry and we're actually the only one that exists in the service industry," Garcia says.

Garcia has been on the job 10 of the 11 years the organization has been in existence, and says MCTF has had a significant impact on illegal subcontracting in California.

"I'd say we have been able to clean up, to bring in about 6,000 jobs from the underground economy into the formal economy, and one of the shifts in that change is that workers are going to properly classified as employees and taxes are going to be withheld on both sides," Garcia says. "And workers' comp is going to be covered and overtime and minimum wage (laws) are going to be followed."

The MCTF, according to its website, has helped collect more than $26 million in unpaid wages for more than 5,000 janitors. One of the most prominent cases the group has been involved with targeted a handful of the state's largest grocery chains, all of whom were using a prime contractor who was illegally subcontracting to some 200 illegitimate subcontractors.

Those fly-by-night companies were operating out of vehicles or apartments and didn't have legitimate offices, weren't registered with the state, paid in cash — and were employing more than 2,000 janitors as so-called independent contractors.

The stores, which included the state's most prominent supermarket chains, settled the lawsuit for $22 million, and their illegal subcontracting was stopped as a result of MCTF. Cases like that help expose labor violations and highlight the need for client responsibility in a business environment that unfairly demands that work is done for the cheapest price by any means, Garcia says.

"We're raising a voice and saying, 'We need your leadership to support responsible employers. We need you to care when we're bringing you evidence of minimal standard violations,'" she says.

Unfortunately, however, it's an uphill battle. Completely eradicating the practice will be extremely difficult, Garcia says Janitorial is starting to look like the construction trades — which have the motto, "you have to cheat to eat," Garcia says.

"Contractors, especially right now, they're just looking for any way to stay afloat and unfortunately it's more and more looking like you have to break the law to hold onto some of these contracts," Garcia says.

New Legislation Pending

At the federal level, the laws exist to prevent illegal subcontracting — but the enforcement just isn't where it needs to be, BSCs say.

"I really think the government agencies just don't have the wherewithal to go out there and go searching and get the job done" Bego says. "If they did enforce the laws they have it would clean up a lot of this stuff. ... I think they're going to wait until people blow the whistle."

Misclassification of workers has been targeted by new legislation introduced in the U.S. House and Senate; the Employee Misclassification Protection Act was introduced in April, and the Fair Playing Field Act was introduced in September.

The White House has recognized how critical the situation is by endorsing The Fair Playing Field Act of 2010, cosponsored by Sen. Sherrod Brown (D-Ohio), says Allison Preiss, staffer for Sen. Brown.

"Protecting employee rights is even more important during difficult economic times, and Senator Brown is fighting to pass an employee misclassification bill as soon as possible, so that all eligible workers have equal access to these important protections," Preiss says.

While there is no easy answer or fix to the complex problems caused by illegal subcontracting, BSCs who care about the reputation of the industry and about fair treatment of workers are willing to stand up and fight the practice to the best of their abilities.

"I'm passionate about the industry in which I make a living and I'm passionate about the thousands of workers who do the job. They shouldn't be abused, they shouldn't be paid less than minimum wage, they shouldn't have to live in substandard housing and be treated like slaves," Ezzo says. "They should have the benefits of workers' compensation insurance and other benefits that come from being employed — like social security and Medicare and all those things we pay for someone who legitimately works a job for their living."