HIRING DYNAMICS IN INDIA: WORKER CLASSIFICATION, RISKS AND STRATEGIES

An organization planning to expand its workforce often encounters challenges in determining the suitability of workers for its operations.Having an understanding of different classifications of workers in each jurisdiction and the compliance requirements that come with hiring a particular type of workforce is crucial.

The Indian Staffing Federation, in its 2023 annual report, highlights that the flexi staffing industry in India witnessed a double-digit new employment growth trend of 14% YOY 2022-2023. The employment demands were primarily driven by sectors such as FMCG, e-commerce, manufacturing, healthcare, retails, logistics, banking, energy, etc. and also had an impact on women workforce participation.

Given the rate of growth, hiring trends have emerged in the Indian market. Companies’ preferences in

hiring employees, contract workers and consultants depends on the business needs and the associated advantages and challenges. For instance, engaging contract workers or consultants instead of hiring employees on direct payroll, allows employers to save employee benefit costs. However, employing full-time employees provide employers with greater authority over work schedules, employee availability and performance. Hence, the various options require careful consideration.

In this article, we explore the prevailing worker classification in India from a legal perspective, potential reasons for the rise in engaging contract workers and consultants in the IT industry, and discuss key considerations while engaging contract workers and consultants.

Navigating the Distinction: Worker Classification

Under various employment legislations in India, workers are divided into three main categories:

1. Employees: These individuals are directly employed by the company on its payroll. The company is liable for providing social security benefits such as PF, insurance, gratuity, maternity benefits etc. The terms of engagement of employees are governed by the local shops and establishments act or the factories act.
2. Contract Workers: These individuals are engaged by a company (principal employer) through a manpower supply contractor company (contractor). These individuals are not on the payroll of the principal employer but of the contractor, who is responsible for wages and benefits. In India, the Contract Labour (Regulation and Abolition) Act, 1970 (“CLRA”) regulates the terms of employment of such contract workers. As per the CLRA, in case the contractor fails to fulfil its obligations towards the contract workers, the principal employer is held responsible. Further, when a principal employer engages contract workers through a contractor, compliances such registration, license, registers, records, etc. are triggered under the CLRA.
3. Independent Consultants/Freelancers: These individuals are engaged by a company directly pursuant to a service or consultancy contract, which governs the terms of their engagement. They are engaged independently by a company on a retainership and typically their engagement is non-exclusive.

Permanent and Perineal Activities: Insights From the CLRA Perspective

In the intricate structure of a business, diverse layers of work converge to form a fully functional enterprise. Every company has its core and permanent activities, which forms the fundamentals of its operations. However, a company operates within a broader context. To support its primary operations, there are ancillary activities that, while not directly related to its core business, are essential for the company’s overall functioning and growth. Frequently, businesses find it to be more economically viable to delegate these ancillary activities to specialized organizations. This is where the CLRA becomes significant, providing a crucial framework for companies opting to outsource various activities.

In certain states in India, the CLRA prohibits the employment of contract labour in specific core activities of an establishment. For instance, the CLRA as applicable in the state of Andhra Pradesh, specifies that the use of contract labour is prohibited in the “core activities”, which are activities fundamental to the establishment’s purpose, excluding sanitation works, canteen and catering services, running of hospitals, and housekeeping (provided these activities are not by themselves the primary business of the establishment[1]). Nevertheless, principal employers are permitted to hire contract labour for the core activities under certain conditions.

The Supreme Court recently in a case[2], held that the workers employed in perennial or permanent work of an establishment should not be considered as a contract worker under the CLRA. The court observed that tasks of a permanent or perennial nature cannot be assigned to the contract workers and must be carried out by regular or permanent employees.

Factors Driving Contract Workers and Consultants’ Engagement in the IT Sector

Due to the increase in the demand of contract workers and consultants, the subcontracting costs for India’s IT firms have surged significantly, rising by nearly 60% over the past two years[3]. Engaging contract workers and consultants is becoming a prevalent strategy for businesses for several reasons such as:

• • Efficiency in talent acquisition: Contract workers sourced through staffing agencies, can be onboarded swiftly as compared to the regular hires due to the readily available talent pool maintained by these agencies.
  • Try-and-buy strategy to combat attrition: Many firms are adopting a “try-and-buy” strategy, wherein individuals are initially hired on a contractual basis and later transitioned into full-time employees. This approach helps mitigate the impacts of high attrition rates.
  • Need for specific skills: Rapid expansion of new businesses is compelling IT service providers to seek specific skills beyond their internal resources, driving the engagement of contract workers and consultants.

Risk of Misclassification

As discussed above, engaging workers through a contractor would attract the provisions of CLRA and the compliances thereunder. In the event of failure of the contractor to pay employee benefits etc. to the contract workers, as per the provisions of the CLRA, the principal employer shall be held liable. Needless to say, the principal employer would have a recourse under the contact to recover such amount from the contractor.

Another aspect that should be considered while engaging a contractor is the nature of work that the principal employer requires the contract workers to perform. In case the nature of work falls within the permanent and perineal/core operations of the principal contractor, there may be a risk of misclassification and the contract workers could challenge their appointment and seek employment with the principal employer along with back benefits. Further, the contract workers could also claim additional benefits given by the principal employer to its regular employees so as to be at par.

Similarly, in case of consultants, if the consultancy is structured in a way that the consultant is required to work exclusively for the company or the engagement is renewed periodically, there exists a risk of misclassification and regularization of employment.

Risk Mitigation Strategies

Considering the statutory provisions, legal aspects in engaging contract workers and consultants alongside regular employees, and safeguarding the interests of user-enterprises, the following measures may be adopted to mitigate the underlying risks:

For workers hired through contractor, the risk mitigation strategy may include:

• 1.  ensuring that the service agreement with the contractor is on a principal-to-principal basis and specifies that the contractor is liable for payment of wages, benefits, compliance with employment laws, etc.
  2. ensuring that the principal employer does not control the employment terms of the contract workers. Matters such as leaves, salary increment, hiring, termination, etc. are decided by the contractor.
  3. ensuring that the service agreement has adequate warranty and indemnity provisions in favor of the principal employer and other mechanisms such as recovery of cost, performance bonds, liquidated damages, dispute resolution, etc.
  4. conducting due diligence at the time of onboarding the contractor and also at regular intervals to ensure it remains compliant with applicable laws.

In case of consultants, the risk mitigation strategy may include:

• 1.  ensuring that the consultant is not exclusively working for the company and that the agreement between the consultant and the company is for a fixed duration and is not renewed periodically.
  2. the consultancy agreement with the consultant should clearly establish that the consultant is an independent service provider and there is no employer-employee relationship.
  3. ensuring that the company does not absolutely control (directly or indirectly) the work performed by the consultant.
  4. ensuring that the consultant is not eligible for any benefits, allowances, and perquisites given by the company to its employees.

An important point to note here is that when determining the nature of relationship between the parties, the Indian courts do not solely rely on the clauses in the consultancy agreement or the terminology used for describing the relationship; they also assess the practical functioning of the relationship in terms of the control exercised over the contract worker’s/ consultant’s activities, and to that extent the company will also need to ensure that adequate practical processes are in place to mitigate any misclassification risk arising from the arrangement.

Therefore, it is crucial for the employers to understand that the nature of the working relationship determines a person’s employment status. By understanding the factors that Indian courts consider and adhering to the best practices, organizations can make well-informed hiring decisions, minimize misclassification risks, and stay compliant with the applicable laws.

Authors: Mr. Vineet Aneja, Managing Partner,Ms. Raveena Anand, Senior Associate and Ms. Somya Bhargava, Associate

Disclaimer: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to herein. This publication has been prepared for information purposes only and should not be construed as a legal advice. Although reasonable care has been taken to ensure that the information in this publication is true and accurate, such information is provided ‘as is’, without any warranty, express or implied, as to the accuracy or completeness of any such information.

Footnotes

[1] Section 2 and 4 of Contract Labour (Regulation and Abolition) (Andhra Pradesh) (Amendment) Act, 2003

[2] Mahanadi Coalfields Ltd v. Brajrajnagar Coal Mines Workers’ Union 2024 SCC Online SC 270

[3] https://economictimes.indiatimes.com/tech/information-tech/subcontracting-costs-rise-60-in-2-years-for-top-four-it-firms/articleshow/101373298.cms?from=mdr