In this episode, hosts Brad and Michael share the story of a Texas dermatologist whose thriving practice was undermined by business operational missteps, one of which involved the misclassification of a key employee. Tune in to learn the legal differences between independent contractors and employees, the tax and operational implications of each, and the agreements necessary to safeguard your practice from costly mistakes.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1.
Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, with my co-host, Michael Byrd.
Michael: As a business and health care law firm, we meet a lot of interesting people and learn their amazing stories. This season’s theme, Brad, is Unintended Consequences. We sometimes find ourselves in a situation that can be traced back to a seemingly inconsequential or unrelated decision.
Brad: Well, do we have an unexpected consequence to discuss today, Mr. Michael?
Michael: Yes, Brad. Hold tight though. Because first I want to talk about a lawsuit filing that I came across online. And this lawsuit was more of a story of what should be expected consequences.
Brad: All right, I’m interested. What’s it about? [00:01:00]
Michael: So, this lawsuit alleges that a multi-billion dollar technology company orchestrated a corporate espionage scheme to steal trade secrets from a competitor.
Brad: Scheme and espionage are definitely red flag words and exciting words. And I hear it, I’m like, I’m wanting to know more about it. So, sounds like something out of a movie even.
Michael: Yeah. And so, I won’t bring up the names of the companies because I don’t know of any context, so I’ll refer to this multi-billion dollar company as the competitor company, and the other one is the victim company. So the allegations say this was a deliberate attack by the competitor company perpetrated over four months to take sales leads, sales pipeline, and the entire playbook for pitching prospective clients.
Brad: All right. This seems like it would be very harmful information [00:02:00] to fall into the hands of your competitor.
Michael: Yeah. The crazy part is the allegations say that this competitor company orchestrated it from the highest levels of their organization, including the Chairman of the Board and the CFO.
Brad: That’s pretty much crazy shocking. Skipping over the fact that they have actual fiduciary duties to the business. You can almost say that – you could maybe see like in the lower end employees who aren’t paid as well, that they might be a risk to the organization. But it’s crazy to imagine someone at the top of the organization taking this type of risk.
Michael: Yeah. I mean, it makes you wonder what else they did, right? Like what other competitive advantages this competitor company sought over the years? Because it’s coming from the top, right? I mean, it’s not like, oh, this was my first time. I just got caught. And so, it was pretty insidious looking, at least on the way it was alleged.
Brad: Well, how did they do it?
Michael: Well, the lawsuit alleges that [00:03:00] the competitor company cultivated a spy within the victim company’s employee base.
Brad: All right. How did the victim company become aware that there could be a spy or a problem in general?
Michael: So the victim company, I guess they’ve got their systems in place with their IT, and there were some irregular searches that were flagged by their IT department. And it was one particular employee of the victim company that over a four month period, this employee was doing these unique searches, and so the company started investigating.
Brad: All right, what did they find?
Michael: Well, what they found first was that this employee of the victim company kept running searches using the name of the competitor company as a means to find out any time the competitor company was mentioned inside the victim company’s database of things.
Brad: Yeah. I mean, I guess it doesn’t seem unusual that [00:04:00] someone would search for your competitors, but made unusual inside of your system to do it that way. But I understand how this would be helpful.
Michael: I think that’s where the investigation came. Because they’re like, well, it’s an unusual pattern by one person. But then as they dug deeper, these searches, they realized were picking up details of the sales pipeline of the victim company, especially when the victim company and the competitor were in competition over the same deal, and so it was giving a lot of information that they alleged the competitor company could use.
Brad: Yeah, that sounds pretty bad, Michael.
Michael: Well, the investigation revealed that this employee searched the competitor company’s name an average of 23 times per day over this four month period.
Brad: That’s a lot of time to look at that competitor. How did they make this connection to the employee who was actually working with this [00:05:00] – I guess the other…
Michael: The competitor company?
Brad: Yeah.
Michael: Well, the victim company did a test that security pros call a honeypot.
Brad: Yeah. I love it. And for those that don’t know, in the business world, the honeypot is like a decoy system or a network designed to track and trap criminals. And sometimes, I guess bad employees, allowing the security personnel to really monitor and analyze the activities and methods they’re using. Now, for me as an espionage book reader, I mean, that’s more like the spy novel talk. There are other types of honeypots, but then my 13-year-old boy might get out of control, but I won’t go into details.
Michael: So the victim company set this trap and they had a very small group within the victim company, like the victim company’s general counsel, and a few others. And they sent a letter outside to the competitor company, seemingly giving them a notification that they discovered inside the victim company a [00:06:00] Slack channel that might be problematic, and that had information in it that if made public would be hurtful to the competitor company. And in reality the Slack channel existed, but there was nothing in it. It was a trap. Within a few hours of this letter going to the competitor company, the suspected traitor searched for and found this newly created Slack channel.
Brad: Busted. Okay, you’re right. That is not exactly unintended consequences, but I feel like this could be made like into like a Brad Pitt and George Clooney movie. Did the Chairman and the CFO, I believe, go to jail or get fired? And did the victim company take any other legal actions against the competitor?
Michael: All we know right now, this seems like a relatively recently filed lawsuit, so I’m sure that it’s just getting started. And of course, they haven’t won anything yet, so these are just allegations at this point. [00:07:00] I was really drawn in by the espionage and the scheming and the honeypot.
Brad: You should have started with honeypot and the rest would have been fine.
Michael: So this is a good time to segue into our story about unintended consequences.
Brad: Is a honeypot involved?
Michael: No.
Brad: Okay. Let me know. I’ll still listen. Audience members, I’m still listening.
Michael: Brad today’s story is about a dermatologist in Texas back when he first started his relationship with us. Brad, you’re going to be so happy. I’m going to pre-call that you are going to be so thrilled with the character names for today.
Brad: Ooh, I’m excited. It probably has to do with Saints then, right? Or maybe a movie reference?
Michael: I wouldn’t go Saints reference. Thats going to maybe be for your birthday or something I’ll do that. But even better, Brad, think eighties movie. Our main character is Dr. Del Griffith.
Brad: Okay. Audience members, if y’all aren’t catching onto Michael’s hint, eighties movies, [00:08:00] Del Griffith Planes, Trains and Automobiles, which is amazing. For audience members who are not old like Michael and young like me. The movie is iconic. It’s a comedy about Neil Page played by Steve Martin, a tightly wound marketing executive who’s desperate to get home to Chicago for Thanksgiving. His traveling’s are just wrecked by weather and cancellations and just pure bad luck. And along the way, he luckily pairs up with Del Griffith played by John Candy, rest in peace. And now Del is overly talkative and clumsy and believe it or not, he’s a shower curtain ring salesman. Yes, I did say that correctly. And as the two navigate these series of chronic mismanagements of the via Planes, Trains and Automobiles, hence, obviously the name of the movie; this mismatched personalities clash. But eventually they form an unexpected bond, and the film blends slapstick humor with heartfelt moments and ends in a touching note about friendship and compassion. [00:09:00] How did I do?
Michael: You did great, Brad. You did great.
Brad: Hold on. Kennedy, you want to see it now? Kennedy’s nodding her head. She even wants to see it now.
Michael: Okay. Yeah. So, just so you know, we’re not really going to break down Plane, Trains and Automobiles, Brad.
Brad: Oh, I was just about to write my thesis on it.
Michael: So no more Planes, Trains and Automobiles, and no more honeypot. Moving on. So, Dr. Del, our dermatologist, is energetic and a little business-clumsy, but the patients loved him. And he finally realized he needed help, which led us to starting a relationship together.
Brad: Okay. So what were we doing for Dr. Del then?
Michael: Well, it was the very beginning, so we start like we usually do with a practice assessment whiteboard.
Brad: Ooh. I think we have another vocabulary word there. That’s different than honeypot. I just wanted to get that in one more time. So for those not familiar with the idea of what a practice assessment is, or in our case, a practice assessment whiteboard. That’s an opportunity where someone will provide you all these documents, like your governing documents and contracts and everything. It’s an opportunity for [00:10:00] a lawyer to really kind of figure out baseline, where are you, and then we can kind of explain to the client, here’s where your position is, this is where you are, and here’s some areas that could be improved.
Michael: Well done, Brad.
Brad: Thank you.
Michael: So we had our whiteboard meeting and found many challenges, as you might imagine with this practice. I’m almost hesitant to tell you the next term I came up with Brad, because you’re barely sitting on the rails with honey pot. We will call his practice Not Pillows Dermatology, PLLC. And when we were reviewing the financials, we were having a hard time tracking what was happening in the practice.
Brad: Yeah. And for those who have not seen the movie, the practice name is pretty awesome, Michael. I’ll not try to explain the meaning because again, my 13-year-old humor brain will go crazy. Your turn for some vocabulary though. What do you mean as a lawyer, that you’re reviewing financials.
Michael: [00:11:00] Actually, we get this question a lot, like, why do you need to see our financials? And really for us, financials are a great truth serum to what’s actually happening with the business with the money flow. So they can tell us what they think is the situation, but as we know, it’s often not correct. Like, they don’t have a real understanding of what they’re actually doing, and the financials tell you what they’re actually doing. And so, it helps us using our legal lens, identify what’s happening and help identify areas to explore within the practice.
Brad: That makes sense. And so when you were doing that, when you were looking at the financials, did you find a honeypot?
Michael: No, Brad, I did not. I still haven’t found it. It was another mess.
Brad: I’m just trying to get that in there.
Michael: I know. I know you’re going to throw me off. Dr. Del was doing his own books when he started the practice. And then kind of even worse, he started having [00:12:00] his receptionist do the books after that. And so I know many are wondering, well, what does that mean? What are the books? The books are how a business inputs the money coming in and going out. And so, good business discipline is to create categories for the flow of money that’s coming in and going out so that it can start to tell you a story of what’s happening.
Brad: Yeah, I’m assuming, because you said even worse, the receptionist because maybe she wasn’t properly trained on it. And I think maybe taking a step back, a good business bookkeeping is kind of like maintaining how you’re supposed to maintain your checkbook is what I should say. You know, if you’re keeping up with your checkbook, every transaction must be accurately recorded, so that obviously protects you from overdrafts and errors because you don’t have the funds. With bookkeeping, that’s the same kind of concept on the business side, right. You need to meticulously track the income and expenses. The practice that does this will have a clear picture of their financial health and enable to really make informed decision making [00:13:00] as to how to pay for things timely. And then of course, there’s regulatory and other issues that you face when it comes to this, but that’s the really the way of looking at it from a good accounting perspective.
Michael: Yeah. For Dr. Del, he had inconsistent labels on how he tracked the money coming in, and really, you nailed it, the receptionist, the reason I made that comment is that she just had no training on it. And so, he handed over something that she had no background or understanding how to do it, but almost as bad as that is just that he really didn’t either. And then they like handed it off from one to the other, so there was a lot of inconsistency in how things were tracked. And so you can use software, but if you have QuickBooks to run reports like balance sheets and profit and loss statements. But if you don’t have good labeling, it doesn’t tell you an accurate story. But that’s what we were trying to find when we were looking for the financials is the P&L, and the balance [00:14:00] sheet to see kind of in a report fashion what was happening.
Brad: All right. So now we have an idea of what you found so far in this assessment. What else did you look at?
Michael: We looked at the corporate documents and key contracts as well. Since the financials were such a mess, we were able to identify some issues from these documents, from the corporate documents and the key contracts.
Brad: Yeah. And I think for our audience members to think about it from this perspective, this is probably what you think attorneys do look at, which is we are. We do look at these kind of things. We look at your – so we’ll call your corporate documents and then we’ll look at your certain really important contracts. And for our audience members, what do we mean by that? So when we talk about governing documents or corporate documents, these are these documents that are the formation of your business. That could be your articles of incorporation or certificate of formation. We will look at your bylaws or shareholder agreements or company agreements. There are a lot of different terminologies that are out there. And obviously those are the things you look for. And ultimately trying to figure out [00:15:00] who owns what, what does your cap table look like, meaning, how much money the people put into that. That helps gives us a picture of your, of your governance of your actual entity. But then there’ll be certain key contracts that really control the business and go to the flow of funds and your financials. So, what could be some of those key contracts, Michael? That could be your lease, right? Your landlord. Maybe you have a commercial lease or maybe you have a management service agreement, or maybe you have certain key employees that are under contracts, or maybe certain non-disclosure agreements. So these are all things that we look for to figure out what does it look like on, at least on the form side, not at the substance, but at least on the form side, right?
Michael: Yeah. So we did that, and I discovered an independent contractor agreement for his associate dermatologist. And we’ll call him Dr. Neil Page.
Brad: Nice. I’m happy they were back into the Planes, Trains and Automobiles talk, and that’s interesting that you found an independent contractor agreement that’s not unusual. But what was an important thing about finding this particular independent contractor agreement with Dr. Neil? [00:16:00]
Michael: I was aware of Dr. Neil being Dr. Del’s associate, but Dr. Del referred to him as his employee. And when I looked at the financials, they were so poorly done that you couldn’t really tell how they were treating Dr. Neil’s payments. So, finding an independent contractor agreement made a big deal.
Brad: Okay. For those who don’t know, there’s a huge legal difference between an employee and an independent contractor, and I’m guessing this may have been where the unintended consequences happened.
Michael: Correct, Brad. We need to go backwards in time a bit to see how Dr. Del made some simple decisions that seemed logical at the time and created unintentional serious risk to the practice.
Brad: Well, Michael, please tell me that we’re not going back 20 years like we did that first episode this season.
Michael: Regrettably, no. We can’t go back that far, Brad. Okay. You know, if I could go deep on context again, I would.
Brad: Yes, you would.
Michael: But this is only a few years prior. [00:17:00] So Dr. Del had met Dr. Neil at a conference when Dr. Neil was completing his fellowship training. And so, they got to talking, Dr. Del wanted to focus his practice more on elective cosmetics, and he could see a potential for Dr. Neil to come in and help with traditional derm practice and the most part of the practice.
Brad: Okay. And for those non-dermatologists, audience members listening, mostly typically an insurance reimbursement procedure to help remove skin cancer. Traditional dermatology treatments, like skin checks are often also reimbursed by insurance as well.
Michael: Exactly. And so, they continued talking. Dr. Del decided to bring Dr. Neil on and they shook hands. And then Dr. Del got his college buddy who was a real estate attorney to drop the contract.
Brad: I’m sure there, like his college buddy, the real estate attorney was a really good and great guy, [00:18:00] and a really good real estate lawyer. But I’m going to say that that may have also triggered an unintended consequences of conversation.
Michael: Yeah. It’s not the best. And then to make matters more complicated, before the attorney could even start drafting, Dr. Neil had reached out and requested that the agreement be structured as an independent contractor agreement so that he could deduct business expenses. So he was like the one, the “employed physician” was like, no, I want to be an independent contractor status so he could deduct these expenses.
Brad: Now, I’m going to use a little logic here, and based on the fact this is a flashback, clearly the real estate attorney did this and did he explain the ramifications to Dr. Del?
Michael: No, I realized during our whiteboard that he did not, so I started asking some of those questions, and Dr. Del had shared that when they went into this together with Dr. Neil, that the most important thing [00:19:00] to him when they did the agreement was a strong non-compete. He did not want Dr. Neil to be able to run off with his most practice that he was going to hand over. And then the second most important thing to Dr. Del was that Dr. Del wanted to make sure that Dr. Neil didn’t slack off. Dr. Del needed to know that if he was going to pay him this compensation, that Dr. Neil would be fully committed to the practice.
Brad: And it’s not uncommon for a client to say, here’s some pointers or terms and conditions that are really important to me and I really want – I wish they could be in part of the contract. So, was the independent contractor with Dr. Neil or with Dr. Neil’s professional entity?
Michael: It was with Dr. Neil directly as an individual.
Brad: Oh, no, Michael.
Michael: Alright, so we’ve reached a point, we’ve set it up, let’s go to break and then come back and talk about the risk to Dr. Del and the practice, and we can find out what happened.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, with my co-host, Michael Byrd. Now Michael, this season, our theme is Unintended Consequences, and we just had a great story about learning about Dr. Del and it sounded like he kind of was a mad scientist with a big heart. We left learning really about his decision made when Dr. Del thought he needed to bring on an associate, Dr. Neil, and to start it off, let’s talk about seemingly kind of easy decision that Dr. Del made by agreeing to allow this new doctor to come in as an independent [00:21:00] contractor or on the side of independent contractor agreement, that seems relatively common requests.
Michael: It is. I mean, they’re often aspiring doctor-preneurs, and they have a vision from a business perspective of being able to ride off their expenses, their quasi business expenses, like their car. Yeah, like their car, country club membership, those types of things. And so, they talk about this and sometimes they’re advised by their tax advisor that the ideal way to do that is through an independent contractor agreement.
Brad: Yeah, the CPAs or your tax advisors often don’t understand the legal impact of this decision, but they love the tax fund that they have with it. Now, Michael, explain the difference between an employee and an independent contractor.
Michael: Yeah. So the first thing to – most important thing to understand is this is not an aspiration. Like, you can’t just say, I deem you an independent contractor.
Brad: [00:22:00] If you really want to be one.
Michael: No, it’s not labeling like QuickBooks, like when you just create a label. They’re actually, this is a designation that is tracked at the IRS level and it’s tracked at the state level. And the way people as individuals are treated is impacted by what is the source of that revenue stream. And so, if you’re an employee, you heard you get your W2 and you have to withhold taxes, and so that’s a pretty straightforward approach. As an independent contractor, it’s completely different and you get what’s called a 1099. And so in that circumstance, the tax flow and the tax impact is different. But most importantly is the government has kind of a set of categories that they use to help determine, [00:23:00] are the characteristics of how this relationship is working employment or independent contractor. And there’s a little bit if it walks like a duck and quacks like a duck, then it’s a duck type approach. And so, just because you deem it so as an independent contractor agreement that IRS may not agree.
Brad: Yeah, and for audience members to understand, this is where you might hear the term a misclassification of an employee. And a misclassification means that just because you carry them as an independent contractor or a 1099 versus being a W2, if you don’t do it correctly and they are misclassified, there are some significant legal and financial consequences to the business because understand from the government’s perspective, when employees classified as independent contractor, they do not get to get access to your health insurance or overtime pay or unemployment insurance. And so for that reason, it makes it more [00:24:00] difficult for them to even think about doing that while your regular employees get access to it all the time. And then again, going back to if you do misclassify it, well what happens is, is that employee may not have paid their taxes timely, or you might as the employer owe back taxes along with penalties. And again, that misclassified employee could also always bring a lawsuit to seek back those benefits they missed, so it’s critical for employers to understand that truly the legal and critical for them to understand that these two different classifications is a big issue. And you want to make sure that you’re mitigating that risk by classifying employees correctly.
Michael: Yeah. And the IRS is looking for nefarious behavior by employers. It’s not the case here, but employers for employees have to pay payroll taxes, a portion of that. And so they’re looking like, are you trying to get out of that and push all that onto the employee that you classify as an independent contractor? [00:25:00] And so all the things that you talked about coming together, really the laws built to design the employee side and protect against bad behavior by the employer, which is where all this risk comes from.
Brad: Meaning that the IRS or the state governments really want to pressure you to have them as a regular employee versus independent contractor, which then leads to something you said near the end, and I had the ahh moment, which is – tell the audience why it matters that Dr. Neil signed this individually versus through a professional entity.
Michael: Yeah, I mean, it’s pretty simple and some states have a little bit more risk than others. But the basic premise is, is that if you contract as your professional entity to be an independent contractor, it’s impossible for an entity to be an employee. An employee is defined as a human – an individual. And so. you create some level of protection [00:26:00] in how you set up the arrangement versus just straight with the individual. You know, that is one of the things that would be a recipe for more increased risk, more risk to the practice.
Brad: And you said earlier that one of the other important elements was that they have an enforceable non-competes. I’ll jump in and kind of address that piece is understanding, generally speaking, when it comes to non-competes, courts generally don’t like to enforce them unless there’s certain restrictions done. So let’s just use a typical employee. For your typical employee because of the control and other elements and things that you give them, assuming it meets whatever the state guidelines are for non-compete, courts may reluctantly but still enforce it. The moment someone becomes an independent contractor, courts start having, going back to that misclassification that Michael was talking about earlier, there’s less control that’s supposed to be asserted over that employee. That independent contractor is supposed to have [00:27:00] a lot more freedom than your typical W2 employee. And because of that, if a court sees that an independent contractor has a non-compete and are prohibited from working with other competitors, they start saying, well, this feels more like again, a misclassification and or, I, the court should not enforce it because they are supposed to be more free. It adds an element, so from a enforceability perspective, makes it more difficult and at the same time hurts you in any arguments with the IRS because you asserting more control than you would otherwise.
Michael: Yeah, I mean, it’s a classic case of employee makes a request at the time, going back to the beginning of, I want to be able to deduct these expenses. And Dr. Del’s like, well, it seems fine with me. And he had a real estate attorney on who didn’t know to ask these questions of, okay, well, how does this change the nature of the relationship and how does this impact [00:28:00] your goals and vision for what this relationship will look like?
Brad: Well, Michael, we’re almost out of time, so what I’ll do is I’ll ask two things. One, some final takeaways, but two before you give that whatever happened with this whole relationship.
Michael: Yeah. So heartwarming ending Brad. They were actually ready at the point that we identified this to become partners, and so they’re like, we will just use this opportunity to build out a fresh corporate structure. And Dr. Neil bought into Not Pillows Dermatology.
Brad: Awesome. Any other thoughts, like final thoughts for our audience to think about?
Michael: Yeah, I mean, it goes back to – it’s really easy to make a decision where your filter is, oh, it doesn’t seem any harm to me. Or it seems reasonable. And not to just get some good advice if you don’t really know what are the implications, like you don’t know, what you don’t know kind of thing. [00:29:00] And so instead of just being like, well, I don’t know anything, so it must be fine. Be like, well, I don’t know anything, so maybe I should ask if this is something I need to be concerned about.
Brad: Well, Michael, that’s all the time we have for today, but next Wednesday show we’ll be back and we’ll be discussing unintended consequences of complex business models. Thanks again for joining us today. And remember, if you like this episode, please subscribe, make sure to give us a five star rating and share with your friends.
Michael: You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com.
Outro: ByrdAdatto is providing this podcast as a public service. This podcast is for educational purposes only. This podcast does not constitute legal advice, nor does it establish an attorney-client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own, and their appearance on the program does not imply an endorsement of them or any entity they represent. Please consult with an attorney on your legal issues. [00:30:00]
