Why Franchisees Use Subcontractors

• Current Difficulty with Finding Employees: The tight labor market has made subcontractors an appealing solution.
• Avoidance of Payroll Taxes: Many franchisees believe subcontractors reduce administrative burdens like payroll taxes.
• Belief that “1099 Employees Don’t Require Coverage”: A common misconception that can lead to significant exposure.
• Flexibility in Workforce Management: Subcontractors offer adaptability to meet fluctuating demand.

The Dangers of Using Subcontractors

Coverage Responsibility: Subcontractors must either have their own insurance coverage (with proof provided) or obtain a waiver from the labor commission. Without this, any work performed, injuries sustained, or damage caused by the subcontractor becomes 100% the franchisee’s responsibility.

Example: A franchisee hired a subcontractor for routine HVAC maintenance without verifying the subcontractor's insurance. During the job, the subcontractor accidentally ruptured a pipe, causing extensive water damage to the property. Additionally, the subcontractor slipped on the resulting water spill and suffered a serious injury.

It was later discovered that the subcontractor lacked both general liability and workers' compensation coverage. Because the franchisee failed to verify insurance, they were held liable for the $50,000 repair bill for the property damage and the subcontractor's medical expenses, which included ongoing treatment and lost wages. The total claim exceeded $100,000, all of which could have been avoided with proper insurance monitoring.

Self-Insurance Risks: Without workers’ compensation coverage, franchisees are effectively self-insuring the risk of injury, including associated medical bills and lost wages.

Problems with Insurance Markets

Preferred Carrier Limitations:

• Preferred carriers typically only allow up to 25% of total work to be subcontracted. Any percentage beyond this threshold may result in non-renewal or policy declination.

Limited Options:

• Option 1: Classification as a General Contractor
  • Exponentially higher premiums.
  • Not ideal for businesses focusing on specific tasks (e.g., fence installation) rather than varied scopes of work.
• Option 2: Securing Coverage with a Surplus Market Policy
  • Policies may include exclusions for circumstances relevant to operations.
  • Premiums are often significantly higher.
  • If subcontractor insurance is not actively monitored:
    • Carriers may reclassify subcontracted expenses under the primary classification.
    • Premiums can increase drastically.
    • Policies can be canceled or non-renewed.

Why This Is a Serious Problem

• Legal Risks: Legal battles over negligence can arise if claims involve uninsured subcontractors.
• Subcontractor Side Jobs: Liability for unrelated side jobs performed by subcontractors can still fall on the franchisee.
• Uninsured Subcontractors: Increase liability and risk exposure.
• Insurance Monitoring Challenges: Certificates of Insurance must be continuously obtained and verified, as they may be inaccurate or outdated.
• Operational Risks: Lack of controls, systems, and processes, as well as absent safety protocols, can lead to increased incidents and liability.

Examples of Insurance Problems

• Market Challenges: Difficulty securing insurance markets for accounts with heavy subcontractor usage.
• Misclassification Issues: Initial misclassification of work can lead to significant premium increases when corrected.
• Policy Exclusions: Insurance policies may include exclusions for subcontracted work, leaving gaps in coverage.

How to Mitigate Your Risk

• Treat Uninsured Subcontractors as Employees: Adjust payroll estimates to account for uninsured subcontractors.
• Enforce Subcontractor Agreements: Use strict, enforceable agreements with all subcontractors.
• Monitor Subcontractor Insurance Actively: Implement robust systems for monitoring required insurance to ensure compliance. Regularly verify the validity and accuracy of Certificates of Insurance.

By integrating systems and processes to actively monitor subcontractor insurance, franchisees can mitigate risks, protect their operations, and avoid costly uninsured claims like the one described above.