Mark Pestronk
Q: Our travel agency has many independent contractors, and from time to time one of them embezzles client funds. Is our agency legally liable to make the client whole? What can we do to prevent such theft?
A: The host-IC relationship is a business-to-business relationship. In a B2B relationship, one business is not liable for crimes committed by the other business, unless the businesses conspire with each other.
So your agency is not legally liable for embezzlement or any other crimes committed by ICs. Nevertheless, clients think otherwise, and in major fraud and embezzlement cases, prosecutors and state attorneys general may also take the position that you are responsible for the client's loss, especially if the IC did business under your agency's name.
Take these steps to minimize the chances that your agency will be victimized by IC fraud:
First, screen prospective ICs with care. This means obtaining employment and IC history, checking references, refraining from retaining prospective ICs who don't provide references and performing criminal background checks and credit checks. Contrary to popular belief, you don't need the prospect's consent to do those checks, but it is probably a good practice to tell the prospect about what you are going to check.
Second, if the IC operates as a corporation or limited liability company, get a personal guaranty in your IC agreement. If the owner objects to personal liability, tailor the guaranty to cover only debts for which your agency might be liable. If the owner still objects, consider declining to take on the IC.
Third, provide protections in your IC agreement and issue periodic reminders about them. Without your consent, do not allow ICs to accept currency or to deposit client checks or wire transfers in their own bank accounts, and do not allow ICs to use their own credit cards to pay suppliers or to use their own credit card merchant accounts when collecting client payments.
Fourth, if you allow ICs to issue airline tickets, have an employee review the reservation before the ticket is issued, monitor for suspicious patterns such as weekend spikes, make sure client checks clear before you issue tickets and require ICs to follow ARC's credit card acceptance rules. Although most ticket fraud is perpetrated by clients, rogue ICs can be in league with the client fraudsters.
Fifth, consider business owner's insurance against embezzlement and fraud by ICs (and employees). This insurance is different from errors and omissions insurance, which does not cover embezzlement.
Some hosts will see all these protections as too draconian for ICs that they think can be trusted. That's fine, but realize that you may be taking a risk.
Some readers will see these rules as red flags that could prompt state or federal taxing authorities to reclassify the host-IC relationship as one of employment. In my experience, auditors accept the need for anti-embezzlement controls even in valid IC relationships. Since your state's rules could be less favorable, have a knowledgeable attorney review them.