How an Employment Law Audit Can Prevent Wage Theft and Sham Contracting
Protecting your business from costly wage theft claims and sham contracting penalties starts with a proactive employment law audit that identifies compliance gaps before regulators do.
Understanding the Real Cost of Wage Theft and Sham Contracting to Your Business
Wage theft and sham contracting represent two of the most serious compliance failures an employer can face under employment law. Wage theft occurs when employees are not paid their lawful entitlements including minimum wages, overtime, penalty rates, superannuation, or leave entitlements whether through deliberate underpayment or systemic error. Sham contracting arises when a business misclassifies an employee as an independent contractor to avoid employment obligations, stripping workers of their Fair Work Act protections and entitlements.
The financial and reputational consequences of these breaches extend far beyond the immediate underpayment. Employers found liable for wage theft face back-payment obligations that can span years, often accompanied by superannuation guarantee charge penalties, interest, and significant legal costs. Civil penalties can be very significant and vary depending on the type of breach, whether it is a ‘serious contravention’, and whether the employer is a small business. For non-small business employers, maximum penalties per contravention can be as high as $469,500, and for certain serious contraventions can be up to $4,695,000. Individuals and small business employers face lower maximums, but exposure can still multiply quickly where there are multiple employees, pay periods, or contraventions.
From 1 January 2025, intentional underpayment can be a criminal offence under federal law, and the offence is aimed at intentional conduct (not honest mistakes). In Victoria, earlier state wage theft offences have been treated as largely inoperable following commencement of the Commonwealth scheme, and Victoria has moved to repeal those offences.
Beyond financial penalties, the impact on your brand reputation can be devastating. Public prosecutions, media coverage, and Fair Work Ombudsman enforcement actions damage stakeholder trust and employee morale. Prospective employees increasingly research employer compliance records before accepting offers, and wage theft allegations make talent acquisition significantly harder. For businesses considering sale, merger, or investment, undisclosed wage liabilities and compliance failures materially reduce enterprise valuation and can derail transactions entirely. Investors and acquirers conduct rigorous employment law due diligence, and historical wage theft or sham contracting exposes both current owners and potential buyers to inherited liability and reputational risk.
Red Flags That Signal Your Business May Be at Risk
Certain operational practices and workforce structures consistently signal elevated risk of wage theft or sham contracting liability. Recognising these red flags early allows employers to address compliance gaps before they escalate into Fair Work Ombudsman investigations, employee claims, or litigation.
One of the most common warning signs is inconsistent or unclear worker classification. If your business engages workers as independent contractors but exercises significant control over how, when, and where they perform work, you may be operating a sham contracting arrangement. Key indicators include requiring contractors to wear uniforms, setting their hours, providing equipment and tools, prohibiting them from delegating work, or integrating them into your organizational structure as if they were employees. Courts assess whether a worker is an employee or contractor by reference to the total legal rights and obligations, and where parties have a valid, comprehensive written contract, the High Court has emphasised that characterisation is usually determined primarily by the contract’s terms (unless the contract is a sham or displaced/varied). Practical “red flags” remain important because they often signal contract risk (e.g., the contract may not reflect reality, may have been varied, or may be vulnerable in dispute).
Other red flags include paying flat rates or salaries without regard to hours worked, failing to maintain accurate time and attendance records, not providing pay slips that detail all entitlements, or routinely requiring employees to work unpaid overtime. Businesses that rely heavily on junior rates, apprentice wages, or piece rates without proper award interpretation are also at heightened risk. Additionally, if your payroll system has not been updated to reflect modern award changes, National Employment Standards amendments, or superannuation guarantee increases, systemic underpayment is likely occurring.
High employee turnover, frequent complaints about pay, or requests for clarification on entitlements should prompt immediate internal review. Similarly, if managers lack training on award interpretation, rostering compliance, or record-keeping obligations, the risk of inadvertent wage theft increases substantially. For healthcare providers, NDIS service providers, and startups experiencing rapid growth, the complexity of award coverage, allowances, and penalty rate calculations creates additional compliance risk that requires proactive management.
What an Employment Law Audit Actually Examines
An employment law audit is a comprehensive, systematic review of your workplace policies, practices, payroll systems, and contractual arrangements designed to identify compliance gaps and quantify potential liability. Unlike reactive investigations triggered by employee complaints, a proactive audit allows you to detect and remediate issues before they attract regulatory scrutiny or litigation.
The audit process begins with worker classification review. This involves examining all contractor agreements, service agreements, and employment contracts to determine whether the legal characterization aligns with the actual working relationship. Auditors assess the degree of control, integration, risk allocation, and independence to identify sham contracting risk. For employees, the audit verifies correct award or enterprise agreement coverage, classification levels, and applicable pay rates.
Payroll and entitlement analysis forms the core of the audit. This includes reviewing pay records, timesheets, rosters, and payslips to verify compliance with minimum wages, penalty rates, overtime, allowances, leave accruals, and superannuation contributions. Auditors reconcile actual payments against award or agreement entitlements, identifying underpayments and calculating back-pay liability. Particular attention is paid to complex entitlements such as shift loadings, weekend and public holiday penalties, higher duties allowances, and annualised salary arrangements that may not adequately compensate for all hours worked.
The audit also examines record-keeping practices to ensure compliance with Fair Work Act and Fair Work Regulations requirements. Employers must maintain accurate time and wage records for seven years, and failure to do so can result in reverse onus of proof in underpayment claims. Policy documentation, including employment contracts, contractor agreements, workplace policies, and procedure manuals, is reviewed for legal compliance, internal consistency, and enforceability. For businesses in regulated sectors like healthcare, the audit may also assess NDIS worker screening compliance, clinical governance frameworks, and privacy obligations that intersect with employment practices.
How Audits Identify Misclassification Before It Becomes a Legal Problem
Misclassification of employees as independent contractors, whether intentional or inadvertent exposes businesses to significant liability under sections 357 and 358 of the Fair Work Act. These provisions prohibit sham contracting arrangements and misrepresenting employment as an independent contracting relationship. Proactive audits identify misclassification risk by applying the legal tests established by Australian courts and tribunals before regulatory action or employee claims arise.
The audit applies the multi-factor test articulated in cases such as Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd and Jamsek v ZG Operations Australia Pty Ltd. This involves examining the written contract, but more importantly, assessing the practical reality of the working relationship. Key factors include the degree of control exercised over the worker, whether the worker is integrated into the business structure, whether the worker bears commercial risk, the worker's ability to delegate or subcontract work, whether the worker provides their own tools and equipment and the parties' mutual intention at the time of contracting.
By conducting structured interviews with managers and workers, reviewing work practices, and analysing contractual terms against actual operational reality, auditors identify arrangements where the substance of the relationship contradicts the contractual label. For example, if a 'contractor' works exclusively for your business, follows your directions on work methods, uses your equipment, wears your uniform, and cannot refuse tasks or delegate work, the relationship is likely employment regardless of what the contract states.
Early identification through audit allows businesses to voluntarily reclassify workers, rectify underpayments, and implement compliant arrangements before facing Fair Work Ombudsman investigation or court proceedings. Voluntary disclosure and remediation, particularly when supported by audit evidence and legal advice, significantly reduces penalty exposure and demonstrates good faith compliance efforts. This proactive approach protects your business from the reputational damage and criminal liability associated with deliberate sham contracting, while ensuring workers receive their lawful entitlements and protections.
Building a Defensible Compliance Framework After Your Audit
Identifying compliance gaps through audit is only the first step. Building a defensible, sustainable compliance framework requires systematic remediation, process improvement, and ongoing monitoring to prevent future breaches and demonstrate due diligence to regulators, investors, and employees.
Begin by addressing identified underpayments promptly and transparently. Calculate back-pay liability accurately, including superannuation guarantee shortfalls and interest where applicable. Communicate with affected employees clearly, providing detailed explanations of the error, the remediation plan, and the steps being taken to prevent recurrence. Where wage theft has occurred, consider voluntary disclosure to the Fair Work Ombudsman under their Small Business Helpline or self-disclosure protocols. Proactive disclosure, coupled with evidence of genuine remediation efforts, can significantly reduce penalty exposure and demonstrate good faith.
Implement robust payroll governance and verification processes. This includes regular payroll audits, award interpretation training for HR and payroll staff, and systematic reconciliation of timesheets against award entitlements. Invest in payroll systems capable of accurately calculating complex entitlements, penalty rates, and allowances based on current award provisions. Establish clear escalation protocols for payroll queries and award interpretation questions, ensuring access to specialist employment law advice when needed.
Update and standardise all employment documentation. Ensure employment contracts clearly state award or agreement coverage, classification levels, and applicable rates. For contractor arrangements, document the genuine commercial relationship, including risk allocation, independence, and the right to delegate. Draft clear, enforceable workplace policies addressing flexible work requests, hybrid work arrangements, right to disconnect, medicinal cannabis use, and psychosocial hazard management. Provide managers with practical checklists and templates to ensure consistent, compliant decision-making.
Establish a compliance training and monitoring program. Train managers and supervisors on their obligations under the Fair Work Act, award interpretation, record-keeping requirements, and the consequences of wage theft and sham contracting. Implement regular compliance reviews and spot audits to verify ongoing adherence to policies and procedures. Maintain comprehensive documentation of all employment decisions, particularly those involving classification, remuneration, and flexible work arrangements, to establish defensible business grounds and procedural fairness.
For businesses preparing for investment, sale, or merger, a post-audit compliance framework provides documented evidence of due diligence and risk management. Clean employment records, robust policies, and proactive remediation of historical issues materially enhance enterprise valuation and reduce transaction risk. By embedding compliance into operational culture and governance, you protect your business from regulatory action, preserve your brand reputation, and create a workplace that attracts and retains talent while supporting sustainable growth.
Worried your business could be exposed? Get an Employment Law Audit under legal advice
If you want to reduce the risk of wage underpayment claims, sham contracting penalties, and deal-breaking issues during a sale or investment round, Northbridge Legal can run a confidential employment law audit designed to:
identify award/classification and contractor misclassification risk
quantify potential underpayment exposure
help you remediate issues quickly and defensibly
update contracts, policies, and payroll governance so you’re “due diligence ready” for future valuations and transactions
Because the audit is structured as part of obtaining legal advice, the work may be protected by legal professional privilege (depending on the circumstances).
Book a confidential audit consult with Northbridge Legal
By Awash Prasad
Founder & Principal Lawyer
NorthBridge Legal
Level 1, 117 Pascoe Vale Road
Coolaroo, VIC 3048
(03) 9647 2769
