Nation & World

Companies win federal contracts while flouting labor law

Southern Mechanical, a Nashville, Tenn. based heating and air conditioning firm, installed dozens of units at this private apartment complex near Bier Creek in Raleigh. Southern Mechanical is one of hundreds of companies who improperly treat workers as independent contractors.
Southern Mechanical, a Nashville, Tenn. based heating and air conditioning firm, installed dozens of units at this private apartment complex near Bier Creek in Raleigh. Southern Mechanical is one of hundreds of companies who improperly treat workers as independent contractors. News & Observer

Robert Malick has weathered plenty of uncertainty in the 22 years he’s run a multimillion-dollar heating and air conditioning firm.

His secret to success: Follow the money and the people who can get it.

To do it, his company, Southern Mechanical, landed government-backed housing projects and used a hiring strategy that federal officials have been trying to combat for years. On payroll forms he filed on jobs around the Southeast, his Nashville, Tenn., company left blank a space for tax withholding and explained: “1099 employees pay their own taxes.”

“It puts the monkey on their back to produce instead of being an hourly employee that just hangs out on the job,” Malick said in an interview.

Treating his workers as independent contractors saves Malick on payroll taxes and unemployment insurance, nearly 10 percent of wages. It also may run afoul of numerous state and federal laws and regulations, and it undercuts his competitors.

Southern Mechanical was one of hundreds of companies cashing in on U.S. government-funded projects while likely disregarding the law, a McClatchy investigation reveals.

Roofers, painters and bricklayers paid meager hourly wages are required to file taxes as if they were self-employed, which means paying their share and their companies’ share to Social Security and Medicare. But many live in the underground economy, paying no taxes or less than they owe.

In North Carolina, nearly 45 percent of the 826 companies taking part in construction of federally funded or backed affordable apartments during the recession deducted no taxes from laborers and mechanics. In Texas, as many as one-third of the companies on federally funded projects appear to have misclassified workers.

The problem persisted in Florida, too, where 20 percent of companies on these projects treated manual laborers as independent contractors. The issue isn’t isolated to the South: A random sampling of construction projects across the country shows that 14 percent of 235 companies filing payroll reports withheld no taxes from workers generally considered employees.

Some of those companies had a history of other problems:

– South East Construction Corp. of Wilmington, N.C., had its certificate to do business revoked by the North Carolina secretary of state in 2010 for failure to file taxes with the state Department of Revenue. Two years later, it landed a job doing carpentry work on an affordable housing development in Wilmington. The revocation is still in place, according to records with the secretary of state. The company owner, James Haverly, could not be reached.

– Just a week before VR Enterprises Group of Miami started work on a low-income housing project in Key West, one of its employees filed a lawsuit accusing the company of failing to pay overtime wages. A judge awarded the employee $3,180. Company owner Victor Lavastida now runs a construction company called Brave Builders, which is owned by Sandra Morales. That company is being sued by six former employees, who say wages weren’t paid.

Morales defended her practice of treating workers as independent contractors, saying the general contractor advised her to do that. The general contracting firm didn’t return calls requesting comment.

Southern Mechanical has been treating hourly workers as independent contractors for years in plain sight of the government with no pushback, federal payroll records show.

Although revenue collectors from Washington, D.C., to Indiana and Mississippi have pursued Southern Mechanical for various unpaid tax debts, the company hasn’t been blocked from taking part in government contracts. While the federal government sought $260,000 in unpaid corporate taxes from the company in 2013, Malick’s workers were busy installing units in more than 20 housing projects backed by the government throughout the Southeast.

The government has a history of doing business with companies that have tax or other legal problems. Inspectors at the Government Accountability Office found that at least $24 billion in stimulus funds went to businesses owing more than $750 million in unpaid federal taxes, according to a 2011 report. The year before, GAO investigators found that half of the 50 companies with the most egregious federal labor-standards violations had government contracts.

Even when the proof is volunteered – through the company owners’ admissions in payroll records – regulators rarely take action.

Red flags disregarded or missed

Southern Mechanical was industrious during the construction slump as many competitors limped along. Malick said his firm landed work on more than 50 federally funded or backed projects.

The company more than doubled its operating revenue during the slump, from $6.7 million in 2008 to $15 million in 2012, according to Dun & Bradstreet, a business information company that collects data from lenders.

The general contractors who hired Southern Mechanical to take part in federal contracts either disregarded or missed red flags. Indiana state regulators filed more than 30 tax warrants against Southern Mechanical between 1998 and 2009; in 2001, the state revoked its license to do business there.

The liens involve unpaid sales taxes and haven’t been settled, according to Robert Dittmer, spokesman for the Indiana Department of Revenue. Malick said the issues dealt with a beef he had with a general contractor and that the company was still doing business in the state.

Since 2006, Southern Mechanical’s certificate to do business in North Carolina had been suspended for failure to file annual tax returns, yet the company continued to do business in the state. In July, after being asked by McClatchy about the suspension, the company contacted the Revenue Department and was reinstated by the secretary of state.

The company has another problem in North Carolina: Allowing unlicensed HVAC mechanics to be subcontractors is against the state licensing board’s regulations. While Southern Mechanical itself is licensed, its workers are not. That would be OK if they were treated as employees, but it’s not if they’re independent contractors.

After speaking with a reporter this summer, company officials reported their use of 1099s to the North Carolina licensing board. The board is investigating.

Layers of construction managers, developers and government officials could have stopped Southern Mechanical from treating workers as subcontractors but didn’t.

The U.S. Department of Housing and Urban Development is ultimately responsible for employees being paid correctly on these projects, but it pushes the task of collecting and reviewing payrolls onto local officials.

HUD doesn’t train the locals to spot the problem of misclassifying workers as contractors, however. Even when HUD labor-compliance officials at the regional office in Atlanta reviewed Southern Mechanical’s records on projects insured by the Federal Housing Administration, they didn’t raise any issues.

Southern Mechanical’s controller said she took the lack of reprimands as a sign the company was doing things properly.

“I’m sure if there was an issue, especially with a HUD job, somebody would have caught it before now,” Shannon Wilkins said.

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‘We were just happy to have a job’

Bob Malick opened his firm in 1992 after years as a field supervisor with J.R. Hobbs, a major mechanical company in Georgia. Malick’s father-in-law, Harry Johnson, and brothers soon joined the company.

Southern Mechanical stayed local at first, riding the boom of apartment complex building in the Nashville area. Out-of-state firms also flocked to Tennessee in the mid-1990s, Malick said, taking advantage of the upswing.

When the apartment bubble burst in Nashville, Malick called the connections he’d made with out-of-state contractors.

His prices were competitive, and soon Southern Mechanical’s crews moved into Malick’s native Georgia and neighboring Alabama and South Carolina. The company’s reach expanded west to Mississippi and north to Kentucky, Indiana and Ohio. Malick is also licensed to do business in Colorado and Iowa.

To keep pace, Southern Mechanical, like many other construction firms, leaned heavily on immigrant labor.

Zabad Santana remembers the droves of immigrants clamoring for work with companies such as Southern Mechanical in the early 2000s. Santana, a California native born to Mexican immigrants, moved to North Carolina in 2001 to take advantage of the building boom and soon found himself installing air conditioners for Southern Mechanical.

Santana had never built anything before, let alone performed HVAC work. But Santana said in an interview this summer that he was happy to get a wad of cash each Friday from his crew leader, a Hispanic immigrant. At first, he made $7 an hour. Soon, he was bumped to $10.

One day, Santana said, he was invited to dinner by Rick Malick, Robert’s brother. Rick Malick extended an invitation to Santana: Find workers and run a crew for us.

It seemed too good to be true. Without any formal training, without any tools and equipment, Santana could be a boss. He found Hispanic immigrants to work on his crew.

Each week, Santana said, he cashed the check Southern Mechanical wrote him, then distributed cash to the workers he’d recruited. He took out no taxes; he paid no unemployment benefits. Southern Mechanical issued him a 1099 at the end of the year. Santana said the arrangement didn’t sound shady.

He hustled, working seven days a week on jobs throughout the Carolinas and into Virginia.

“We were just happy to have a job,” said Santana.

The Malicks handled all communication with the general contractor, including securing the job. They told Santana where to go and when, and bought all the equipment he installed. When inspectors came to the site, one of the Malick brothers handled their questions, Santana said.

In an interview this summer, Malick described his workforce as “pieceworkers.” He also called them “employees.” On the payroll forms, he indicated they’re both – “1099 employees” – though such a hybrid doesn’t exist in the eyes of the IRS.

Company owners must heed federal law when they choose how to classify their workforces. The deciding factors deal with control – who’s in charge – and what financial investment or gain that worker has. Typically, legitimate subcontractors are paid lump sums, negotiate prices and build enough into the bids to cover overhead and profits.

According to payroll reports the company filed for projects in North Carolina and South Carolina, each mechanic or laborer earned between $10 and $20 an hour. Malick said he buys a workers’ compensation policy to cover everyone, regardless of whether he issues them a 1099 or takes out taxes each week.

Malick said he’d conferred with a lawyer about his practices a decade ago. He said he was advised that treating them as contractors was “the best way to do it” and that it was a “clean” way to do it.

He said he didn’t understand why competitors would find his practice unfair.

“If that is the issue, why don’t they do the same thing?” Malick asked.

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Mounting troubles

A slip of the hand while installing air conditioners can cost lives. In the late 1990s, the North Carolina licensing board for life-safety trades such as HVAC, plumbing and fire sprinklers adopted rules that allowed regulators to have more control over the trades.

Anyone doing the work must have a license or be an employee of someone who does. Subcontracting to unlicensed plumbers and mechanics encourages haste, not care, said Dale Dawson, the executive director of the North Carolina licensing board.

Dawson said this summer that Southern Mechanical’s practices conflicted with state codes. His investigation is pending.

This isn’t the first time Southern Mechanical’s employment obligations have come into question.

According to court records, the Tennessee Department of Labor and Workforce Development issued an $8,940 lien in 2004 for uncollected unemployment taxes. Companies are obliged to pay that tax on employees, so they may collect unemployment benefits if laid off. Southern Mechanical settled the lien in 2008.

The state tax lien was but one of mounting financial troubles Malick faced in the mid-2000s. The IRS demanded $109,000 in back taxes. Suppliers, who said they were owed more than $1 million for equipment, wanted their debt settled, too. The company filed for bankruptcy in 2004, but it emerged later and continued to operate.

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Santana, the labor broker the Malicks had recruited, didn’t know about the company’s brewing trouble. He did know that his checks were arriving more slowly. The final payments for some jobs hadn’t arrived at all.

By Santana’s count, the company owed him nearly $11,000. He said he paid his workers with a cushion he’d planned to spend on his wife and young son.

Santana grew more and more aggravated. One day in 2003, he drove to Nashville to collect his money. Santana said he was offered a truck as payment, rather than cash. He was so eager to finally part ways with the company that he took the keys to the truck and left, he said.

Problems persisted

Southern Mechanical did more work than any other HVAC company on the 64 low-income housing projects HUD funded through the recession in North Carolina. Records show the company also installed units at a high-rise seniors apartment project in Auburn, Ala., as well as an affordable development near Charleston, S.C., both of which were funded in part by stimulus money.

Malick said his company also performed government jobs in Virginia, Georgia and Tennessee.

All told, government jobs held Southern Mechanical steady during the construction slump. In 2012, his company did 22 projects requiring payroll reports to the federal government, Malick said; last year, the number jumped to 28.

Still, the company’s problems persisted over the past several years. According to court records, Johnson, Malick’s business partner and father-in-law, was indicted last fall on charges of stealing money from the company. The criminal case was closed after the company recouped the money, court records show. Johnson couldn’t be reached for comment.

Johnson has since parted ways with the company, said Wilkins, the controller, but the company’s legal troubles brought the scrutiny of the IRS.

In February 2013, the IRS filed a tax lien against Southern Mechanical for $260,000 in unpaid corporate taxes.

The company’s government work went uninterrupted in the 10 months it took to pay off the tax lien. An auditor from the IRS spent many days at the company’s headquarters in Nashville before filing the lien, said Wilkins. The auditor reviewed the company’s records, including its payroll records for employees, Wilkins said.

She offered the IRS auditor’s lack of questions about the company’s employment practices as another sign it’s doing everything right.

Rick Rothacker of The Charlotte (N.C.) Observer, David Raynor and Peggy Neal of The News & Observer in Raleigh, N.C., and Nicholas Nehamas of the Miami Herald contributed to this article.

We want to know your thoughts and experiences with misclassification. Share your feedback directly with the reporters: mlocke@newsobserver.com or 919-829-8927; or fordonez@mcclatchydc.com or 202-383-0010; or on Twitter @mandylockenews or @francoordonez.

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