PEO Agreement Fine Print – 10 Terms You Need to Be Aware of Before You Sign

This is the season for you to evaluate whether the PEO model is the right fit for your business.  Throughout this evaluation process, you will cover many topics, such as the PEO’s human resources delivery model, HRIS technology, employee benefits, and costs associated with the PEO’s services. However, there is one critical issue you will likely not review before you make your decision—the PEO agreement. The client service agreement (CSA) is the binding contract that dictates the responsibilities of each party in this arrangement.

Below is an outline of some of the most common provisions that you need to be aware of and why it’s important to address them before you become a client of a professional employer organization:

Termination: 

Your rights:  PEOs will allow a client to leave at any point throughout the relationship with a minimum required notice.  PEO standards range from 30-60 days, with much of the industry requiring only thirty days’ notice.  A few PEOs will put an initial term requirement in their agreement that requires you to remain with them for the first twelve months with no latitude to leave should your experience be less than expected. Beware of these types of restrictions.

  • PEO AgreementPlease make sure you are aware of any early termination penalties that may exist and how they are calculated.

PEO rights:  Debiting funds from your account for payroll, taxes, and employee benefits, amongst other things, is something a PEO takes very seriously.  Should you not have sufficient funds in your account when it’s time for payment, the PEO will typically reserve the right to terminate you immediately for cause.

 

  • We have seen this happen, and it’s not a pleasant scenario when a client has to scramble to find employee benefits coverage, payroll, workers’ comp insurance, etc. Always make sure to have your account funded, and if you hit a snag with cash flow/credit, ensure that you communicate this with your PEO partner so there are no surprises on either side.

Unemployment tax:

There should be an indication of when the PEO can adjust your unemployment tax rate.  Make a note of when this may be, as it could materially affect the economics of your situation should your rate(s) change drastically.

PEO’s right to hire, terminate, and reassign:

Every client service agreement contains language that grants these rights to the PEO so that they may maintain compliance with state and federal co-employment statutes and employment laws.  The following are examples that highlight the need for the PEO to maintain this level of flexibility within the construct of co-employment:

 

  • If you hire an employee who cannot satisfy I9 documentation requirements, the PEO must retain its ability NOT to hire this employee onto its platform.
  • Conversely, suppose it’s determined after a thorough PEO review that your termination of an employee could be deemed a discriminatory practice.  In that case, the PEO may decide to reassign this employee to its own payroll in order to avoid a potential lawsuit.

Service fee increases:

Typically, a period of notice of when your service fees can be raised and by how much is outlined in the CSA.  Make sure you are comfortable with the timing and amount of leeway the PEO gives itself to increase these costs.

Drug-free workplace:

Many PEOs will incorporate a drug-free policy within their CSA that gives them the ability to test employees for drug use after filing a workers’ compensation claim.  Drill down on this component if it does not fit your company culture, as you can avoid this stipulation.

Employment Practices Liability Insurance (EPLI):

Every PEO will require you to maintain an EPLI policy to protect your company and themselves if an employee sues for an employment-related matter.  Most will include this policy within their standard offering at no additional charge.  However, make sure you fully understand their policy limitations and deductibles to determine if it meets your business needs.

COBRA continuation fees:

Most PEOs include a fee for your former employees who elect medical insurance continuation coverage through COBRA.  If you are to leave the PEO, this fee can become quite substantial for those participants you leave on their policy.  Ensure that you understand the costs associated with this.

Reduction in force:

Some PEOs will have a stipulation in their agreement that allows them to assess additional fees should you have a reduction in employee headcount during the initial term of the contract.  The idea behind this is twofold:

 

  • The PEO has priced your administrative fees with your headcount as it exists today, so if it drops significantly after (typically 25%+) you begin, this may put unanticipated financial stress on the PEO.
  • Whenever there is a mass layoff or significant drop in headcount, the likelihood of an employment-related lawsuit increases dramatically, and the PEO may argue that they have greater financial exposure in these situations.

Pricing exhibit/addendum:

This is where the actual fees and taxes are outlined. Make sure it is crystal clear exactly how much you will be required to pay in administrative costs and, as significantly, HOW you will be charged.

 

  • How you are charged can come in one of two ways:
    • Flat dollar amount—As described, you will pay a flat dollar fee per employee per month (PEPM).
    • Percent of payroll—This is where it can get tricky.  If you see percentages on your pricing addendum, be very aware of what those percentages are.  This is how the PEO will bill you, and if you do not understand these percentages, it will be challenging for you to understand your costs in the future.

It is common for PEOs to charge additional fees for delivery of payrolls, off-cycle checks, customized reports, international services, EFT, W2 adjustments, 401k setup, NSF defaults, employee hiring/termination.

Funding and credit approval:

Since PEOs assume specific liability for funding your payroll and other obligations, they may run a credit check or require you to provide financial proof of solvency.  Typically, their credit approval process is outlined in the CSA, and it behooves you to seek this approval early in the process.  We have seen many declinations in this area that prevent a company from using their preferred PEO.

ACH, reverse fed-wire, and fed-wire are the three main ways a PEO will accept funding of payroll, taxes, benefit premiums, fees, and other costs.  The size of your payroll, your length of time in business, the PEO’s policies, or other factors may determine which option is available to you.  If ACH is not offered, there are likely additional costs associated with the wiring of funds.

Conclusion:

As with any contract, this is a fluid document, and oftentimes, a PEO will be open to negotiating specific language to help ensure your comfort with the terms.  That said, each PEO has a different approach, and while one may be open to redacting a certain clause, another may not be as flexible.

If you need help in this evaluation, please feel free to contact us as we have a deep understanding of the approach of many PEOs in this area.

You can also download our eBook, The Truth About PEOS, to discover the 9 critical components you must consider before choosing the right PEO for your business.

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Onward Advisors combines unique perspectives and expert insights from decades of working at top PEOs. We do this through a unique, case-by-case approach, providing leading-edge analysis from our online platform to give clients unparalleled clarity and personalized analysis on which PEO solution is best for them.

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