Appeals court rejects employer scheme forcing workers to form shell corporations

December 23, 2025

A baking company's worker classification strategy backfired when a federal court saw through it

Federal court shuts down employer strategy of forcing workers to form corporations as workaround to employment law protections.

In a decision handed down December 22, 2025, the United States Court of Appeals for the Second Circuit ruled that employers cannot dodge employment protections simply by requiring workers to create corporations and sign contracts through those shell companies. The case, involving two truck drivers and a baking company, offers a clear warning to HR departments everywhere: courts will look past corporate paperwork to see what is really happening on the ground.

Nathaniel Silva and Phil Rothkugel started working for Schmidt Baking Distribution in 2020 as regular delivery drivers, classified as W-2 employees through a staffing agency. Their jobs were straightforward. They drove trucks to Schmidt's warehouse, picked up fresh baked goods, delivered them to stores, and stocked shelves.

Several months in, Schmidt gave them an ultimatum. To keep working, they would need to form their own corporations and sign new agreements as business entities. Neither driver had ever run a company before, but Schmidt walked them through the process. Silva created Silva's Baked Goods. Rothkugel formed Trout Slayers Baked Breads Inc.

The new contracts called the arrangement an independent contractor relationship and included mandatory arbitration clauses that would prevent the drivers from joining together in a class action lawsuit. But here's what didn't change: the actual work. Silva and Rothkugel still drove the same trucks, delivered the same products to the same stores, and had no say in pricing or sales strategies.

When the drivers sued in Connecticut court claiming wage and overtime violations, Schmidt tried to force them into individual arbitration based on those contracts. A district court agreed, reasoning that agreements between two businesses fall outside the employment protections of the Federal Arbitration Act. Schmidt appeared to have won.

The appeals court saw things differently. Circuit Judge Maria Araújo Kahn pointed to a telling detail in the fine print: personal guarantee provisions that made Silva and Rothkugel personally liable not just for money, but for actually doing the work. That provision, the court noted, "blurs the line between a supposedly business-to-business contract and an agreement for personal services."

The court zeroed in on how these corporations came to exist. Silva and Rothkugel were not entrepreneurs who built companies and then sought contracts with Schmidt. They were workers who were told to incorporate or lose their jobs. The court described their corporations as "mere instrumentalities" created to disguise employment contracts as commercial transactions.

This matters because Section 1 of the Federal Arbitration Act exempts transportation workers from mandatory arbitration. The Supreme Court ruled in 2019 that this exemption covers not just traditional employees but also independent contractors. Schmidt's strategy was essentially trying to add another layer: if workers contract through corporations they control, maybe the exemption vanishes.

The Second Circuit rejected that logic. The court emphasized that Congress wrote the law to cover "contracts of employment of workers," not "contracts of employment with workers." That small preposition carries weight. The focus is on whether a contract involves work performed by workers, regardless of what entity signs the paperwork.

Schmidt argued the relationships looked more like franchise or distributor arrangements. The contracts even included language about purchasing distribution rights for specific sales territories. The court was unpersuaded. Adding business-sounding terms to a work agreement does not transform its fundamental nature.

The decision carefully distinguished cases from other circuits involving actual business entities. The Ninth Circuit, for instance, ruled that corporations employing tens or hundreds of drivers to manage multiple delivery routes are genuinely different from individual transportation workers. The Fourth Circuit reached a similar conclusion about a company that hired 450 drivers.

Silva and Rothkugel, by contrast, were solo operators performing manual labor themselves. The corporate structure added nothing but paperwork.

For HR professionals, the message is unambiguous. Requiring incorporation as a condition of employment will not protect companies from employment law obligations when the underlying relationship remains one of worker and workplace. Courts will examine who initiated the corporate formation, whether duties changed after incorporation, whether the worker had prior business experience, and whether the entity employs additional staff.

The case now returns to district court, where the drivers can proceed with their class action rather than being forced into individual arbitration. The court made clear it would not allow employers to circumvent employment law protections for transportation workers by requiring those workers to take corporate form.

The record, the court found, unequivocally demonstrated that the companies Silva and Rothkugel were required to create served as instrumentalities to dress individual employment contracts in the garb of commercial transactions.