Silicon Valley Misclassification: ‘New York’ Magazine Focuses on How the 1099 Economy May Be Exposing Tech Start-Up Companies to Costly Liability for Their Use of Independent Contractors

Today’s online edition of New York Magazine’s “Daily Intelligencer” includes a comprehensive article on how Silicon Valley start-up tech companies using “the 1099 model” may be exposed to employment, tax, and benefit law liabilities that could drive them out of business or cause them to change to a W-2 model. Kevin Roose’s fine article is entitled “Does Silicon Valley Have a Contract-Worker Problem?”

Roose predicts that venture capital funding sources that have invested in 1099-model start-ups may not have anticipated their potential exposure to the types of class action lawsuits where the contract workers allege that they are not really independent contractors but actually misclassified employees. The article examines companies that use the 1099 model – such as TaskRabbit (errand service), Homejoy (house cleaning), Uber (car service), BloomThat (flower delivery), Washio (laundry services), and Spoonrocket (meal delivery) – and concludes that “If their [freelance 1099ers] are classified as employees then that suddenly makes their business model untenable.”

Three things seem to have prompted the article. The first was Roose’s hiring of a house cleaner through a San Francisco start-up called Homejoy, which was offering home cleanings in the Bay Area for $19. As Roose noted, that was not $19 per hour or $19 per room, but $19 for his entire home. Striking up a conversation with the cleaner, he found out that the worker was homeless and, to Roose’s surprise, was not an employee of Homejoy but an independent contractor referred to Roose by Homejoy. The second event was Roose learning that a federal appellate court had just ruled that FedEx Ground had misclassified 2,300 drivers in California that it had treated as independent contractors. The third was Roose hearing that Uber had been sued in Massachusetts and California in a class action lawsuit alleging that they were being misclassified as independent contractors. Roose asks: “Could courts destroy the 1099 model?” The answer to that question is below, but first we address investments by private equity firms in companies that use a business model built around independent contractors.

Hidden Due Diligence Risks

In our blog post in January 2013 entitled “Hidden Due Diligence Risk in Mergers, Acquisitions and Investments: Independent Contractor Misclassification Oftentimes Overlooked by Private Equity Firms, Hedge Funds and Other Investors,” which was republished in the American Bar Association’s January 23, 2013 Business Law Today, we observed that many due diligence reviews in mergers, acquisitions, and investments have ignored the issue of independent contractor misclassification liability, noting:

“This is a difficult exposure to identify unless the legal team digs below the information typically provided by the seller or available in public records. In view of the crackdown by federal and state governments on the misclassification of employees as ICs, an increase in state misclassification legislation, and a steady stream of class action lawsuits claiming that certain workers have been disguised as ICs, due diligence efforts should not overlook this often hidden exposure.” The article discusses what private equity firms should examine during due diligence, how to determine exposure to independent contractor misclassification liability, and the use of post-closing due diligence to minimize or eliminate this type of legal exposure.

“Could Courts Destroy the 1099 Model?”

The answer to Roose’s question is, yes – but only if the tech companies that use that model do not take care to structure, document, and implement their independent contractor relationships in a manner consistent with federal and state independent contractor laws, provided the business model, once properly designed and implemented, is not built on directing and controlling the manner by which the 1099ers perform their work. Appellate courts such as the one that recently doused FedEx focused on the independent contractor agreement drafted by FedEx as well as FedEx Ground’s own policies to conclude that, although FedEx arguably lacks control over some parts of its drivers’ jobs, such lack of control over certain parts of the drivers’ roles is not sufficient to “counteract the extensive control it does exercise” including the right to control the appearance of its drivers, its vehicles, the times the drivers can work, aspects of how and when drivers must deliver packages, and the decorum by which the drivers must conduct themselves.

In our August 29, 2014 blog post on that case entitled “Earthquake in the Independent Contractor Misclassification Field,” we concluded that FedEx Ground lost before the court in California because of a misplaced reliance on an independent contractor agreement and its policies and procedures that were good, but by no means good enough.  Plainly, although FedEx is a savvy company, close scrutiny by a court found one fallacy after another in the very documents FedEx created – sufficient in degree to lead the court to rule against FedEx. As we noted, “IC agreements and policies and procedures that are not drafted in a state-of-the-art manner, free from language that can be used against the company, can cause businesses that use ICs to face class action litigation or regulatory audits or enforcement proceedings they may be able to otherwise avoid.”

This is not to say that every 1099 business model can be sustained under close scrutiny by the courts simply because its independent contractor agreement reads like a dream. Even a well-drafted independent contractor agreement has no legal value if it does not accurately reflect the actual structure of the relationship and is not implemented in a state-of-the-art manner, and the courts have regularly stated that they are not bound by what is stated on paper if it is not what is put into practice.  Further, even when well structured, elegantly documented, and carefully implemented independent contractor relationships survive legal scrutiny under federal labor, tax, or benefit laws, they may not pass muster under what we have referred to as a crazy-quilt of state independent contractor laws.

What Can Investors and Tech Companies Do to Minimize IC Misclassification Liability?

Many new and existing companies have resorted to IC Diagnostics™ to enhance their level of independent contractor compliance and determine whether a group of workers not being treated as employees would pass the applicable tests for independent contractor status under governing state and federal law.  That proprietary process also offers a number of practical, alternative solutions to enhance compliance with those laws, including restructuring, reclassifying, and redistributing 1099ers, as more fully described in our White Paper on the subject.

All too often – and not surprisingly – many start-ups seek out infusions of capital before they have taken the time and energy to examine legal compliance issues that may be activated by operation of their new businesses. Other times new businesses (and for that matter, many established businesses, like FedEx Ground) simply fail to document and/or implement their 1099 models in a manner that minimizes independent contractor misclassification liability.  And, as noted in our due diligence post and article, private equity firms and investors do not conduct the level of due diligence they should. Roose’s article is a good reminder that not all start-ups (as well as existing businesses) are investment grade, but the overwhelming number can be if time and resources are invested in independent contractor compliance as well.

Richard Reibstein (NYC), Lisa Petkun and Andrew Rudolph (Philadelphia), with Greg Bishop, Andy Chan, and Tom Fitzpatrick (Silicon Valley)

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U.S. Labor Department Awards $10.2 Million to 19 States to Help Finance Their Crackdown on Independent Contractor Misclassification; Four States Get “Bonus” Awards for Improved Detection Results

The news from Washington, D.C. yesterday is that the U.S. Department of Labor is funding 19 states’ efforts to crack down on businesses that unwittingly or intentionally fail to make unemployment contributions for individuals misclassified as independent contractors. While class actions in court continue to receive the most attention, unemployment proceedings continue to plague many businesses that use independent contractors to supplement their workforce or carry out their business objectives – and the Obama Administration, supported by Congressional funding, is keeping its headlights focused on unemployment challenges to detect and deter independent contractor misclassification.

Labor Secretary Thomas Perez issued a press release on September 15, 2014 that carried out the Obama Administration’s continuing efforts to crack down on independent contractor misclassification. As noted in our March 4, 2014 blog post, the President has maintained his Administration’s commitment to “[i]ncreasing support for [state] agencies that protect workers’ wages and overtime pay, benefits, health and safety, and invest in preventing and detecting the misclassification of employees as independent contractors.”  To that end, Congress passed the Consolidated Appropriations Act of 2014 authorizing grant funding of no less than $10 million for “activities to address the misclassification of workers.”

Which States Received Grants?

The 19 states that received grants totaling $10.2 million were California, Delaware, Florida, Hawaii, Idaho, Indiana, Maryland, Massachusetts, New Hampshire, New Jersey, New Mexico, New York, Oregon, South Dakota, Tennessee, Texas, Utah, Vermont, and Wisconsin. According to the press release, the funds will be used to increase the ability of state unemployment insurance tax programs to identify instances where employers improperly classify employees as independent contractors or fail to report the wages paid to workers. The states selected for grants will reportedly use the funds for a variety of improvements and initiatives, including enhancing employer audit programs and conducting employer education initiatives.

Four states received “high-performance bonuses” totaling over $2 million: Maryland, New Jersey, Texas, and Utah. According to Secretary Perez, this innovative program rewards states with additional grant funds “due to their high performance or most improved performance in detecting incidents of worker misclassification.”

What Does This Mean to Businesses Using Independent Contractors?

In February 2013, we published a blog post that focused on how a single claim by one worker can lead to the administrative equivalent of a class action for independent contractor misclassification. Any business using independent contractors to supplement its workforce or to carry out its business model bears the risk that one or more individuals it classifies as 1099ers will file for unemployment benefits or that a state where one of those 1099ers resides will commence an audit of its unemployment and payroll taxes.

Use of independent contractors remains a highly risky business for those companies that do little more than hand those individuals an independent contractor agreement when they commence providing services and a Form 1099 shortly after year’s end. Even large and legally savvy companies have tripped over their own feet in the past few years, most notably FedEx Ground, which was the subject of an adverse federal appellate ruling only last month where it was found to have misclassified its drivers as independent contractors.  As noted in an earlier blog post, that courier company’s IC agreement was used against the company by the appellate court to conclude that FedEx sufficiently directed and controlled the work by its Ground Division drivers to turn them into employees.

The likelihood that these types of agreements will survive judicial or administrative scrutiny is low – unless the business takes affirmative and comprehensive steps to structure, document, and implement an independent contractor relationship in a state-of-the-art manner that not only serves the company’s business objectives but also can withstand a challenge under one of the many federal or state laws governing independent contractor status. While some independent contractor relationships may comply with federal tax or employee benefit laws, they may stand little chance of complying with a crazy quilt of state laws, which can differ greatly from state to state.

Many companies have begun to use IC Diagnostics™ to restructure, re-document, and re-implement their independent contractor relationships before they receive a summons for a class action lawsuit, a notice for a federal or state administrative audit, or an inquiry from the local unemployment office about an individual who is seeking benefits.  Both an audit and an unemployment claim can lead to the equivalent of an administrative class action, where an unemployment agency finds a single individual to be an employee instead of an independent contractor and orders the business to remit contributions for the employee “and all similarly situated employees.”  These proceedings can, in turn, lead to follow-up regulatory challenges by state workers’ compensation agencies, state tax commissioners, state wage and hour divisions, and of course the IRS and the U.S. Department of Labor – or a plaintiffs’ class action lawyer seeking an array of damages.

As described in our White Paper describing ways that companies can minimize the risks of misclassification liability, there are a number of alternatives that businesses can consider, including re-structuring, re-documenting, and re-implementing their business models, embarking on a voluntary or government-sponsored reclassification, or redistributing independent contractors through the use of a knowledgeable workforce management or staffing firm.

Increasingly, businesses are also making use of IC Diagnostics™ after they have received a summons, audit notice, or unemployment inquiry.  While pro-active steps are far more likely to produce positive results, a belated start to enhancing independent contractor compliance can serve to considerably mitigate legal exposure and substantially reduce or eliminate risks going forward.

Richard Reibstein, Lisa Petkun, Andrew Rudolph

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August 2014 Monthly Independent Contractor Compliance and Misclassification Update

This month’s headline developments are the seismic decisions, issued on August 27, 2014 by the U.S. Court of Appeals for the Ninth Circuit, concluding as a matter of law that FedEx Ground had misclassified over 2,300 drivers in California and a smaller group of drivers in Oregon. The appellate decision reversed a district court decision applicable to over 40 lawsuits filed around the country by FedEx Ground drivers. The Ninth Circuit decision, which is arguably the most significant legal development to date in 2014 in the field of independent contractor misclassification, was based on the court’s close examination of the terms of the independent contractor agreement and the policies and procedures used on a nationwide basis by FedEx Ground. This game-changing decision is likely to have broad ramifications across all industries, and cause regulators and class action lawyers to more closely scrutinize independent contractor agreements in an effort to determine if the company in question retains sufficient direction and control over the manner or means by which the work is performed by individuals who claim to be employees and not independent contractors.

In the Courts (3 cases)

    • FED EX GROUND SLAMMED BY NINTH CIRCUIT IN DECISION CHANGING INDEPENDENT CONTRACTOR LANDSCAPE. Federal appeals court overturns a lower court decision applicable to 42 court cases where the lower court had found that FedEx Ground delivery drivers were independent contractors and not employees. The Ninth Circuit Court of Appeals reversed that decision as it applies to California and Oregon law, finding that FedEx Ground had the right to exercise control and/or actually exercised control over the drivers’ appearance and dress, their vehicles, the times the drivers work, how and when drivers deliver their packages, and the “decorum” that the drivers must exercise to “foster the professional image and good reputation of FedEx.”  See our detailed blog post on August 29, 2014, including the impact that the decision will have on other companies using independent contractors and how companies can minimize misclassification liability by restructuring, re-documenting, and re-implementing their independent contractor relationships. Alexander v. FedEx Ground Package System, Inc., No. 12-17458 and 12-17509 (9th Cir. Aug. 27, 2014); Slayman v. FedEx Ground Package System, Inc., Nos. 12-35525 and 12-35559 (9th Cir. Aug. 27, 2014).
    • NEWPAPER AGREES TO PAY $3.2 MILLION TO SETTLE CLASS ACTION LAWSUIT BROUGHT BY ITS HOME DELIVERY CARRIERS. After six years of costly litigation, Lee Publications (d/b/a North County Times) of San Diego has settled an independent contractor misclassification lawsuit brought by home delivery newspaper carriers.  The plaintiffs alleged many causes of action against the newspaper, including failure to pay minimum wage, hourly wages and overtime wages and failure to reimburse the carriers for their business expenses. Although the class action claim was limited to exclude the minimum wage claims, the parties settled the state law claims alleging failure to reimburse the carriers for their reasonable business expenses and for unfair business practices. An approval hearing regarding the proposed settlement is scheduled for October 2014. Dalton v. Lee Publications, Inc., No. 08-CV-1072 (GPC NLS) (S.D. Cal. August 15, 2014).
    • WASHINGTON STATE DISCRIMINATION LAW CAN APPLY TO INDEPENDENT CONTRACTOR ALLEGEDLY FIRED IN RETALIATION FOR COMPLAINING ABOUT DISCRIMINATION. The Washington Court of Appeals has found Northland Services Inc. liable for the retaliatory dismissal of an independent contractor truck driver, Larry Currier, under the Washington Law Against Discrimination (WLAD), even though the driver did not have an employer-employee relationship with the company. The independent contractor driver complained to the company that another independent contractor had directed racially derogatory statements at a Latino driver. Two days later, the company terminated Currier’s contract. Although the company argued that the WLAD did not apply to independent contractors and, consequently there could be no retaliation as a matter of law, the Court of Appeals disagreed. It found that the WLAD extends broad protections to “any person” engaging in statutorily protected activity from retaliation by an employer or “other person.” Currier’s complaint about the discriminatory treatment of others was found to be a statutorily protected activity and the timing of the termination of the contract to the complaint by Currier and other evidence served as a causal link evidencing retaliation. Currier v. Northland Services Inc., No. 70128-2-I (Ct. App. Wash. August 4, 2014).

 On the Legislative Front (2 matters)

    • VIRGINIA GOVERNOR ISSUES EXECUTIVE ORDER CREATING INDEPENDENT CONTRACTOR MISCLASSIFICATION TASK FORCE. Virginia Governor Terry McAuliffe signs Executive Order 24 establishing an interagency task force to combat worker misclassification and payroll fraud. In a press release issued by his office on August 15, 2014, the Governor stated: “Every Virginian who works hard and follow the rules should get the pay and benefits that they deserve. This executive order will begin a process to ensure that employers throughout the Commonwealth follow the same rules when it comes to benefits and pay for their employees.” The activities of the Task force are to include reviewing existing statutes and regulations related to worker misclassification and payroll fraud; evaluating current enforcement practices; developing procedures for more effective inter-agency cooperation and joint enforcement; implementing a pilot program for joint enforcement; developing educational materials; advising about technological improvements in misclassification and payroll fraud detection; and recommending changes to legislation or administrative rules.
    • PENNSYLVANIA LEGISLATOR INTRODUCES BILL TO BOOST ENFORCEMENT OF CONTRUCTION INDUSTRY MISCLASSIFICATION. Pennsylvania state senator Mike Stack (D. Philadelphia) introduces Senate Bill 1454 in an effort to enhance the enforcement of the current independent contractor misclassification laws in Pennsylvania, particularly the law prohibiting misclassification in the construction industry. In an August 12th press release, Sen. Stack stated:  “When it comes to protecting workers and taxpayers from employer manipulation, the state Department of Labor is not up to the job. It’s time to give local law enforcement the tools to prosecute when they uncover violations of state labor law.”  The bill seeks to amend Act 72 (the Construction Workplace Misclassification Act), which required that construction industry businesses satisfy a rigid test for those classified as independent contractors and made it a criminal offense for employers in the construction industry to misclassify employees. The proposed bill, which is currently pending before the Senate Labor and Industry Committee, would allow local district attorneys to investigate and prosecute violations of state law regarding exploitation of the “independent contractor” class of employees. Senator Stack was harsh in his assessment of Pennsylvania regulators, whom he said have resolved less than one third of complaints in the three years following the enactment of Act 72.

Regulatory and Enforcement Initiatives (1 matter)

  • ILLINOIS  REPORTS CRACKDOWN ON IC MISCLASSIFICATION AS AUDITS INCREASE. The Illinois Department of Employment Security (IDES) reported on August 11, 2014 that in the prior year, nearly 20,000 workers in that state were found by the IDES to have been misclassified as independent contractors and that the IDES assessed unemployment insurance contributions and penalties attributable to over $250 million in unreported taxable wages. According to the state’s Bureau of Labor Statistics, Illinois had the most productive employer auditing effort in the country, with 3,635 audits conducted of employers in 2013.

Other Noteworthy Matters (1 Matter)

  • INDEPENDENT CONTRACTOR TAXI DRIVERS “UNIONIZE” IN BAY AREA.  San Francisco cab drivers vote on August 13, 2014 to join the San Francisco Taxi Workers Alliance, which is the first independent contractor affiliate of the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO).  This alliance was formed in an effort to gain political and legal strength against emerging trend of app-based ride services like Lyft and Uber, in the face of what the taxi drivers believe to be inaction by the City of San Francisco to regulate Internet-based ride services.

Published by Richard Reibstein, Lisa Petkun, and Andrew Rudolph. Compiled by Janet Barsky. * * * * To receive blog posts and regular Monthly IC Compliance and Misclassification News reports, you may subscribe by e-mail or RSS to the Independent Contractor Compliance and Misclassification Legal Blog. * * * * Invitation to upload content: Readers may contribute to this repository of newsworthy matters by sending an e-mail to ICComplianceBlog with any recent:

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Earthquake in the Independent Contractor Misclassification Field: Changed Landscape Following Serious Legal Blow to FedEx Ground by Federal Appellate Court

FedEx Ground has been at the epicenter of the crackdown on IC misclassification by government regulators, state legislators, and plaintiffs’ class action lawyers since 2007, when a California appellate court found single-route FedEx Ground delivery drivers to have been misclassified as independent contractors (ICs) instead of employees.[1] But in 2009[2] and 2010[3], FedEx Ground won significant court decisions involving the IC status of its Ground Division drivers, including a December 2010 decision by a federal district court judge presiding over dozens of IC misclassification cases in a “multi-district litigation.” That decision, issued over 3-1/2 years ago, had granted summary judgment in favor of FedEx Ground in 42 IC misclassification lawsuits brought by drivers in 27 states, including California and Oregon.

On August 27, 2014, however, the IC misclassification landscape for FedEx Ground dramatically reverted to its 2007 state.  Only two days ago, two decisions were issued by the United States Court of Appeals for the Ninth Circuit. That highly regarded federal appellate court reversed the December 2010 decision by the federal district court judge in the multi-district litigation where 42 cases were decided in FedEx Ground’s favor.

The impact of these new Ninth Circuit decisions is likely to reinvigorate the crackdown against companies using an IC business model that is not structured, documented, or implemented in a manner that demonstrates compliance with state or federal IC laws. As noted below, those companies that have enhanced their IC compliance consistent with the thrust of the Ninth Circuit decisions and applicable state and federal laws will have a far lesser risk for IC misclassification liability than those companies that use ICs but knowingly or unwittingly fail to do so in a compliant manner.

The Game-Changing Decisions by the Ninth Circuit

The two Ninth Circuit decisions covered lawsuits filed by FedEx Ground drivers in California and Oregon under the laws of those states.  Both of those cases had been decided in FedEx Ground’s favor by the federal court judge in the multi-district litigation.

The California case, Alexander v. FedEx Ground Package System, Inc., No. 12-17458 and 12-17509, is a class action involving approximately 2,300 individuals who provided delivery services to FedEx Ground on a full-time basis in California between 2000 and 2007. Those drivers sought unpaid wages and reimbursement of unpaid driving expenses.

The Oregon case is Slayman v. FedEx Ground Package System, Inc., No. 12-35525 and 12-35559.  It is a smaller class action involving approximately 360 individuals who were full-time delivery drivers for FedEx Ground in Oregon from 1999-2009.  Those drivers in Oregon sought similar types of state law damages as did the drivers in California.

The Court first examined the FedEx Ground contract (called the Operating Agreement) that the company entered into with each of the drivers, as well as its written policies and procedures.  It concluded that by virtue of the FedEx standard agreement and its policies and procedures, the drivers were employees and not independent contractors under both California and Oregon law.  Specifically, in the California case, the Court found that:

  • FedEx has the right to and actually controls the appearance of its drivers, including their clothing, from their hats down to their shoes and socks, as well as their hair and hygiene. Managers may prevent the drivers from working if they are not properly groomed and dressed.
  • FedEx can and does control its drivers’ vehicles, including the color of the paint that their vehicles must be and the requirement that they display the distinctive FedEx logo.  FedEx also requires that the vehicles be “clean and presentable [and] free of body damage and extraneous markings” – requirements that “go well beyond those imposed by federal regulations.” In addition, FedEx dictates the vehicles’ dimensions, including the dimensions of their “package shelves” and the materials from which the shelves are made. Managers may prevent drivers from working if their vehicles do not meet specifications.
  • FedEx can and does control the times its drivers can work, even though the Operating Agreement specifies that FedEx has no right to set specific working hours; “it is clear from the [Operating Agreement] that FedEx has a great deal of control over drivers’ hours, structuring their workloads so that they have to work 9.5 to 11 hours every working day.  Further, FedEx managers have the right to adjust drivers’ workloads to ensure that they never have more or less work than can be done in 9.5 to 11 hours. In addition, drivers are not supposed to leave their terminals in the morning until all of their packages are available, and they must return to the terminals no later than a specified time. If drivers want their vehicles loaded, they must leave them at the terminal overnight. In the Court’s view, “[t]he combined effect of these requirements is substantially to define and constrain the hours that FedEx’s drivers can work.”
  • FedEx can and does control aspects of how and when drivers deliver their packages. It assigns each driver a specific service area, which it “may, in its sole discretion, reconfigure.” It tells drivers what packages they must deliver and when by negotiating the delivery window for packages directly with its customers.”
  • FedEx requires drivers toconduct all business activities with . . . proper decorum at all times” and comply with “standards of service,” including requirements to “[f]oster the professional image and good reputation of FedEx”.

In response to FedEx’s argument that it lacks control over some parts of its drivers’ jobs, the Court concluded that such lack of control over certain parts of the drivers’ roles is not sufficient to “counteract the extensive control it does exercise.”

While FedEx pointed out that the FedEx Operating Agreement permits a driver to delegate to other drivers, take on additional routes, or sell his route to a third party, the Court noted that FedEx may refuse to let a driver take on additional routes or sell his route to a third party, and FedEx’s senior managers have the authority to reject proposed replacement drivers based on failure to meet FedEx standards such as grooming requirements.

Are these two decisions by the Ninth Circuit final? Yes and no.  The decisions were made by a panel of three federal appellate judges.  FedEx has the right to seek review by all of the judges in the Ninth Circuit, but that is discretionary by the Court.  FedEx may also seek review by the U.S. Supreme Court, although it is unlikely that that Court will agree to hear the case inasmuch as the Supreme Court accepts very few employment cases each year to review.

The Significance of the Ninth Circuit Decisions for Other Companies Using ICs

FedEx Ground lost these two decisions because of a misplaced reliance on an IC agreement and its policies and procedures that were good, but by no means good enough.  A quick review of the language in the Operating Agreement and the policies and procedures would give one the impression that FedEx knew what to write and how to write it, but close scrutiny by a court found one fallacy after another – sufficient in degree to lead the court to rule against FedEx. By their very nature, therefore, IC agreements and policies and procedures that are not drafted in a state-of-the-art manner, free from language that can be used against the company, can cause businesses that use ICs to face class action litigation or regulatory audits or enforcement proceedings they may be able to otherwise avoid.

Instead of waging battle for years against its IC-drivers as well as many state attorney generals, to whom FedEx has paid many millions of dollars in settlement of labor law and tax claims, Fed Ex Ground could have earlier sought to enhance its compliance with federal and state labor, benefits, tax, and other laws affecting ICs. The first step is restructuring the relationship with the ICs in a manner that still serves the corporate objectives.  The second step is redrafting IC agreements in a state-of-the-art manner.  The third step is re-implementing the relationship in a manner consistent with the IC structure and agreement – and not at cross-purposes.  This is one of the fallacies noted by the Ninth Circuit when it relied not only on the inartfully drafted IC agreement but also policies and procedures that apply to all ICs and undermine the independent nature of the independent contractor relationship.

Some businesses have chosen to use IC Diagnostics™ to enhance their level of IC compliance and determine whether a group of workers not being treated as employees would pass the applicable tests for IC status under governing state and federal law.  That proprietary process also offers a number of practical, alternative solutions to enhance compliance with those laws.

Published by Richard Reibstein, Lisa Petkun, and Andrew Rudolph

[1] Estrada v. FedEx Ground Package System, Inc., 64 Cal. Rptr. 3d 327 (Ct. App. 2007).

[2] FedEx Home Delivery v. National Labor Relations Board, 563 F.3d 492 (D.C. Cir. 2009).

[3] FedEx Ground Package System, Inc. Employment Practices Litigation, No. 3:05-MD-527-RM (MDL 1700) (Dec. 13, 2010).

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July 2014 Monthly Independent Contractor Compliance and Misclassification Update

The leading development this month in the area of independent contractor compliance and misclassification is an Arizona case that deals with a commonplace event – but  one that carries with it the potential for unanticipated independent contractor misclassification liability – where a company outsources a function to a subcontractor, who uses ICs to render the service.  If the ICs claim that they are employees who have been misclassified, they may also allege that the company that outsourced the work and is indirectly receiving the benefit of the work is a “joint employer” with the subcontractor.  This type of claim is most likely to arise where the ICs are indirectly providing a service to a single client or customer of the subcontractor, or to a select few clients or customers.  The case below finds that the outsourcing company was not a joint employer under the facts in that matter, but if some of the facts were changed in any material respect, the court may have concluded that the outsourcing company could be exposed to IC misclassification liability.  The “Takeaway” below explains how outsourcing companies can minimize this potential exposure.

In the Courts (5 cases)

  • ARIZONA COURT FINDS HOME DEPOT IS NOT A JOINT EMPLOYER WITH 3PD DELIVERY, WHICH RETAINED DRIVERS TO DELIVER HOME DEPOT GOODS. As detailed in prior blog posts, drivers who provide delivery services to 3PD customers have succeeded in a number of IC misclassification cases against 3PD; in some cases, they have already collected millions of dollars in class action settlements. This class action case, brought in an Arizona federal district court seeking relief under state and federal wage and hour laws, sought to hold Home Depot liable as a joint employer with 3PD for allegedly misclassifying the drivers as ICs. The court disagreed with the drivers, however, and found that Home Depot, whose products were being delivered by the drivers who had contracted with 3PD, was not a joint employer of the drivers. In reaching its conclusion, the court concluded that Home Depot (1) did not have the power to hire and fire the drivers; (2) did not supervise and control driver work schedules or conditions of employment; (3) did not control the rate and method of pay; and (4) did not maintain employment records of the drivers. The court also took into account additional factors such as Home Depot’s lack of ownership of the trucks; that uniforms were provided by 3PD and the driver (not by Home Depot); and the driver’s profits were determined based on his own managerial skill – each of which, the court concluded, militated against a finding of Home Depot as a joint employer. Montoya v. 3DP, Inc., No. CV-13-8068-PCT-SMM (D. Ariz. July 9, 2014).
    Takeaway: Where independent contractors provide services to a single client of the business that retains them, or to only a few customers, the client itself may be a secondary target of plaintiff class action lawyers, especially if the client has “deeper pockets” than the contracting business. Home Depot was able in this case to deflect the joint employer claim by the drivers providing services to 3PD. However, other clients or customers that direct or control the manner in which the services are performed or otherwise play a role in the performance of the workers’ services may unwittingly be exposed to IC misclassification liability that they never anticipated. Prudent customers require their vendors who provide services to them through individuals classified as ICs to satisfy the applicable tests for proper IC classification. This can be accomplished through the use of IC Diagnostics™, a proprietary process that minimizes IC misclassification exposure.
  • CALIFORNIA APPELLATE COURT UPHOLDS ARBITRATION AGREEMENT IN LAWSUIT ALLEGING IC MISCLASSIFICATION. A field agent for a Washington State real estate company who had filed a class action lawsuit in California alleging that the firm had misclassified him and other similarly situated workers was ordered by a California appellate court to arbitrate his claims instead of pursuing them in court. The class action lawsuit sought to adjudicate claims for unpaid overtime, missed meal and rest breaks, and unreimbursed expense claims against the real estate firm, Redfin Corporation, under the California Labor Code and the state Unfair Competition Laws. The plaintiff had signed a Field Agent Independent Contractor Agreement that contained an arbitration clause covering all disputes arising under the Agreement and requiring arbitration in Washington State. Although the plaintiffs argued that a number of the claims were pleaded under California statutes and therefore did not arise under the Agreement, the appellate court rejected that argument, finding instead that because the “Agreement is the instrument that classified him as [an independent contractor] and that governed his relationship with defendant, including the services he was to provide and the method by which those services would be compensated,” the claims therefore “arose out of” the Agreement. Galen v. Redfin, No. A138642 (Cal. Ct. App. 1st Dist. July 21, 2014).
  • GO-GO DANCERS AT GAY NIGHT CLUB GAIN CLASS CERTIFICATION IN IC MISCLASSIFICATION CASE IN GEORGIA. A federal district court in Georgia granted class certification to group of male go-go dancers at a gay night club, BJ Roosters, in an IC misclassification lawsuit alleging violations of the FLSA and retaliation. The court based its decision to grant class certification for a proposed class of hundreds of dancers because it determined that the dancers had similar responsibilities; were all subject to the club’s policies; set the dancers’ schedules; had the authority to approve or ban dancers’ stage names; retained control of the clothing the dancers could wear at the club; retained strict control over which dancers could perform in different areas of the club; and had controlled which dancers would be permitted to entertain guests in VIP rooms and the compensation dancers could receive from customers in those rooms. Allen v. Jobo’s, Inc. d/b/a BJ Roosters, No. 1:13-CV-3768-RWS (N.D. Ga. July 3, 2014).
  • TUTORING COMPANY FOUND TO HAVE MISCLASSIFIED TUTORS AS INDEPENDENT CONTRACTORS IN NEW YORK. A New York appellate court determined that a tutoring referral and billing company, Ivy League Tutoring Connection, misclassified tutors as ICs where the tutors provided in-home tutoring sessions to clients seeking assistance with school work and test preparation. The Court based its decision, which upheld an administrative determination by the Unemployment Insurance Appeal Board, on the following factors: the company screened, interviewed and conducted criminal background checks on prospective tutors; it paid the tutors a set hourly rate; it matched clients with the tutor it deemed best suited for each client’s needs; and it restricted the tutor’s solicitation of the company’s clients both during the relationship and for three years after the relationship ended. Matter of Ivy League Tutoring Connection, Inc. v. Commissioner of Labor, No. 517901 (N.Y. App. Div. 3d Dep’t July 24, 2014)
  • TRANSPORTATION COMPANY IN CALIFORNIA CANNOT USE FEDERAL LAW TO PREEMPT STATE CLAIMS FOR IC MISCLASSIFICATION. The California Supreme Court held that IC misclassification claims against a trucking company, Pac Anchor Transportation, Inc., alleging violations of the California Unfair Competition Law (UCL), are not preempted by the Federal Aviation Administration Authorization Act (FAAAA). The complaint was brought by the State of California against Pac Anchor, alleging that the company misclassified drivers as independent contractors and thereby illegally lowered their costs of doing business by engaging in acts of unfair competition, including but not limited to, failing to pay unemployment insurance taxes, provide workers’ compensation coverage, withhold state disability taxes, and paying the minimum wage. The FAAAA provides that a state “may not enact or enforce a law, regulation, or other provision having the force and effect of a law related to a price, route or service of any motor carrier…with respect to the transportation of property.” In rejecting the preemption argument, he California Supreme Court held: “The sections of the California Labor Code and Unemployment Insurance Code … make no reference to motor carriers or the transportation of property. Rather, they are laws that regulate employer practices in all fields and simply require motor carriers to comply with labor laws that apply to the classification of their employees. In fact, the [trucking company] conceded ‘that those state employment laws…are laws of general application whose effects on the carriers’ prices, routes, and services is remote.’” People ex rel. Harris v. Pac Anchor Transportation, Inc., No. S194388 (Sup. Ct. Cal. July 28, 2014).


Regulatory and Enforcement Initiatives
(2 Matters)

  • MASSACHUSETTS COLLECTED $15.6 MILLION IN IC MISCLASSIFICATION LIABILITIES IN 2013. Massachusetts Labor and Workforce Development Secretary Rachel Kaprielian announced on July 23, 2014 that the Joint Enforcement Task Force on the Underground Economy and Employee Misclassification, comprised of multiple state agencies and the Attorney General’s Office, collected $15.6 million in 2013 in unpaid wages, back taxes, unemployment insurance premiums, and fines and penalties related to employer fraud and worker misclassification. According to the press release, the Massachusetts Misclassification Task Force has recovered since its inception “nearly $56 million from unlawful businesses by enforcing labor, licensing and tax laws.” Massachusetts Attorney General Martha Coakley stated: “This ongoing effort ensures that we are protecting workers by combatting fraud and abuse, returning significant funds to the Commonwealth, and leveling the playing field for all businesses that play by the rules.”
  • MISSOURI LABOR DEPARTMENT EXPLAINS IC MISCLASSIFICATION TEST IN THAT STATE. Officials from Missouri Department of Labor and Industrial Relations, participating in the Mid-America Labor Management Conference on July 8, 2014, explain that the most important factor in determining whether an individual is an independent contractor or employee under Missouri law is whether the business retaining the worker exercises control over the manner in which the work is performed. Thomas Pudlowski, contribution field manager in the Missouri Division of Employment Security (DES), said the DES uses the IRS 20-factor test and “looks at the substance of the relationship rather than the label.” He also advised: “There is not just one factor that can be relied upon for determining whether you have a business-independent contractor relationship or an employer-employee relationship. You’ve got to look at all the factors as a whole.


On the Legislative Front

  • VIRGINIA LAW INCREASES IC MISCLASSIFICATION PENALTIES UNDER ITS WORKERS’ COMPENSATION LAW. Effective July 1, 2014, a new law takes effect with respect to penalties for Virginia businesses that fail to provide workers’ compensation coverage to those who have been misclassified as independent contractors. According to the Virginia Workers’ Compensation Commission website, the new state law provides that an employer shall be assessed a civil penalty of up to $250 per day of noncompliance, subject to a maximum penalty of $50,000, plus collection costs. The Commission advises businesses that “the facts of the work circumstances will determine if the individual is covered for workers’ compensation, regardless of payment on a 1099 designation.”

Published by Richard Reibstein, Lisa Petkun, and Andrew Rudolph. Compiled by Janet Barsky.

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