Thrilled by a personal e-mail from Microsoft Corp. Chairman Bill Gates praising his ideas for improving the firm's movie Web site, Jim Emerson jumped at a chance to join the giant software company five years ago. He hesitated only slightly when he was told he would have to sign on as an "independent contractor" rather than a full-time employee.

The job as senior editor of the site would give him "a foot in the door" and likely become permanent, he recalled a supervisor saying. But after three years of working up to 90 hours a week, and even sleeping in his office, Emerson said he found that the orange badge he and other contractors and temporary workers wore made him a lot different from the regular workers, who wore blue badges.

He couldn't buy things at the company store. He wasn't permitted to work in an office that had windows. He couldn't use the company health club. He wasn't allowed to attend company parties, even when they honored products he helped create.

His orange badge also meant he wasn't eligible for company-paid health insurance, vacation or sick leave. And he couldn't participate in the company pension plan, which allowed regular workers--many of whom became wealthy--to buy company stock at discounted prices.

"I didn't know about this caste system, and what's an employee and what's not," Emerson said in an interview. Now he is part of a group of an estimated 10,000 current and former independent contractors and other longtime "temporary" employees due to receive what may be more than $100 million, thanks to a federal appeals court's decision that the U.S. Supreme Court last week declined to review.

The case hasn't captured as much attention as the government's antitrust suit against the company. But it could have lasting consequences for employers and the estimated 10.2 million American workers--7.8 percent of the work force--employed in temporary or contract jobs or as independent contractors, according to the Bureau of Labor Statistics.

"It's a very important case," said Margaret Levi, director of the University of Washington's Center for Labor Studies. "Employers are going to be looking over their shoulders more and worrying about whether they are categorizing their part-time and temporary employees properly."

The ruling by the 9th U.S. Circuit Court of Appeals said some of the workers at Microsoft--where temps and independent contractors make up about 20 percent of its U.S. work force--essentially become "common-law" employees.

Though employers have leeway on pay, vacation and health-care issues, the court found, federal law requires that retirement benefits be uniform. So Microsoft has to make up to those who worked at least half time, or five months a year, the money they lost by not being offered company stock at a discount as full-time workers were, the court ruled. The court decisions haven't swayed Microsoft's position on the issue. Spokesman Dan Leach said Friday: "The employees of temporary staffing agencies are employees of temporary staffing agencies."

He said the company has made some changes in its arrangements with temporary agencies in recent years. Microsoft now requires the agencies to offer a medical and dental insurance package to their workers, 13 days of paid vacation per year, training opportunities and a retirement plan.

In court documents, the firm's attorneys said the temporary workers received higher hourly salaries than regular employees and had more flexibility to take time off. And employing short-term workers gave the company's regular work force employment security.

"Microsoft's personnel practices reflected the new and volatile nature of the software industry in the mid- to late-1980s, not discriminatory intent," its lawyers told the court in April. ". . . As evidence shows, management at Microsoft was concerned about the volatile and unsettled nature of the industry, and with how to achieve the ultimate goal of avoiding the potential for layoffs or overstaffing."

Leach said the company appreciates its contingent workers and does not view them as second-class citizens. "We value the contribution of everyone who helps us make great software," he said.

Temporary workers have long played an important role in the U.S. economy. Employers often turn to short-term employment forces to meet specific business needs, such as providing extra help during holiday seasons. But in recent years, many companies and some government agencies have reduced their regular staffs and hired more temporary workers, usually with less-generous or nonexistent benefit packages, to replace them. Sometimes they hire laid-off workers back as independent contractors.

That trend has spawned several other legal actions, including a workers' suit against Atlantic Richfield Co. and a Labor Department suit against Time Warner Inc. [See related story.]

The combination of these actions, the Microsoft rulings and a tight labor market has caused some employers to reevaluate their policies on temporary workers.

"We call it the Microsoft inoculation," said management lawyer Wayne S. Jacobsen. "People think it's a computer virus. But it's really causing a realization that if you hire 'independent contractors,' some mistakes will be made."

The implications are particularly striking in the high-tech industry, where some experts estimate that more than 10 percent of the workers are temporaries or independent contractors. Staffing flexibility has allowed these companies to cope with short product cycles, workloads that come in sudden bursts, and projects that may quickly fizzle as market needs or technologies change, industry experts say.

Harris Miller, president of the Information Technology Association of America, which represents high-tech companies, said the ruling could jeopardize the health of the computer industry. "It's pretty frightening," Miller said. "They are taking the issue of flexible staffing and turning it upside down. It's a threat to the whole idea of the flexible work force, which is key to the digital economy."

Miller said many temporaries and independent contractors don't want to be employees. "These people are not slaves being shackled to their desks. . . . The idea that people are being forced to become independent contractors by big, bad employers isn't true," he said.

Frederick A. Edelblut, an independent contractor at Microsoft who has worked with the company for more than a decade, translates software manuals into German. He said he gets paid very well and is pleased with his arrangement with the company.

"It's always been my choice," he said. "I value my freedom. I never wanted an umbilical cord tied to Microsoft. I don't think Microsoft owes me anything beyond what they pay me."

Chuck Wolfred, 44, who worked as a software tester for 6 1/2 years, said, "My view is that I was working for the agency." Wolfred, who left in October for a regular job at a software-testing company that does work for Microsoft, said he enjoyed his stay. "It allowed me flexibility and freedom, and I got to play with the newest toys."

Edelblut and Wolfred are part of the class of temp workers who will get paid for stock under the court ruling.

But some worker advocates and labor officials say companies are creating a two-tiered work force and are misusing the words "temporary" and "independent contractor" to legitimize treating some workers unfairly. "Temporary" workers, they say, should refer only to workers who remain at a firm for six months or less.

"Independent contractors," they say, work for many different clients, on their own schedules, with their own equipment. They also set their own prices, in accordance with Internal Revenue Service guidelines that determine who needs to pay payroll taxes and who doesn't.

"This is all about companies mislabeling people to call them temporaries when they are not," said David West, director of the Center for a Changing Workforce, a Seattle-based policy advocacy group that focuses on contingent workers. "This is all about companies using the temporary label to save money on benefits."

The Microsoft case started with a series of IRS rulings in December 1989 that found that the company had improperly designated about 600 workers as independent contractors or freelancers when they should have been considered employees. The IRS said Microsoft was responsible for paying payroll, unemployment and Social Security taxes that are required of employers.

Microsoft responded by paying the back taxes and hiring a small number of the workers as regular employees, according to court records. Most of the affected workers, however, were told they needed to sign up with temporary agencies Microsoft had selected, and to sign contracts that explained their work status.

Those who signed up continued to do the same work. But they received their paychecks from temporary agencies, not from Microsoft, out of money Microsoft paid the agencies. Those who refused to sign the contracts, saying they believed they were employees, were terminated.

There has been debate in Microsoft management levels about the effect the use of so many contingent workers has on morale and product quality. In a June 30, 1989, e-mail message in the court records, for example, then-Microsoft executive Anne Milkovich related that Chief Financial Officer Frank Gaudette, who is now deceased, said he "didn't know what to do about temps but the very nature of the status conflicts with everything he thinks the company should adopt in terms of management philosophy (not in so many words). He also said that there needs to be some accordion to accommodate fluctuating work flow, that manufacturing uses temps quite successfully, but they are truly temps who work temporarily. I said there are people who want to freelance for [Microsoft], just not as many as Microsoft wants; he agreed."

The doubts were apparently set aside. Microsoft's use of temporary workers continued to grow, even after the IRS ruling. Their number climbed from about 440 at the time of Milkovich's e-mail memo to about 6,000 today. They work as software testers, graphic designers, editors, technical writers, receptionists and office support staffers. Some have been temporaries there for more than seven years.

Microsoft spokesman Leach said about 35 percent of the workers Microsoft permanently hired last year had been temporary workers there. "The marketplace is very competitive," Leach said. "There are 3,000 job openings today at Microsoft. There are many people today who make a choice--who choose to work for a temporary staffing agency."

But many of the workers who filed the original lawsuit in 1992 testified that they signed agency contracts because they didn't understand the nature of the relationship with Microsoft, felt pressured to accept the company's terms because they needed money, or were falsely promised, as Emerson claims, that if they accepted a temporary assignment, they would be rewarded with an official "head count" job after they had proved themselves.

"During the three-plus years I worked for Microsoft, I was repeatedly asked to assume long-term assignments with the promise of being considered a 'regular' or 'head count' employee in the future," Martha Harrah said in a court deposition. Harrah's first job at the company was managing the distribution of a children's software program. She later helped develop Microsoft's education Web site, which helped the firm compete more successfully with Apple Computer's Macintosh products, long dominant in educational software.

During that time, Harrah said in sworn testimony, she worked full time at the company's offices, under the full supervision of Microsoft managers, using Microsoft equipment. She said her only regular contact with the temporary agency was that it issued her paycheck. Dozens of other workers similarly testified that they had worked for the company in the same way, year in and year out, side by side with workers who were designated as regular employees, who had full benefits and many of whom gradually became rich because of their stock purchases.

Washington state agencies also disputed Microsoft's characterization of the workers. Its Department of Employment Security granted one temporary worker unemployment compensation after he was fired from a Microsoft project because he met the legal standards to be considered an employee.

And the state Department of Labor and Industries, which governs workers' compensation programs there, filed legal briefs on the workers' side in the lawsuit because the department agreed that the workers had been improperly classified by Microsoft.

In 1998, when it became apparent the stakes in the case might be high, the company amended the contracts it asked temporary workers to sign, requiring them to give up any money they might win from a class-action lawsuit or stop working for the company.

U.S. District Judge John Coughenour called Microsoft's action "outrageously arrogant" at a court hearing last January. Microsoft later amended the contract to eliminate the language.

The original lawsuit had asked for the full package of employee benefits, including health coverage, paid vacation and pension benefits. Winning on the pension issue meant the case's focus shifted to Microsoft's employee stock-purchase plan, the part of its retirement program that lets workers buy company stock at 85 percent of its market price, without paying broker fees.

The stock-purchase plan is a high-ticket item because Microsoft shares have skyrocketed in value in the past decade and split eight times. Microsoft's Lisa J. Yeager said in court filings that a company worker who bought 20 shares of stock in January 1987 would have paid $818 under the plan. Those 20 shares would have grown to 720, worth $107,280, by January 1998.

That stock price escalation, of course, was what created the class of Seattleites now known as the "Microsoft millionaires." Some of them live lavish lifestyles in spacious homes on the region's sloping hillsides. Others retired early to manage their investments and engage in philanthropic activity.

The sharp appreciation in the stock price also means that some of the temp workers in the lawsuit could get more money from their stock than they received in salary while at Microsoft.

David Stobaugh, the lawyer who represents the workers, said it's ironic that Microsoft will have to spend so much money to settle the suit when it would have been less expensive to put the affected workers on the payroll and pay them benefits, as many workers sought. "Health insurance certainly would have been cheaper, and if Microsoft had let them buy into the stock plan, it would have cost them almost nothing," he said. "They would have spent less money than they will have to spend, plus it would have been the right thing to do."

Analysts have estimated as much as $40 million could be divided among the workers. But Stobaugh said $100 million is a more likely number. Microsoft spokesman Leach said, "I'm not about to speculate on what the court hasn't decided."

About a dozen of the affected workers said in interviews that they sued not for the money, but because they believed they had been treated unfairly.

Squire Dahl, 28, a lawyer who has been a contingent Microsoft worker for more than a year, said the difference in status is a constant irritant. In October 1998, for example, the company newsletter contained a story about a lavish Halloween bash being planned. The last sentence, however, read, "Blue Badges Only," Dahl said.

"It's amazing the effort Microsoft puts into perpetuating this myth" that one group of workers is so different from another, he added.

The stock-fueled wealth gap between blue badges and orange badges, who often performed similar jobs, also created animosity, some of the temporary workers said.

Richard Pauli, 51, recalled an incident after he returned to work being off for two months--without pay or health insurance--because of temporary paralysis. A regular worker came in to the office and began boasting about the sharp uptick in the stock prices he was enjoying as a regular employee. The man said, "I got $18,000 richer last night," Pauli recalled, shaking his head.

Pauli, who worked at Microsoft for six years, was also upset to learn he would not be permitted to bring his stepdaughter to Take Our Daughters to Work Day because he wasn't a regular employee. He said he feared he and his daughter would be turned away at the door because of his orange badge.

Emerson, who left Microsoft in 1998 after the company shut down the Cinemania Web site, said "the cult of Microsoft" drew people in and then they couldn't or wouldn't leave. "It's like a bad marriage," he said. "You just can't get away."

Other workers have expressed their dissatisfaction with the company's personnel policies by signing on as members of the fledgling Washington Alliance of Technology Workers, known as Washtech. The new Seattle-based union was organized by two former Microsoft temps and is being funded by the Communications Workers of America.

Levi, of the Center for Labor Study, said the big irony to her is how Microsoft's efforts to ensure job security for one group of workers backfired with another group of workers, leaving them so angry that they were willing to pursue a legal case for more than eight years. She said it also created complicated human resource problems.

"At Microsoft, it's a very stratified system," she said. "If you're not the right color badge, you get excluded from certain kinds of things and not invited to the company picnics. You feel different. It's having a weird, demoralizing effect, and it is skewing the organization. It's a complex problem."

Spokesman Leach cited a recent Microsoft party to celebrate the launch of its new Windows 2000 software as one way the company has changed its relationship with its temporary workers. It now tells its temporary agencies to tell their employees they can come to such events--with one slight twist. "Our managers have been working with the temporary staffing agencies to see if they are interested in co-hosting these events--but that's their employer, remember," he said.

Do's And Don'ts For Temps At Microsoft

As the temporary workers' lawsuits wound through the courts, Microsoft sought to ensure its contingent workers were not mistaken about their place within the company.

The temporary agencies that Microsoft used provided the workers with handbooks that laid out the ground rules in explicit detail:

* Temporary workers were barred from using company-owned athletic fields. (That was for insurance liability reasons, the company explained.)

* At some facilities, temporaries were told they could not drive their cars because it would create parking problems for regular workers. Instead, they were told to take the bus.

* Temps were told they should not try to participate in the social clubs -- such as chess, tai chi or rock -- climbing affinity groups -- open only to regular employees.

* They were not permitted to buy goods at the company store or attend parties given for regular employees, such as the private screening of the latest "Star Wars" film, or company-wide meetings held at the Kingdome stadium in Seattle.

* Their e-mail addresses were to be preceded with "a-" before their names, so that anyone with whom they communicated would know their non-permanent status in the company.