Filed under: IC Compliance | Tags: Federal IC Laws and Bills, independent contractor liability, Independent contractor misclassification
On December 12. 2012, Rep. Erik Paulsen (R. Minn.) introduced a bill that bears many similarities to a bill introduced earlier this year by 33 Democrats. The Independent Contractor Tax Fairness and Simplification Act (H.R. 6653) would, like the Fair Playing Field Act (H.R. 4123) introduced on March 1, 2012 by Democrats, eliminate prospectively the “safe harbor” that has been relied upon since 1978 by many businesses that may have misclassified employees as independent contractors (ICs).
Similarly, both bills would allow a business that has treated a worker as a IC to qualify for a form of retroactive safe harbor for purposes of past employment tax liability if the business has had a reasonable basis for not treating the worker as an employee and has consistently reported the earnings of the worker and others similarly situated on a 1099 basis.
Neither the Democrats’ earlier bill nor this new bill introduced by a Republican Congressman would, if enacted, eliminate the use of ICs; rather, the proposed “Findings” in both bills acknowledge the important role ICs play in the economy.
Key Differences
There are a number of key differences between the bills, however. The Fair Playing Field Act bill, if enacted, would require the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. On the other hand, this new bill, H.R. 6653, specifically prohibits the issuance of new regulations or Revenue Rulings by the Department of the Treasury with respect to the employment status of any individual for employment tax purposes.
While both bills expressly state that the term “employment status” shall mean the classification of an individual as an employee or IC “under the usual common law rules,” H.R. 6653 (unlike the Democrats’ bill) would codify a new form of “safe harbor” if the worker meets all four of the following factors:
- incurs significant financial responsibility for providing and maintaining equipment and facilities;
- incurs unreimbursed expenses or risks income fluctuations because remuneration is “directly related to sales or other output rather than solely to the number of hours actually worked or expenses incurred”;
- is compensated on such factors as percentage of revenue or scheduled rates and not solely on the basis of hours or time expended; and
- “substantially controls the means and manner of performing the services” in conformity with regulatory requirements, or “the specifications of the service recipient or payor and any additional requirements” in the parties’ written IC agreement.
Analysis
This bill puts forth a new safe harbor that appears to be limited to a defined segment of ICs who bill for services on the basis of scheduled rates, such as truckers and messenger couriers. Thus, the bill would exclude from this safe harbor many legitimate ICs that are traditionally compensated on an hourly rate, such as professionals (including sole practitioner lawyers, accountants, architects, designers, and interpreters) as well as sole proprietors in the skilled trades (including electricians and plumbers). It would also exclude legitimate ICs who have little or no expenses or equipment, such as freelance editors and writers. Other legitimate ICs would undoubtedly also be excluded under the four-factor test.
The bill also appears to have a misclassification escape clause that has not been recognized by the courts and administrative agencies as indicative of IC status. In the fourth factor, a service recipient may direct the service provider by inserting into the parties’ IC agreement its “specifications” or “any additional requirements” without creating an employment relationship. Generally, requirements imposed by the service recipient as to how the work is to be performed are taken into account in determining if the hiring party exercises control or direction over the means and manner by which the services are performed. Such direction and control is typically indicative of employee status. In contrast, specifications and requirements as to the end-product of the services, i.e., what the services the individual is being hired to perform, are not indicative of employee status inasmuch as all ICs must be told what they are being retained to do.
The scope of both bills are limited. Neither bill would have any impact on whether a worker is an IC or employee under the federal Fair Labor Standards Act (FLSA), which governs minimum wages and overtime. The determination of whether a worker is an IC or employee under that labor law is based on a variation of the common law standard frequently referred to as the “economic realities” test. Thus, a worker that may qualify for IC status under H.R. 6653 may not qualify for IC status under the FLSA.
State labor, unemployment, and workers compensation laws would not be affected by either bill. Some of those laws are not based on the common law but rather contain a different statutory scheme that have a list of factors that must be met in order to qualify for IC status.
Takeaway
Most companies with business models that are IC-dependent or simply make use of multiple ICs are aware that they are at risk of IC misclassification liability if they have not properly classified these workers. Businesses can enhance IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers, using IC Diagnostics™ as described in our “White Paper” on minimizing IC misclassification liability.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, IC Diagnostics, independent contractor liability, Independent contractor misclassification
The U.S. Department of Labor recently scored a meaningful victory in yet another court case where a company failed to structure, document, and execute properly an independent contractor relationship with workers who were paid on a 1099 basis. In Hilda L. Solis, Secretary of Labor v. Cascom, Inc. and Julia J. Gress, U.S. District Court Judge Thomas M. Rose of the Southern District of Ohio the court found that the Cascom’s cable installers were employees under the federal Fair Labor Standards Act, having been misclassified as independent contractors by Cascom, thereby subjecting the company and its owner to damages for unpaid overtime wages.
This case illustrates what a company should not do to if it wishes to pay workers on a 1099 basis. The court found that:
- Cascom’s relationship with its cable installers was structured in such a manner that Cascom directed the installers how to perform their work, provided training for the installers, prohibited the installers from using others to perform the work unless approved by Cascom, and required assignments to be accepted, among other things indicative of an employment relationship.
- Cascom’s contracts with its cable installers were inconsistent with IC status; for example, certain provisions afforded Cascom the right to control the manner in which the work was performed and gave Cascom the right to change the terms of the agreement at any time.
- In practice, Cascom issued written orders to the installers, required them to account for all materials daily, made work mandatory at certain times, and forbade installers from leaving the field without first checking in with their supervisors.
The position of cable installer is another example of a function that can be legitimately structured and documented as an independent contractor, consistent with federal and most state law tests for IC status. It is similar to the jobs of workers in many other industries that lawfully can exist either within a legitimate IC or an employment relationship, depending on how that relationship with the hiring party is structured, documented, and executed in practice. Examples of some of the many workers that can lawfully be either ICs or employees under federal and most state laws include:
- physicians,
- recruiters,
- interpreters and translators,
- truck drivers and couriers,
- computer technicians,
- taxicab drivers,
- physical and occupational therapists,
- designers,
- models,
- carpet installers,
- writers,
- insurance agents,
- coaches and trainers,
- instructors,
- attorneys,
as well as many others. Some states have statutes specifically excluding certain types of workers from being considered employees, or specifically mandating that they be regarded only as employees. Further, many states have laws with different tests for determining if an individual is an employee or independent contractor, depending on the law in question (e.g., tax, wage and hour, or unemployment).
The Cascom case demonstrates the value of using a methodology such as Pepper Hamilton’s IC Diagnostics™ to (a) evaluate whether an existing position can be legitimately structured as an independent contractor relationship, and (b) if so, whether it needs to be restructured, documented, and executed (and how to do so) to maximize the likelihood that those workers will be held to be ICs and not employees. The proprietary tools used by Pepper Hamilton’s Independent Contractor Compliance practice include its 48 Factors-Plus analysis and its IC Compliance Scale.™
What is next for Cascom in terms of this case involving misclassification of employees as independent contractors? If an appeal to the U.S. Court of Appeals for the Sixth Circuit is unsuccessful, Cascom may be facing not only liabilities for unpaid overtime compensation but also unpaid payroll taxes at the federal and state levels, unpaid unemployment tax payments and workers compensation premiums, unpaid employee expenses, and unpaid employee benefits.
An adverse IC determination, however, should not necessarily be regarded as an obligation on the part of the business to treat those workers as employees on a going-forward basis. If the liabilities from an adverse IC determination can be satisfied, many businesses, including Cascom, can adopt an IC model that will likely survive future scrutiny under federal and most state laws, provided the business properly engages in bona fide restructuring, conducts proper re-documentation, and implements and follows new, state-of-the-art IC practices.
Your comments are invited.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Federal and State Agency Programs and Publications, Form 1099, IC Diagnostics, independent contractor liability, Independent contractor misclassification, misclassification liability
On September 19, 2011, Secretary of Labor Hilda Solis and IRS Commissioner Doug Shulman signed a Memorandum of Understanding to coordinate both agencies’ law enforcement efforts aimed at businesses that misclassify employees as independent contractors. At a ceremony held at the Labor Department headquarters in Washington, Secretary Solis said, “We’re standing united to end the practice of misclassifying employees.” Commission Shulman likewise stated that “This agreement takes the partnership between the IRS and Department of Labor to a new level.”
The Memorandum of Understanding between the two federal agencies will enable the Labor Department and IRS to share information with each other and coordinate law enforcement efforts. The agencies will also provide outreach materials and guidance for businesses using independent contractors and for employees who may be misclassified.
Secretary Solis also announced that seven states have signed memoranda of understanding with the Wage and Hour Division of the U.S. Department of Labor to address and combat employee misclassification. Those states are Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah, and Washington. Four other states have agreed to enter into similar memoranda of understanding with the Wage and Hour Division: Hawaii, Illinois, Montana, and New York.
Takeaway 1. Use of independent contractors remains a legitimate business model. The Labor Secretary noted in her press release that the use of an independent contractor business model, even those that attempt to “change, obscure or eliminate the employment relationship,” are “not inherently illegal.” Thus, businesses that lawfully pay some of its workers on a 1099 basis should not hesitate to continue with such business models – except in those states where the test for independent contractor status under applicable state wage, unemployment, workers compensation, or tax laws are more restrictive than the tests under the federal labor and tax statutes.
Presently, about half of the states have more restrictive tests for independent contractor status than the tests under federal law. Nonetheless, companies can often take bona fide actions to enhance their independent contractor compliance in almost all of those states.
Takeaway 2. It is not too late to enhance independent contractor compliance. Companies that use a number of independent contractors are facing a more aggressive law enforcement effort at the federal and state levels than ever before. Companies that are audited by the IRS now run an even greater risk that a finding of misclassification by the IRS will be shared with the state Tax Commissioner as well as with federal and state labor departments.
Although government law enforcement efforts are increasing, most independent contractor disputes still derive from challenges by the workers paid on a 1099 basis. While class action lawsuits get the most publicity, the most common type of legal challenge to an employee’s classification status involves unemployment benefits. More and more workers being paid on a 1099 basis are applying for unemployment benefits. In the course of determining whether the worker is entitled to unemployment benefits, state Labor Departments typically make an inquiry of the company about the worker’s status as an employee or independent contractor. If the state Labor Department concludes the worker has been misclassified, it usually issues a determination that the company should have been paying unemployment taxes not only for the claimant but for all other similarly situated workers as well. An assessment of unpaid unemployment taxes, plus interest and penalties, typically follows.
Pepper Hamilton uses its proprietary IC Diagnostics™ tools, including its 48 Factors-Plus Analytics™, to advise companies how they can enhance their independent contractor compliance and minimize or eliminate misclassification liability. In a legal environment that is increasingly skeptical of businesses that issue 1099s, companies that take steps now to further enhance their compliance with the independent contractor laws can remain well ahead of the curve and soften any bumps in the road.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Federal and State Agency Programs and Publications, Form 1099, IC Diagnostics, independent contractor liability, Independent contractor misclassification
The IRS yesterday announced a new program to permit taxpayers to voluntarily reclassify independent contractors as employees for federal employment tax purposes.
The program, called the “Voluntary Classification Settlement Program” (VCSP), would allow businesses to voluntarily reclassify workers who currently receive 1099s from the company by making what is referred by the IRS as a “minimal payment covering past payroll tax obligations.” That payment to the IRS would be “10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509 of the Internal Revenue Code,” according to the IRS Announcement, published September 21, 2011 on the IRS website. Participation in the VCSP would also eliminate interest and penalties on the liability and, most importantly, exempt companies from an employment tax audit for worker misclassification in prior years.
Companies who wish to participate in the VCSP can apply by filing Form 8952, the “Application for Voluntary Classification Settlement Program,” at least 60 days before it would like to begin treating the workers as employees.
This IRS voluntary program is another alternative means of achieving compliance with federal tax laws governing employee misclassification. Those alternatives have been discussed in articles and prior blog posts by the publishers of this site, and include bona fide restructuring of the relationship between companies and workers paid on a 1099 basis, the use of an employee leasing or staffing company, and reclassification outside of any government program – using IC DiagnosticsTM and other proprietary compliance tools of Pepper Hamilton’s Independent Contractor Compliance practice.
Employers that have misclassified workers in the past may also be eligible for a safe haven from liability for employment taxes under Section 530 of the Revenue Act of 1978. To be eligible, a business (other than one utilizing certain technical service workers) must have had a reasonable basis for treating workers as independent contractors, must have consistently treated the workers as independent contractors, and must not have treated any substantially similar workers as employees. A bill introduced in Congress last year, the Fair Playing Field Act of 2010, would have eliminated Section 530 relief prospectively, but no action was taken on that proposed legislation and the bill has not been re-introduced in this Congress. While Section 530 remains in effect, the IRS’s new voluntary program may be less attractive than Section 530 relief to those companies that believe they qualify for this safe haven.
While there are advantages to participation in this new voluntary program, there will likely be some genuine concerns by companies that this new IRS program may backfire and actually increase, rather than minimize, potential misclassification liability.
In a telephone conversation with the principal author of the IRS announcement this morning, September 22, 2011, we raised one of the most pressing concerns that companies are likely to face: would the IRS share information about a company’s participation in the program with the U.S. Department of Labor and state labor and tax commissioners under the IRS’s existing information-sharing agreements with other federal and state agencies under recent programs published by the IRS and U.S. Department of Labor?
We noted that a business may be concerned that any sharing of information by the IRS with other federal and state agencies about a company’s participation in the IRS’s new voluntary program may lead to an unwanted array of enforcement actions by those other government agencies. Enforcement actions may include investigations, audits, administrative proceedings and government-initiated lawsuits for allegedly past unpaid overtime wages, unemployment taxes, workers compensation premiums, and state tax liabilities – all of which could expose a company participating in the VCSP to even greater financial costs than were saved with the IRS. The principal author of the IRS announcement was unable to say definitively whether information about participants in VCSP would or would not be shared by the IRS with other federal or state agencies.
Another concern about the new voluntary IRS program is that it does not provide safety from potential misclassification liability from private lawsuits under federal and state wage and hour laws and the federal employee benefits law. (Nor does the safe haven under Section 530, for that matter.) Many companies remain concerned about potential exposure to private class action lawsuits by workers who may claim that they have been improperly paid on a 1099 basis and are allegedly owed unpaid overtime under state or federal law or unpaid benefits under a company’s employee benefit plans. Such companies may prefer one of the other alternatives noted above in order to enhance independent contractor compliance. Those alternatives reduce or eliminate prospective exposure to misclassification liability not only in the tax context but also in the labor and benefits arenas.
Yet another potential objection to the new IRS program is that companies that reclassify individuals who previously received 1099s may worry that reclassification is a form of “admission” of past misclassification, as well as an invitation to those receiving 1099s from the company to challenge their past classification as independent contractors. The authors of this blog post have advised companies how to properly reclassify workers in a manner to minimize this concern, but changing a worker’s tax treatment may remain the choice of last resort for many businesses.
Further analysis of the VCSP will be posted on this site in the future, including any information published by the IRS regarding the information-sharing issue discussed above.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Federal IC Laws and Bills, independent contractor liability, Independent contractor misclassification, misclassification liability
On Friday, April 8, 2011, Senators Sherrod Brown (D-Ohio), Tom Harkin (D-Iowa), and Richard Blumenthal (D-Conn.) introduced the Payroll Fraud Prevention Act (S. 770), a trimmed-down version of the Employee Misclassification Prevention Act bill that was introduced into both houses of Congress a year ago. Taking a cue from state legislators that have labeled new state laws involving wage violations as a form of “payroll theft,” the sponsors of the bill characterize misclassification of employees as a form of “payroll fraud.”
The bill, if enacted, would expand the federal Fair Labor Standards Act (which currently addresses minimum wage, overtime, and child labor laws) to cover misclassification of employees as independent contractors. It would create a new definition of workers called “non-employees,” impose upon businesses the obligation to provide a classification notice for both “non-employees” and “employees,” make the misclassification of “employees” as “non-employees” a new labor law offense, and expose businesses to fines of up to $5,000 per worker for each violation of the law.
Unlike last year’s bill introducing the Employee Misclassification Prevention Act (EMPA), this proposed legislation would not impose new recordkeeping requirements upon businesses, thereby removing one of the more objectionable provisions of EMPA.
The purposes of the Payroll Fraud Prevention Act were detailed in a press release issued Monday, April 11, 2011 by one of the co-sponsors, Senator Brown. He characterized companies that misclassify employees as “cheating workers . . . and other businesses that play by the rules.” He also focused on the effect of misclassification on the “tax gap” that both the federal and state governments have been experiencing,” saying the bill will “relieve the burden on American taxpayers who foot the bill when businesses [misclassify their workers].”
Although the bill seeks to crack down on misclassification, nothing in the Payroll Fraud Prevention Act would prohibit businesses from continuing to use independent contractors that are properly classified as such; it only prohibits companies from misclassifying workers as independent contractors when such workers are really “employees.”
Nonetheless, all businesses would be affected by the Payroll Fraud Prevention Act, because it imposes a notice requirement upon every company that uses either employees or independent contractors. Further, any business that fails to provide the required notice would be subject to heavy fines, even if its independent contractors are properly classified or if it uses no independent contractors.
If enacted into law as drafted, the Payroll Fraud Prevention Act would:
- expand the Fair Labor Standards Act to cover “non-employees” who perform labor or services for businesses, even if the “non-employees” are properly classified as independent contractors;
- pierce the so-called “corporate veil” by including in the definition of “non-employees” those who provide services through a corporation or LLC, if they are required to create or maintain such entities as a “condition for the provision of such labor or services”;
- add a new provision making it a “special prohibited act” under federal law to “wrongfully classify an employee as a non-employee”;
- require every business to provide a prescribed written notice to all workers performing labor or services, notifying them that they have been classified by the business either “as an employee or non-employee,” directing them to a U.S. Department of Labor website for further information about the rights of employees under the law, and informing them to contact the Labor Department if they “suspect [they] have been misclassified”;
- impose upon businesses a penalty of $1,100 up to $5,000 per worker for a violation of the notice requirements or for misclassifying an “employee” as a “non-employee”;
- create a presumption that a “non-employee” is an “employee” if the business fails to provide the worker with the prescribed notice at the time the “non-employee” begins providing services; and
- impose triple damages for willful violations of the minimum wage or overtime laws where the employer has misclassified the worker.
In addition, the Payroll Fraud Prevention Act would direct the Secretary of Labor to establish a misclassification website; impose additional penalties upon employers that misclassify employees for unemployment compensation purposes; authorize the Department of Labor to report misclassification information to the IRS; and direct the Labor Department to conduct “targeted audits” of certain industries “with frequent incidence of misclassifying employees as non-employees.”
The introduction of this bill is consistent with the national labor policy of the Obama Administration. Under the last-minute budget compromise reached by the President and Congress on April 8, 2011, commonly referred to as the “Continuing Resolution,” no less than $21.3 million is to be funded to the Secretary of Labor to continue “initiatives related to the identification and prevention of worker misclassification.”
Your comments are welcome.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: IC Diagnostics, independent contractor liability, misclassification liability, State IC Laws and Selected Bills
The Pennsylvania Construction Workplace Misclassification Act was signed into law on October 13, 2010. Also called House Bill 400 and Act 72 of 2010, the new law went into effect on February 10, 2011.
Earlier this month, the Pennsylvania Department of Labor and Industry published three documents on its website related to the Construction Workplace Misclassification Act: a summary of the Act; a Construction Workplace Misclassification Complaint Form; and a Construction Workplace Misclassification Act poster that presumably employers would file at their worksites. There is no language in the Act that requires companies to post the new law, and the poster does not state that it must be posted.
As noted in our prior blog post on this new law, the law imposes civil and criminal liability for misclassification of construction workers as independent contractors; it also creates a nine-part test for construction companies to meet if they wish to continue to classify workers as independent contractors. One of the requirements is a written independent contractor agreement which complies with the new law.
Takeaway 1: When drafting or revising an independent contractor agreement to comply with the law, construction companies should take the opportunity to restructure their relationships with their independent contractors to maximize the likelihood that (a) the agreements will be drafted in a manner that will satisfy the requirements of the new Pennsylvania law, and (b) the relationships between construction companies and their independent contractors, in fact, mirrors the provisions in the contract. All too often, the written agreement looks and sounds like it complies with the law, but the facts “on the ground” deviate materially from the provisions in the contract. Construction companies that only address the need to have a written agreement are giving themselves a false sense of security. As the new law states in the second factor, the individual must be “free from control or direction over the performance of such services under the contract and in fact.”
This second factor cannot therefore be fulfilled by simply reciting in the contract that the independent contractor is “free from control or direction over the performance of [construction] services.” Using Pepper’s “IC Diagnostics” and “48 Factors Plus” analysis, the lack of control and direction over the performance of services can be a matter of ”fact,” as well.
Takeaway 2: For other steps that construction industry businesses should take to ensure compliance with the new law, see “Steps to Ensure Compliance” at the end of the Client Alert co-authored by Bruce Ficken (the Chair of Pepper Hamilton’s Construction Industry Practice Group) and Richard Reibstein (the author of this blog post and Co-Chair of Pepper’s Independent Contractor Compliance Practice Group).
Your comments are invited.
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, independent contractor liability, misclassification liability
Last month, the federal district court judge assigned to handle dozens of state law class action claims brought around the country against FedEx Ground by its drivers, who have claimed they are “employees” misclassified as independent contractors (ICs), issued a comprehensive ruling covering 42 of the of the remaining lawsuits. These lawsuits, which had been consolidated in the U.S. District Court for the Northern District of Indiana, alleged violations of an array of labor, benefits, and other state laws.
Judge Rules that the Drivers are ICs Under Most State Laws
Judge Robert L. Miller Jr. had previously ruled on the classification of FedEx Ground drivers in two states: in his most recent decision involving Kansas law, Judge Miller found the drivers to be ICs; whereas in an earlier decision involving Illinois law, he found the drivers to be employees, noting the differences in the various state law definitions of what constitutes an IC. Now, in a 182-page decision covering over 42 lawsuits involving laws in 27 states, Judge Miller found that the drivers were properly classified as ICs in lawsuits covering 23 states, that they were employees and thus improperly classified as ICs under state laws in only three states, and that their status was moot in a lawsuit filed in another state. The judge also remanded back to their original courts a few of the lawsuits and reserved for later decision a small number of unresolved claims.
In issuing his comprehensive ruling, Judge Miller followed the analysis he detailed in his decision in August of this year involving Kansas law, which was analyzed in a prior blog post on this site. The federal court judge concluded in his decision last month that, just as the drivers were ICs under the common law of Kansas, they are also ICs under the law of 23 of the remaining 27 states.
The court made clear that the most important factor for determining whether an individual is an employee or IC in Kansas and the other 23 states in which he ruled in favor of FedEx is “the right to control the methods and means of the drivers’ work.” The court distinguished this type of control from a company’s control over the results to be produced, which the court noted does not indicate employee status.
The court then repeated its conclusion in the Kansas case, finding it equally applicable in the lawsuits in 23 of the remaining states:
“Upon review of the evidence in the light most favorable to the
plaintiffs, the only reasonable inference is that FedEx hasn’t retained
the right to direct the manner in which drivers perform their work.
FedEx supervises the drivers’ work and offers numerous suggestions
and best practices for performance of assigned tasks, but the
evidence doesn’t suggest that FedEx has the authority under the
Operating Agreement to require compliance with its suggestions.
Further, other factors strongly weigh in favor of independent
contractor status; in particular, the parties intended to create an
independent contractor arrangement, the drivers have the ability to
hire helpers and replacement drivers, they are responsible for acquiring
a vehicle and can use the vehicle for other commercial purposes, they
can sell their routes to other qualified drivers, and FedEx doesn’t have
the right to terminate contracts at-will. Although some facts weigh in
favor of employee status, after considering all the relevant factors, the
court finds that the plaintiffs are independent contractors as a matter
of [Kansas] law.” (Emphasis added)
The Plaintiffs’ Misplaced Reliance on the FedEx IC Agreement and Its Policies and Procedures
The procedural posture of this case posed special evidentiary issues, which eventually resulted in the many unfavorable rulings for the plaintiff-drivers. As the court noted, this was a multi-district litigation (MDL) consisting of class actions, which limited the scope of the evidence that the court could consider in deciding the drivers’ classification status. In seeking MDL status instead of trying each class action in each state, Plaintiffs’ counsel chose to rely solely upon two sets of documents: (a) the nationwide FedEx Ground Operating Agreement that classified the drivers as ICs and set forth the written relationship between the parties, and (b) the company’s nationwide policies and procedures governing its Ground Division drivers. This evidentiary standard was chosen by plaintiffs’ counsel in order to qualify for class action status and to satisfy the requirements for MDL consolidation, which streamlined the lawsuits so they did not have to be separately litigated.
As a result, the federal court noted that it could not consider particularized (so-called “anecdotal”) evidence of the degree of control allegedly exercised by FedEx Ground over the manner and means of the drivers’ performance of their services. In effect, the drivers argued that the two sets of documents alone, the IC agreements and the policies and procedures, demonstrated by a preponderance of the evidence that FedEx Ground exercised control over the way in which the drivers performed their work, thereby rendering them employees and not ICs.
Judge Miller disagreed with the plaintiff-drivers in the overwhelming number of cases, each of which he analyzed under the law governing employee versus IC status for each state in question. Noting that the plaintiffs’ counsel erroneously claimed that he was refusing to consider “anecdotal” evidence that showed that FedEx Ground exercised control over how the drivers performed their jobs, Judge Miller made it clear that he had forewarned plaintiffs’ counsel that by seeking to proceed with their consolidated MDL case they would not be able to introduce individualized or particularized proof of control outside of the IC agreement and the nationwide policies and procedures.
California Law Not Controlling
The plaintiff-drivers had also asked the federal court to give controlling effect to the decision in Estrada v. FedEx Ground, where the California courts had held that the drivers in that state were employees and not ICs. The federal court concluded, however, that “the facts before the Estrada court and those before this court are dissimilar insofar as the facts available to this court don’t go beyond the Operating Agreement and generally applicable Policies and Procedures.”
Four Takeaways
The federal court’s decision provides four main takeaways for companies that use ICs and for attorneys handling cases of this nature:
- First, FedEx Ground’s operating agreements provided the plaintiffs-drivers with sufficient evidence to win class action status for their state and federal court lawsuits. As the district court judge initially found, the operating (IC) agreements provided enough evidence that FedEx Ground exercised control over the manner and means of how the drivers performed their services to justify certifying the cases as class actions and consolidating them in a multi-district case before a single federal court judge. By their very nature, therefore, IC agreements and policies and procedures that are not drafted in a state-of-the-art manner can cause companies that use ICs to face class action litigation they may be able to otherwise avoid.
- Second, plaintiff’s counsel took a gamble by proceeding in a manner relying solely upon the operating agreement and policies and procedures to prove IC status. While this decision undoubtedly reduced considerably the amount of time and effort needed to ready this case for decision by the federal court, using 20-20 hindsight that decision backfired on plaintiffs because such evidence was not alone enough to prevail in the case. Had the plaintiffs sought to litigate each case separately and allowed themselves the opportunity to introduce “anecdotal” evidence of alleged control over their day-to-day affairs, the result in some or all of the cases may well have differed, as was the case in the Estrada case in California.
- Third, while the court’s decision does not prevent FedEx Ground drivers in future misclassification lawsuits from relying upon “anecdotal” evidence of real-life control that they have been allegedly subjected to, as a practical matter FedEx Ground has now revised its operating agreements in many states and restructured its relationship with its IC drivers in a more legally defensible manner. See our prior blog post.
- Fourth, instead of waging battle for years against its IC-drivers and 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 by redrafting its IC agreements in a state-of-the-art manner and restructuring the manner in which it uses its IC-drivers so as to avoid or minimize legal challenges. Notably, it has now sought to do that to a large extent (as noted in the third bullet point). Whether such changes will ultimately prevail on a going-forward basis remains to be seen, but proactive IC compliance enhancement would have avoided many of the past legal challenges to its classification of its Ground Division drivers and saved FedEx hundreds of millions of dollars in legal fees and liability in past and pending lawsuits and administrative proceedings. This case demostrates the costs faced by companies, even those that ultimately prevail in large measure, that do not update and create state-of-the-art IC agreements, policies, and procedures and fail to engage in bona fide restructuring of their IC arrangements in a manner that will enhance their IC compliance.
Your comments are invited.
Richard Reibstein
Attorney at Law
Pepper Hamilton LLP
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Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, IC Diagnostics, independent contractor liability, misclassification liability
3P Delivery, Inc. provides delivery services for major retailers. It has historically classified its drivers as independent contractors and not employees. 3P Delivery was sued in 2008 by two drivers in Oregon and two drivers in Washington for misclassification, claiming that “3P engages in a fraud designed to make its Drivers appear to be running independent businesses, when in reality its Drivers are 3P employees.”
Both lawsuits sought damages including reimbursement of the drivers’ expenses for operating their vehicles (such as the cost of leasing or purchasing the drivers’ trucks, fuel and cargo expenses, and insurance); denial of overtime and other wage payments, paid holiday pay, and other employee benefits; and penalty wages for failure to pay wages in a timely manner.
Among the allegations made were that 3P:
- requires drivers to fill out applications;
- furnishes drivers with pallet jacks, hand trucks and straps;
- pays drivers by a method chosen by 3P (either a fixed weekly amount or commission);
- requires drivers to adhere to 3P standards as set forth in a “Contract Driver Guide Book”;
- advertizes that it maintains its own fleet of clean vehicles;
- controls the workload of drivers;
- does not permit substitute drivers;
- instructs drivers how to load, transport, and unload shipments;
- retains the right to terminate the drivers at will;
- prohibits drivers from using their vehicles to offer delivery services for other companies;
- requires the drivers to submit a daily log of deliveries; and
- evaluates the performance of the drivers.
In connection with the “fraud” claims, the Complaint alleged that 3P required its drivers to sign a contract with 3P Delivery, required the drivers to secure business licenses, created business cards for each driver, and directed (and assisted) drivers in becoming either a Limited Liability Corporation (LLC) or a regular corporation.
After the courts permitted the two lawsuits to proceed as class actions, the parties engaged in substantial pretrial discovery that yielded disclosure by 3P Delivery of over 160,000 pages of documents. Following court-ordered mediation, the parties agreed to settle both cases for $2.25 million: $1.125 million for the Oregon case and $1.125 million for the Washington case.
Takeaways:
1. The real costs: The cost of defending and settling class action cases of this nature is often equal to or greater than the damages to be awarded each member of the class. Here, in addition to the $2.25 million in settlement funds allocated to settlement, the class action lawyers are seeking at least $1.2 million in the Oregon case and $1.0 million in the Washington case in plaintiff’s legal fees for hours they expended. In addition, 3P Delivery likely expended a greater amount in paying defendant’s own legal fees to its lawyers. Thus, when the final “bill” is tallied for the lawsuit, 3P Delivery may have had to pay well in excess of $7 million as a result of misclassifying its drivers as independent contractors.
In addition, companies that settle claims of this nature with class action lawyers usually have to “settle up” with the IRS and state revenue departments as well as state unemployment and workers compensation agencies. The cost of satisfying those government obligations, which can include penalties and fines, can often be larger than the overall cost of a class action.
2. There are ways to minimize or eliminate independent contractor misclassification; neither disguising nor ignoring it appear to be sound alternatives. There is no federal law and only a few state laws that prohibit trucking and delivery companies from classifying its drivers as independent contractors. The 3P Delivery case is an example of how a company can become a casualty of failing to structure its relationship with its drivers in a bona fide manner that complies with applicable employment, tax, benefits, and independent contractor laws.
Misclassification typically starts with structuring a business without being aware of the sizeable legal risks of operating a business in a way that fails to comply with labor, tax, and employee benefits laws applicable to independent contractors and employees. When a business finally becomes aware of the risks, there are three alternatives: (1) do nothing, as most businesses seem to continue to do; (2) disguise the misclassification and try to make it appear to be legitimate without changing the underlying indicia of misclassification, such as what 3P Delivery allegedly did (requiring its drivers to incorporate as LLCs or regular corporations); or (3) enhancing compliance with federal and state independent contractor laws in a bona fide manner , after undergoing an “IC Diagnostics”TM process.
As noted in articles and other posts by the publishers of this blog, if the latter alternative is chosen, there are at least three steps companies can take to enhance their compliance with independent contractor laws and minimize or eliminate exposure to future misclassification liability. While taking steps to enhance compliance now will not eliminate past misclassification liability, those companies that take bona fide compliance steps are far less likely to become future targets of class action lawyers and government regulators than companies that choose to do nothing or disguise their misclassification.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, independent contractor liability, misclassification liability
Yesterday a federal court in Manhattan granted a motion for class action certification to a group of adult dancers who have worked at the Penthouse Executive Club in New York City. They alleged, among other things, that the Club violated the federal Fair Labor Standards Act (FLSA) by failing to pay them overtime for hours worked in excess of 40 per week, requiring them to pay a “house fee” that sometimes exceeded $100 per night, deducting service charges for tips paid in scrip issued by the Club, and requiring that the dancers share their tips with other Club personnel. Penthouse asserted as a defense that the adult dancers were independent contractors.
In a 16-page decision by Judge Naomi Reice Buchwald, the court found unpersuasive all five of Penthouse’s arguments, including that class certification would be improper because the issue of whether the dancers were independent contractors was unsuitable for class action treatment. Penthouse argued that this type of inquiry regarding their status as employees or independent contractors required an individualized, fact intensive inquiry into the nature of the dancer’s relationships with the Club.
The New York federal court judge rejected that argument in the same manner that a federal judge in California rejected it less than a month ago in another independent contractor misclassification case, which was reported in this blog .
As Judge Buchwald stated, a plaintiff’s burden in seeking a preliminary class action certification is “simply to make a ‘modest factual showing sufficient to demonstrate that [plaintiffs] and potential plaintiffs together were victims of a common policy or plan that violated the law.’ ” In dismissing this argument, the judge noted that members of the proposed class “all hold the same job title, have the same job responsibilities, work at the same location, and, by extension, are subject to the same ownership and management.” She concluded that “[i]f such a group does not merit at least preliminary class treatment, one would expect that class treatment would rarely be granted in FLSA actions, a proposition that is plainly incorrect as an empirical matter.”
This is by no means the first adult club class action misclassification case. Other class action cases involving claims by adult dancers that they were improperly classified as independent contractors include an exotic dancer case in Massachusetts, an adult entertainment dancer case in Georgia, and another New York City adult dancer case.
Two Takeaways:
1. Where a business uses a relatively large number of independent contractors or is built on an independent contractor model, it faces misclassification liability not only for unpaid overtime but also for unpaid:
- unemployment taxes,
- workers compensation premiums,
- payroll taxes, and
- employee benefits,
just to name some of the many types of claims made by workers who claim they were misclassified as independent contractors.
2. Businesses that use many independent contractors or pay workers on a 1099 basis are well advised to address the issue of their independent contractor compliance before receiving a notice from a state unemployment or workers compensation office, before receiving notice from the IRS or state revenue department that it will be conducting a tax audit, or before being served with a summons and complaint (which can lead to class action certification if the case involves a substantial number of similarly situated workers).
Regardless of any business’s current state of compliance with such laws, there are a number of ways by which organizations can enhance their future compliance and minimize their exposure to future misclassification liabilities, including the costs of defending class actions by workers who receive 1099s instead of W-2s. See “Independent Contractor Misclassification: How Companies Can Minimize the Risks,” Pepper Hamilton LLP, Apr. 26, 2010, by the co-authors of this blog post. Indeed, some of these class actions seek damages for unpaid employee benefits – an area of exposure that can often be avoided simply by properly amending the language of a company’s benefit plans, as explained in the above article.
While efforts today to enhance independent contractor compliance cannot eliminate past exposure to misclassification liability, any changes that enhance compliance with the independent contractor laws will not only minimize or avoid future liability but also lessen the likelihood that the business will become a target for class action lawyers and government agencies.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: independent contractor liability, misclassification liability, State IC Laws and Selected Bills
The New York Construction Industry Fair Play Act goes into effect today, as previously noted in a detailed posting on this site and in an article published in the New York Law Journal by a publisher of this blog. From this point forward in the construction industry, companies and their officers that hire individuals performing construction work but fail to place them on their W-2 payroll, or fail to cover them for unemployment and workers compensation purposes, face civil and criminal liability if the workers do not meet a super-strict definition of the term “independent contractor.”
In addition, all construction industry employers must post on their worksites a required notice prepared by the New York State Department of Labor. As the website of the New York Commission of Labor states:
“Construction industry employers must post a notice about the Fair Play Act in a prominent and accessible place on the job site for all workers to see. The poster is available at the following link: http://www.labor.ny.gov/sites/legal/laws/pdf_word_docs/Fair%20Play%20Act%20revision.pdf.”
The law further provides that the poster “shall be provided in English, Spanish or other languages required by the Commissioner” and “shall be constructed of materials capable of withstanding adverse weather conditions.”
A failure to post the required notice is a violation of the law that subjects the offending construction firm to a civil penalty of up to $1,500 for a first violation and up to $5,000 for a subsequent violation within a five year period.
It is expected that investigators from the New York State Department of Labor will be vigilant to determine if the required notice is properly posted on websites. It is also expected that unions seeking to organize workers on non-union jobsites, as well as agents of unionized construction contractors in competition with union-free firms, will be reporting non-union construction contractors that fail to post the required notice in accordance with the new law.
As noted in a previous posting on this site, the Fair Play Act creates a “presumption of employment in the construction industry” by stating that “any person performing services for a contractor shall be classified as an employee” unless the person is a separate business entity (as defined in the Act) or unless three prescribed criteria are met. Those three criteria are:
(A) the individual is free from control and direction in performing the job, both under his or her contract and in fact; (B) the service must be performed outside the usual course of business for which the service is performed; and (C) the individual is customarily engaged in an independently established trade, occupation, profession, or business that is similar to the service at issue.
To be considered a “separate business entity” under the Fair Play Act, 12 specific facts must all be established. Those 12 factors are set forth in the new law and are detailed in the prior posting on this site, along with the civil and criminal penalties to which construction firms and their officers are exposed for misclassification of construction workers as independent contractors rather than as employees under the strict test imposed by the new law.
The article in the New York Law Journal also covers five key steps that construction employers should take to ensure compliance with the Fair Play Act, as well as commentary about another bill pending in the New York legislature dealing with ICs in all other industries.
Your comments are invited.
Richard Reibstein
Attorney at Law
Pepper Hamilton LLP
The New York Times Building
620 Eighth Avenue, 37th Floor
New York, New York 10018
T: 212.808.2722
F: 866.454.5857
E: reibsteinr@pepperlaw.com
www.pepperlaw.com
