Lessons Unlearned: Franchise and Independent Contractor Agreements Can Be Kiss of Death

This blog post was first published as a Client Alert by Pepper Hamilton LLP on September 22, 2016. 

On September 21, the U.S. Court of Appeals for the Third Circuit issued a stinging decision against commercial cleaning franchisor Jani-King, certifying a class action in an independent contractor (IC) misclassification case arising in the franchising context. Williams v. Jani-King of Philadelphia Inc., No. 15-2049 (3d Cir. Sept. 21, 2016). The court affirmed the district court’s decision to grant the plaintiffs’ motion for class certification in the case, which seeks unpaid wages under Pennsylvania wage and hour laws based solely on the terms of documents created by Jani-King itself. These documents include Jani-King’s franchise agreement and its franchise manuals, which retained sufficient control over the manner in which the franchisee cleaners were required to perform their services and which the plaintiffs argued established an employment relationship. The Third Circuit’s decision, written for a three-judge panel by Judge Fisher, once again highlights the fact that companies can be their own worst enemies when they create agreements and manuals that, on their face, provide plaintiffs’ class action lawyers with all they need to prove that ICs and franchisees are employees as a matter of law.

Prior to the Jani-King decision, the most poignant example of a company creating its own legal trouble by failing to properly structure and document its IC or franchise relationships was FedEx Ground. The legal landscape for FedEx was mixed until August 2014. Before then, FedEx had won a number of its earlier IC legal skirmishes with its home delivery and ground division drivers and lost some. But all that changed when the U.S. Court of Appeals for the Ninth Circuit issued a blockbuster decision on August 27, 2014, concluding that FedEx misclassified those drivers as ICs as a matter of law. That decision was followed only five weeks later by a similar decision from the Supreme Court of Kansas, and the Kansas decision was then adopted in July 2015 in an opinion by the U.S. Court of Appeals for the Seventh Circuit. The Kansas Supreme Court issued a particularly harsh critique of the IC contract, noting that it agreed with yet another appellate court that FedEx’s IC agreement is a “‘brilliantly drafted contract creating the constraints of an employment relationship with [the drivers] in the guise of an independent contractor model—because FedEx not only has the right to control, but has close to absolute actual control over [the drivers] based upon interpretation and obfuscation.’”

The Court’s Decision and Rationale

The named plaintiffs in the Jani-King case are two individuals: one who never hired any employees and performed cleaning services for his franchise himself, except for occasional help from his wife and friends, and the other who performed the cleaning himself, except for a two-month period when he paid an employee to help him. Other franchisees ranged from individuals to those who employed multiple workers.

The Third Circuit noted that there are a number of factors used by the courts under Pennsylvania law in determining if workers are employees or ICs. It stated that “[a]lthough no factor is dispositive, the ‘paramount’ factor is the right to control the manner in which the work is accomplished.” (Emphasis added.) Jani-King argued on appeal that “actual control, not the right to control, is the key factor in the test,” but the court rejected that argument as being inconsistent with Pennsylvania law.

The Third Circuit then examined the specific provisions in the Jani-King franchise agreement as well as its policies manual and training manual and concluded that they show that “Jani-King has the ability to control the manner in which in which the franchisees perform their day-to-day tasks.” Specifically, the Third Circuit quoted from the district court’s decision, which enumerated a number of such “control” provisions in those documents, including:

  • how often franchisees must communicate with customers
  • how franchisees must address customer complaints
  • where franchisees can solicit business
  • what franchisees must wear
  • what types of records franchisees must keep
  • how franchisees may advertise
  • how far in advance franchisees must inform the franchisor of vacations
  • how quickly franchisees must be able to be reached.

The Third Circuit also noted that Jani-King controls the franchisees’ work assignments; has the right to inspect the franchisees’ work; has the ability to change, as it sees fit, the policies and procedures that the franchisees must abide by; and has the right to terminate the franchise agreement at any time. All of those provisions in the documents prepared by Jani-King “‘could be read’ to give Jani-King the right to control the franchisees.” While the court said it was not reaching the merits of the case, it held that those factors supported the district court’s decision to conditionally certify the case as a class action.

Before concluding its decision, the Third Circuit considered one final argument by Jani-King: Franchising is an important and beneficial way of conducting business “that is fundamentally different from other situations involving misclassification claims.” Both Jani-King and the International Franchise Association, which filed an amicus brief on behalf of Jani-King, argued that an adverse decision “directly threatens the viability of franchising in Pennsylvania” and that “systems controls inherent in franchising should be irrelevant when considering whether an alleged employer has the right to exercise day-to-day control.”

The Third Circuit, however, rejected that argument. It noted that, unlike the law in some other states, Pennsylvania law “does not distinguish between controls put into place to protect a franchise’s goodwill and intellectual property and controls for other purposes.” In other words, while Pennsylvania franchise law may allow the franchisor to retain the right to control a franchisee’s actions in order to protect the valid interests of the franchisor, such controls may conflict with Pennsylvania employment and IC laws that regard such controls as indicators of employee status.

Judge Cowen filed a lengthy dissent. He stated that, while he disagreed with Jani-King that franchise system controls are irrelevant to the employment inquiry, he would find in this case that the controls identified by the two other members of the Third Circuit panel “are insufficient by themselves to establish the existence of an employer-employee relationship.” Rather, in his view, the controls must “exceed what is necessary to protect a franchisor’s trademark, trade name, or goodwill.”

The Significance of Jani-King from Both the Employment and Franchise Law Perspectives

The Third Circuit’s decision is a pointed reminder to franchisors, as well as businesses that use ICs, that the form of their agreements can either serve their legal interests or harm them in these types of employee misclassification cases, which have become increasingly prevalent. The Jani-King and FedEx decisions confirm that the best protection for franchisors and businesses that use ICs is to structure, document and implement the franchisee/IC relationship in a manner that is consistent with the IC laws in the states in which the business operates.

While the laws in most states regarding the test for IC status vary considerably, the principal factor in Pennsylvania is the same throughout the nation — whether the business retains the right to control “how” the contractor performs the agreed-upon services. Stated in another way, for IC misclassification purposes, when there are fewer contractual rights to direct and control the individuals in question, courts will be more likely to conclude that the business is compliant with the IC laws.

Of course, merely drafting a franchise or IC agreement that limits the business’s right to control how the services are to be performed is of little value legally if, in practice, the business exercises direction and control over the manner in which services are actually rendered. Such agreements, at most, provide cold comfort to businesses.

Franchisors certainly have every right to protect their valuable interests in their trademarks, trade name and goodwill under franchise law. But, there is no reason why franchise agreements cannot be drafted so as to protect those valuable interests without needlessly over-dictating how the services are to be performed.

Lessons to Learn from Jani-King

The Ninth and Seventh Circuit decisions adverse to FedEx eventually forced that company to settle dozens of IC misclassification lawsuits around the country for $466 million. If Jani-King had learned from the FedEx cases and drafted its franchise agreement and policies with a close eye on IC law, it may have succeeded in preventing conditional class certification in this lawsuit under Pennsylvania law. Many businesses that seek to reduce direction and control, yet wish to maintain a valid franchise or IC model, have resorted to the use of IC Diagnostics™, a proprietary process that examines whether a group of workers would pass the applicable tests for IC status under governing state and federal laws. IC Diagnostics™ then offers a number of practical, alternative solutions to enhance compliance with those laws. For existing businesses, those alternatives include restructuring, reclassification or redistribution, as more fully described in our White Paper.

There is nothing in the majority or dissenting opinions that says that a franchisor cannot seek to protect its intellectual property and goodwill. The challenge is to do so consistent with state IC and employment laws.

One way for franchisors to do so without undue exposure to misclassification liability is through the use of IC Diagnostics™. That process affords franchisors a way to genuinely restructure, re-document and re-implement franchise relationships in a manner that enhances IC compliance, consistent with franchisors’ rights under franchise law. Those relationships need to be documented in a state-of-the-art and bona fide manner that complies with the law yet maintains the essential components of the company’s franchise model. By doing so, companies can maximize the likelihood that they will be able to avoid the types of IC misclassification exposure that Jani-King is now facing simply because its franchise agreement and policy documents did not seek to protect its legitimate franchise interests in a manner consistent with IC law.

Written by Richard Reibstein

 

Contributor: A. Christopher Young

Published by Richard ReibsteinLisa Petkun and Andrew Rudolph.

Posted in IC Compliance | Leave a comment

August 2016 Independent Contractor Misclassification and Compliance News Update

This month’s news update includes four initiatives by the U.S. Department of Labor to combat IC misclassification. The first was the issuance of a new page on the DOL website called “Misclassification Mythbusters.” We critiqued the new DOL page in a blog post, pointing out that the DOL had mischaracterized state and federal IC laws. We stated: “Hopefully, the DOL will take note and remediate these misleading statements.” Following the issuance of our blog post, the DOL took down its “Mythbusters” page and recently restored it, changing each of the mischaracterizations we had highlighted.

The second regulatory initiative was the signing of a memorandum of understanding (MOU) between the U.S. Labor Department and two more state workforce agencies. This brings to 33 the number of states that have joined with the federal government to share information and conduct joint enforcement efforts to combat IC misclassification.

The third administrative action was the U.S. Labor Department’s signing of an MOU with a federal construction agency, the U.S. Department of Housing and Urban Development, to prevent IC misclassification in the construction of housing in six Western states.

The fourth initiative was the issuance of a new “Employee Rights” poster that, for the first time, includes a reference to IC misclassification.

Those actions are discussed in the second part of this news update, in the section called “Administrative and Regulatory Initiatives.”

In the Courts (3 cases)

$2.4 MILLION CONSENT JUDGMENT ENTERED AGAINST CONSTRUCTION COMPANY AND ITS PAYROLL AFFILIATE. A Massachusetts federal district court entered a consent judgment for $2.4 million against a construction company, Force Corporation, and its affiliate, AB Construction Group Inc., for misclassifying the bulk of their 478 employees as ICs and engaging in other wage and hour violations under the Fair Labor Standards Act (FLSA). According to a news release dated August 2, 2016 from the Wage and Hour Division (WHD) of the Department of Labor, an investigation conducted by the WHD revealed IC misclassification including overtime violations and improper record-keeping. The WHD also found that AB Construction was created to provide Force Corp. with much of its labor, and that Force Corp. prepared and controlled the payroll and payment procedures for both companies. The consent judgment orders the companies to pay nearly $2.4 million in back wages and liquidated damages to the employees; refrain from misclassifying employees as ICs; make, keep and preserve accurate records of employees’ wages, hours and working conditions; and engage qualified independent consultants to create an FLSA-compliant payroll system. Perez v. Force Corp., 16-cv-40103 (TSH) (D. Mass. Aug. 1, 2016).

LEADING TRUCKING AND TRANSPORTATION LOGISTICS FIRM SUED FOR IC MISCLASSIFICATION. A California truck driver filed a class action complaint in federal court against one of North America’s largest trucking and logistics firms, J.B. Hunt Logistics, Inc.  The company provides transportation of customers’ products via semi trailer trucks. The IC misclassification lawsuit alleges that the company failed to pay drivers overtime under the FLSA and failed to reimburse them for expenses under the California Labor Code. The driver claims that he and other drivers were required to lease trucks through the Company at their own expense; the Company controlled all aspects of the drivers’ employment; and drivers had no ability to negotiate the fees that drivers received. Guevara v. J.B. Hunt Logistics, Inc., No. 16-cv-06410 (C.D. Cal. Aug. 25, 2016).

UBER’S PROPOSED $100 MILLION SETTLEMENT REJECTED BY FEDERAL COURT AS INADEQUATE. Uber’s $100 million proposed settlement of drivers’ IC misclassification claims, negotiated with counsel for the drivers, was rejected by California federal judge on August 18, 2016.  Judge Edward Chen focused most of his concerns about the adequacy of the proposed settlement on the allocation of “only” to settle the claims brought by the drivers under the California Private Attorneys General Act (PAGA).  The judge noted that the $1 million allocation was only one tenth of one percent of the possible $1 billion value of that claim. He also expressed concerns that the expansive waiver and release covered workers who were not part of the class, covered claims that were not part of the lawsuit, and may adversely affect the prosecution of other cases brought against Uber. On September 7, 2016, the Ninth Circuit Court of Appeals ruled that the class action waiver arbitration agreements, which most of the class members had signed, were valid.  As a result, the number of class members will be dramatically reduced, thereby fundamentally changing the scope of the class action lawsuit. The effect of the Ninth Circuit’s ruling remains to be seen.  Class action waiver arbitration agreements, however, have been subject to rejection by the Ninth Circuit under the National Labor Relations Act. O’Connor v. Uber Technologies Inc., No. 13-cv-3826 (N.D. Cal. Aug. 18, 2016); Yucesoy v. Uber Technologies Inc., No. 15-cv-0262 (N.D. Cal. Aug. 18, 2016).

Administrative and Regulatory Initiatives (5 matters)

“MISCLASSIFICATION MYTHBUSTERS” RELEASED BY U.S. LABOR DEPARTENT, BUT REVISED IN RESPONSE TO OUR EARLIER BLOG POST. The United States Department of Labor released an online publication entitled “Misclassification Mythbusters” in effort to educate the public about IC misclassification. As discussed in our blog post of August 22, 2016, the DOL identified 12 IC misclassification “myths” that it sought to debunk and provided explanations for each of their analyses. Our review of each myth revealed inaccuracies in some of the explanations provided by the DOL, including mischaracterizations of some of tests used to determine IC or employee status. Following the posting of our critique, which implored the DOL to “take note and remediate these misleading statements,” the DOL took down its site and then did, in fact, remediate some of the mischaracterizations, as noted in our Publishers’ Notes added earlier today to the August 22 blog post.

TWO MORE STATES SIGN COORDINATION AGREEMENT WITH U.S. DOL TO COMBAT IC MISCLASSIFICATION. Pennsylvania and North Carolina became the 32nd and 33rd states to sign Memoranda of Understanding with the U.S. Department of Labor (DOL) targeting IC misclassification. On August 4, 2016, the DOL entered into a three-year Memorandum of Understanding (MOA) with the Pennsylvania Department of Labor & Industry and on August 31, 2016, it entered into an MOA with the North Carolina Industrial Commission. The goals of these partnerships include providing clear, accurate, and easy-to-access compliance information to employers, employees, and other stakeholders, and sharing of resources and enhancing enforcement by conducting coordinated enforcement actions and sharing of information consistent with applicable law.  David Weil, the Wage and Hour Administrator of the DOL, stated in press releases announcing each state’s MOA: “The Wage and Hour Division continues to attack this problem head-on through a combination of a robust education and outreach campaign, and nationwide, data-driven strategic enforcement across industries.” He continued: “Our goal is always to strive toward workplaces with decreased misclassification, increased compliance, and more workers receiving a fair day’s pay for a fair day’s work.”

U.S. DOL AND HUD ENTER INTO MEMO OF UNDERSTANDING. In addition to MOUs that the U.S. DOL has entered into with the IRS and state workforce agencies, it recently entered into an MOU with the U.S. Department of Housing and Urban Development.  The MOU was entered into to combat IC misclassification in federally funded construction projects in six western states: Colorado, Montana, North Dakota, South Dakota, Utah and Wyoming. According to a news release dated August 22, 2019, this is the first MOU of its kind representing a new effort on the part of the agencies to work together to protect employee rights and level the playing field for responsible employers by reducing the practice of IC misclassification. Dr. David Weil, Administrator of the Wage and Hour Division said in a news release: “The Wage and Hour Division stands together with the U.S. Department of Housing and Urban Development to protect workers and responsible employers and ensure everyone has the opportunity to succeed. Misclassification deprives workers of rightfully earned wages and undercuts law-abiding businesses.”

NLRB GENERAL COUNSEL TRIES TO CREATE AN IC “MISCLASSIFICATION-PLUS” UNFAIR LABOR PRACTICE. As we noted in our blog post of August 30, 2016, the General Counsel of the NLRB has sought to create a “misclassification-plus” unfair labor practice, as reflected in a recently released NLRB Advice Memorandum. According to the Advice Memo dated December 18, 2016 and made public on August 26, 2016, “where the Employer told its drivers that they were independent contractors and had no right to form a union but treated them as employees in virtually every respect, the Employer’s misclassification of its drivers as ICs interfered with and restrained the drivers in their exercise of Section 7 rights, in violation of Section 8(a)(1).” While a close reading of the Advice Memo makes it clear that misclassification itself is not an unfair labor practice, the NLRB seems to have created an unfair labor practice premised on IC misclassification “plus something more” – even a statement that may be nothing more than a comment protected by Section 8(c) of the NLRA. Pacific 9 Transportation, Inc., Case 21-CA-150875 (Div. of Advice Memo, Dec. 18, 2015, released to public August 26, 2016).

U.S. DEPARTMENT OF LABOR ISSUES NEW “EMPLOYEE RIGHTS” POSTER INCLUDING A REFERENCE TO IC MISCLASSIFICATION.  Effective August 1, 2016, employers are required to post the U.S. Labor Department’s new “Employee Rights Under the Fair Labor Standards Act” notice.  The poster, for the first time, includes a reference to IC misclassification, stating under the section entitled “Additional Information” the following: “Some employers incorrectly classify workers as ‘independent contractors’ when they are actually employees under the FLSA. It is important to know the difference between the two because employees (unless exempt) are entitled to the FLSA’s minimum wage and overtime pay protections and correctly classified independent contractors are not.”

On the Legislative Front (1 item)

ARIZONA LAW CREATES A “DECLARATION OF INDEPENDENT BUSINESS STATUS” TO ASSIST IN DETERMINING IC STATUS IN THAT STATE. A new Arizona independent contractor law aimed at clarifying IC or employee status took effect August 6, 2016. Under the Republican-sponsored bill (HB 2114) signed into law by the Governor, an IC has the option of signing a “Declaration of Independent Business Status” in which the IC must acknowledge that he/she operates his/her own independent business; the IC is not an employee and has no rights to unemployment benefits or any other rights arising from an employment relationship; the IC is responsible for all tax liability; and the IC is responsible for obtaining and maintaining any required registration, licenses or other authorization necessary to perform the services to be provided by the IC. In addition, the IC must acknowledge that he/she satisfies at least 6 out of 10 factors often used in tests across the country to determine IC status. Some of those factors include: the IC is not entitled to health insurance  and workers’ compensation coverage from the contracting party; the IC has a non-exclusive relationship with the contracting party; the IC has the right to accept or decline engagements; the contracting party expects that the IC provides services for others; the IC is not economically dependent on the contracting party; and the contracting party does not dictate the performance, methods or process the IC uses to perform the services. The execution of a Declaration creates a rebuttable presumption of an IC relationship between the IC and the contracting party. The statute makes clear that the failure to execute a Declaration does not create any presumptions and is not admissible to deny the existence of an IC relationship.

Written by Richard Reibstein.

Compiled by Janet Barsky, Managing Editor. 

Published by Richard ReibsteinLisa Petkun and Andrew Rudolph.

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Posted in IC Compliance

NLRB General Counsel Creates a “Misclassification-Plus” Unfair Labor Practice

On August 26, 2016, the National Labor Relations Board made public an Advice Memorandum from the NLRB’s Office of General Counsel regarding an unfair labor practice case arising in the context of independent contractor misclassification. The Advice Memo has already been reported in the trade as ruling that the misclassification of employees as independent contractors, in and of itself, violates the National Labor Relations Act.  A close reading of the Advice Memo, however, reveals that it never quite reaches that conclusion – but nonetheless seems to have extended the law to create a “misclassification-plus” type of unfair labor practice. Pacific 9 Transportation, Inc., Case 21-CA-150875 (Div. of Advice Memo, Dec. 18, 2015, released to public August 26, 2016).

What Does the NLRB Advice Memo Actually Say?

The Advice Memo instructs the Region where the charge was filed to issue a Section 8(a)(1) complaint “in these circumstances, where the Employer told its drivers that they were independent contractors and had no right to form a union but treated them as employees in virtually every respect.”

In the Advice Memo, the NLRB’s Office of General Counsel acknowledges that “[a]lthough the Board has never held that an employer’s misclassification of statutory employees as independent contractors in itself violates Section 8(a)(1), there are several lines of Board decisions that support such a finding.” Yet, when those lines of NLRB decisions are examined, they too depend on acts beyond simply classifying an employee as exempt or not under the NLRA. The first line of Board decisions focuses on actions that prevent employees from engaging in protected conduct, while the second line of cases highlights statements that engaging in union organizing would be futile because the company “would never accept an employer-employee relationship with its workers [that were classified as ICs].” In contrast, merely classifying workers as ICs does not prevent workers from engaging in union organizing nor suggest futility to employees where the company does nothing more than maintain its legal position that the workers in question are ICs and not employees. The third line of cases involves “misstatements of law . . . if the statement reasonably insinuates adverse consequences for engaging in [union] activity.”  Again, merely classifying workers as ICs does not suggest adverse consequences for those who may seek to unionize, even though, as a matter of law, ICs have virtually no protection from termination under the NLRA.

The Advice Memo then examined the allegations in the Pac 9 case, focusing on the following: (1) the company entered into IC agreements providing the drivers with a fair degree of independence but did not abide by those terms, instead directing the manner of performance of the drivers; (2) the company sent drivers a memo that “only ‘employees (not owner operators or independent contractors) have the right to form a union’”; and (3) insisting that drivers are independent contractors, after the Region determined that they were not, “is tantamount to the Employer telling its employees that they engage in Section 7 [union] activities at the risk of losing their jobs.”  The Advice Memo concludes:  “For these reasons, we conclude that on these facts, the Employer’s misclassification of its employees as independent contractors acts to interfere and restrain its employees in the exercise of their Section 7 rights.”

Analysis

On April 21, 2016, we commented in a blog post about another NLRB case involving misclassification of ICs. That case, Intermodal Bridge Transport, Case 21-CA-157647, involved a claim of IC misclassification in the context of unfair labor practices including allegations of interrogation, promises, and threats. We stated at that time that “Because the Intermodal case included allegations of other “classic” violations of the law (threats, interrogations, and promises), it is too early to tell if the General Counsel of the NLRB is taking the position that mere misclassification of workers as independent contractors violates the National Labor Relations Act – or that something more must be done to a worker whom the General Counsel believes should be classified as an “employee” under NLRB and court decisions defining that term.”

The Pac9 case is a significant step beyond Intermodal, where there was no need for the NLRB to stretch the law. In contrast, in Pac9, no overt interrogation, threats, or promises were present. While a close reading of the Advice Memo makes it clear that misclassification itself is not an unfair labor practice, the NLRB seems to have created an unfair labor practice premised on IC misclassification plus something more – even a statement that may be nothing more than a comment protected by Section 8(c) of the NLRA. That time-honored section provides: “The expressing of any views, argument, or opinion, or the dissemination thereof, whether in written, printed, graphic, or visual form, shall not constitute or be evidence of an unfair labor practice under any of the provisions of this Act, if such expression contains no threat of reprisal or force or promise of benefit.” Presumably, Pac9 would have been better off if it expressly told the drivers that, “in our view, you have no right to form a union.”

The first part of the NLRB General Counsel’s proposed remedy would be to require the company to “communicate to its drivers that they are independent contractors and not employees within the meaning of the Act.” While that remedy may be within the Board’s authority, because it qualified the communication by limiting it to the National Labor Relations Act, there is a final part of the proposed remedy that is unlikely to survive judicial scrutiny: “requiring that [Pac9] take affirmative action to rescind any portions of its Agreements with its drivers that purport to classify them as independent contractors and to post the appropriate notice.” As we have observed in many of our blog posts, most federal and state laws use varying tests for IC status, and an NLRB finding that the drivers are employees and not ICs does not mean that the drivers are employees under an abundance of other federal and state laws governing ICs including the federal tax laws.  For the NLRB to require that the company’s IC agreements be re-written would amount to the NLRB imposing its authority well beyond its legal limits. 

Takeaway

As we have previously noted in other blog posts, businesses that utilize independent contractors would be wise to focus on enhancing their compliance with applicable IC laws instead of concerning themselves about an agency that may be expanding its notion of what constitutes an unfair labor practice in the area of IC misclassification. The NLRB Advice Memo in the Pac9 case would have little or no impact on a company that properly classifies its workers under NLRB law.

Businesses interested in enhancing their compliance with IC laws can do so in a variety of ways, as detailed in our White Paper on minimizing IC misclassification risks, including the use of IC Diagnostics,™ which assesses IC compliance under applicable law, restructures and re-documents the IC relationship in a more compliant manner, and then implements the IC relationship in a customized and sustainable fashion.

Written by Richard Reibstein.

Published by Richard ReibsteinLisa Petkun and Andrew Rudolph.

Posted in IC Compliance

“Misclassification Mythbusters”: The Labor Department’s Latest Effort to Crack Down on Independent Contractor Misclassification

The U.S. Department of Labor has just released a dozen Q&A’s on the issue of IC misclassification in an online publication it calls “Misclassification Mythbusters.”  The 12 IC misclassification “myths” that it seeks to debunk are intended to educate workers about their status as ICs and to foster the Labor Department’s continued crackdown on misclassification of employees as independent contractors. Yet, a close review of the answers given by the Labor Department as “mythbusters” reveals that this new federal publication contains some misinformation about the subject.

The first myth is: “If I am an independent contractor under one law, I am an independent contractor under other laws.” The DOL correctly notes that “Even if you are a legitimate independent contractor under one law, you may still be an employee under other laws.” This is one of the most vexing aspects of IC classification, and confounds both workers and businesses.  In an effort to try to help educate the public, the Labor Department recites the tests for IC status under various federal and state laws.  Regrettably, though, it does not characterize some of those tests in an accurate manner.  For example, the DOL mischaracterizes state unemployment insurance law when it says:

“Each state UI law presumes a worker is an employee unless certain tests in each state’s UI law are passed to show that the worker is an independent contractor. The tests in each state differ slightly; however, the tests generally examine the direction and control exercised by the employer over the service performed and whether the worker is customarily engaged in an independent business.”

While some state unemployment laws presume a worker is an employee, not all states have IC tests that start out with a presumption that every worker is an employee. Further, the tests under the unemployment laws in many states do not “differ slightly” from another. Rather, the tests for IC status under many state unemployment laws differ dramatically from each other.  Some states use the IRS test; others use the common law test; a number use a three-factor ABC test; some ABC tests are interpreted quite differently by the courts in one state than another; a few states have tests with close to a dozen factors; and still other states use the FLSA’s economic realities test.  For this reason, state IC tests have been referred to as a “crazy quilt” of laws.

PUBLISHERS’ NOTE (9/8/16): FOLLOWING THE PUBLICATION OF THIS BLOG POST, THE DEPARTMENT OF LABOR ELIMINATED THIS MISCHARACTERIZATION OF STATE UNEMPLOYMENT LAWS.  THE NEW “MISCLASSIFICATION MYTHBUSTERS” SITE BY THE LABOR DEPARTMENT MORE APPROPRIATELY STATES: “Most state laws contain strict tests to determine whether there is sufficient absence of control by an employer that the worker is not an employee but an independent contractor.”

Of the next 11 myths, at least six are afflicted by a recurring inaccuracy. For example, Myth #3 says: “I received a 1099 tax form from my employer, and this makes me an independent contractor.” The Labor Department seeks to debunk this myth by stating that “Receiving a 1099 does not make you an independent contractor under the FLSA.”  No one would reasonably argue that the mere issuance or receipt of a Form 1099 tax form means that a worker is an IC as a matter of law, including the FLSA. But the DOL goes far afield when it next states: “Under the FLSA, you are an employee if your work indicates you are economically dependent on an employer.” (Emphasis added.)  This statement wholly mischaracterizes the law because it erroneously suggests that the test for IC status under the FLSA is a one-factor test – that is, if the worker is economically dependent on a business, the worker is an employee under the FLSA.

The courts, though, have stated that there is no single factor that is determinative of  whether an individual is an employee or independent contractor for purposes of the FLSA – and it is the courts that determine IC status under the FLSA, not the Labor Department. The courts have held that the totality of the working relationship must be examined. This means that all facts relevant to the relationship between the worker and the business must be considered, not simply economic dependence, in determining a worker’s status.  Merely because an otherwise legitimate IC chooses to provide services  to only one business does not automatically turn an otherwise legitimate IC into an employee, especially when the IC has the right to provide services to more than one company.

This erroneous statement by the DOL that IC status under the FLSA is essentially a one-factor test is then repeated verbatim by the Labor Department in five other myths. (See Myth # 5, #7, #8, #11, and #12.)  Thus, together with the errors noted in Myth #1, over half of the “mythbusters” contain misleading information.  Hopefully, the DOL will take note and remediate these misleading statements.

PUBLISHERS’ NOTE (9/8/16): AS NOTED ABOVE, FOLLOWING THE PUBLICATION OF THIS BLOG POST, THE DOL DID IN FACT TAKE NOTE OF ITS MISLEADING STATEMENTS, CHANGING APPROPRIATELY THE DESCRIPTION OF THE IC TEST UNDER STATE UNEMPLOYMENT LAWS.  THE DEPARTMENT OF LABOR ALSO CHANGED THE MISLEADING LANGUAGE IN SEVEN OF THE OTHER MYTHS. THE DOL SITE NOW SAYS THE FOLLOWING ABOUT THE TEST FOR IC STATUS UNDER THE FLSA: “Under the FLSA, you are an employee if, as a matter of economic reality, your work indicates that you are economically dependent on an employer.” THIS CHANGE, HOWEVER, DOES NOT REMOVE THE MISCHARACTERIZATION OF THE LAW THAT THE TEST FOR IC STATUS UNDER THE FLSA IS A ONE-FACTOR TEST. UNFORTUNATELY, THE DOL SITE STILL REFLECTS A MISUNDERSTANDING OF CURRENT FLSA LAW BY THE COURTS, WHICH HAVE STATED THAT NO ONE FACTOR IS DETERMINATIVE OF IC STATUS, ALTHOUGH GREATER WEIGHT IS GIVEN TO WHETHER AN EMPLOYEE IS  ECONOMICALLY DEPENDENT ON THE PARTY RECEIVING HIS/HER SERVICES.”

“Misclassification Mythbusters” follows by a year the issuance of an Interpretation by the Administrator of the Wage and Hour Division dealing with IC misclassification. In July 2015, Dr. David Weil, the newly appointed Administrator of the Wage and Hour Division, issued an Administrator’s Interpretation that, like the “Misclassification Mythbusters” publication,  failed to acknowledge (other than in a few obscure footnotes) that the test for IC status under the FLSA requires and permits an examination of many factors and not just a few. As we noted in our blog post on the Interpretation, while the Administrator acknowledges that legitimate independent contractor relationships “can be advantageous for workers and businesses,” he did not address the fact that a substantial amount of IC misclassification is not the result of an intention to violate federal or state law, but rather unintentional acts by businesses who are perplexed by the very first myth: that even if a worker is an IC under one law, he or she may be an employee under another law with a different test for IC status.

What can those companies do to enhance their IC compliance under an array of differing federal laws and this crazy quilt of state IC laws? As more fully described in our White Paper on “How Companies Can Minimize the Risks of Independent Contractor Misclassification,” businesses have three alternatives to mitigate their risk of misclassification liability: (1) restructuring, re-documenting and re-implementing their independent contractor relationships in a manner that enhances compliance with governing laws; (2) reclassifying their independent contractors; or (3) redistributing them to staffing or workforce management firms or other third-party vendors.

Businesses that wish to maintain an independent contractor model can use IC Diagnostics™ to restructure, re-document and re-implement. This proprietary tool assesses dozens of factors that courts and administrative agencies have identified as being pertinent to a determination of independent contractor status. The process results in a practical, customized and sustainable way to enhance independent contractor compliance, not only with the FLSA and other federal laws but also with the array of differing state laws.

Authored by Richard Reibstein.

Published by Richard Reibstein, Lisa Petkun and Andrew Rudolph.

Posted in IC Compliance

Uber’s $100 Million Settlement Rejected by Judge; Independent Contractor Misclassification Lawsuit to Proceed

Earlier today, Uber was dealt yet another setback in its efforts to settle the IC misclassification lawsuits brought against it by Uber drivers in California and Massachusetts. As readers of this legal blog will recall from our post of April 22, 2016, Uber entered into a proposed settlement with counsel for the drivers that would pay them $84 million at a minimum with the potential of up $100 million, and afford them additional protections from unilateral termination by the company of their status as Uber drivers. Despite the large size of the proposed settlement, numerous objections were filed by proposed class members, by unions seeking to represent the drivers, and by other interested persons and entities. On August 18, 2016, Judge Edward Chen issued a 35-page Order denying the motion filed by the drivers’ counsel and supported by Uber that sought approval of the proposed settlement. Judge Chen expressed concerns about a number of provisions of the proposed settlement, but one reservation about the terms of the proposed settlement overwhelmed all others: Judge Chen found that the proposed payment of $1 million by Uber to settle the claims brought by the drivers under the California Private Attorneys General Act (PAGA) was only one-tenth of one percent of the value of that claim.

Analysis of the Court’s Decision

A claim under the California PAGA law is a private action on behalf of the State. The PAGA claim had been estimated by the drivers’ counsel to be worth up to $1 billion in damages. In order to determine whether the estimate was genuine, the Court had asked the California Labor and Workforce Development Agency (LWDA) to provide its estimate of the potential penalty that Uber would face if the LWDA sought to enforce its penalties against Uber for alleged misclassification of employees – and the LWDA confirmed that the $1 billion amount was accurate. In their negotiations of the proposed settlement, both counsel for the drivers and Uber appeared to shortchange the State of California by allocating only $1 million to the PAGA claim. According to Judge Chen, “the court cannot find that PAGA settlement is fair and adequate . . . .” Rather, Judge Chen concluded that the 99.9% reduction in the amount of the proposed penalty to Uber “has no rational basis.” In a rather harsh comment, the judge stated that “Plaintiffs appear to treat the PAGA claim simply as a bargaining chip in obtaining a global settlement for Uber’s benefit.”

Judge Chen also expressed concerns about the sweeping scope of the waiver and release that was part of the proposed settlement. He found that it covered workers who were not part of the class, covered claims that were not part of the lawsuits, and may adversely affect the prosecution of a number of other cases brought against Uber. While he found  the average amount of recovery for unreimbursed expenses and tips to be modest – only $24 for California drivers and $12 for Massachusetts drivers who drove under 750 miles for Uber, and $1,950 for California drivers and $979 for Massachusetts drivers who drove over 25,000 miles for Uber – the judge concluded that such amounts, although low, were about 10% of their potential recovery and therefore legally “adequate.”

On a more technical issue, the judge expressed concern that the proposed settlement would require him to vacate his prior decision finding the arbitration agreement that Uber sought to impose on drivers to be unenforceable because it contained a waiver of the drivers’ rights to bring a PAGA claim in court and was issued under circumstances that did not adequately explain the nature of the arbitration agreement to the drivers.

The Significance of the Court’s Decision

What exactly does all this mean? First, the parties may seek to negotiate a higher amount of a proposed settlement. As illustrated recently in the case involving Uber’s ride-sharing competitor, Lyft, the parties in that case substantially increased the amount of the settlement following a rejection by a court of the initial proposed resolution. As we noted in our blog post of July 6, 2016, the increase from $12.25 million to $27 million, along with non-economic advantages for the drivers, led the court to eventually approve that settlement following its initial rejection. However, here in the Uber case, the PAGA claim would have to be increased to $100 million to reach the same 10% figure that the judge found minimally adequate with respect to the non-PAGA claims. Uber may have little willingness in essentially doubling its offer to $200 million, including $100 million for the PAGA claims – and the Uber drivers may not insist on that much to settle their PAGA claims. It is expected, therefore, that the parties may seek to increase the PAGA claim to a range of between $25-50 million and take a shot that the court will approve it.

Second, at the end of the court’s decision, it terminated its order prohibiting Uber from seeking to have drivers enter arbitration agreements. Thus, it is expected that Uber may promptly require drivers to sign a new arbitration agreement, presumably without waiving their right to litigate their PAGA claims in court, and allowing the drivers to opt-out if they wish to bring their claims in court. It has been estimated that as few as 8,000 of the hundreds of thousands of Uber drivers in California may remain in the class action if that occurs. However, Uber would be required to arbitrate thousands of cases of IC misclassification.

Third, Uber may simply wish to try the case to a jury. While few companies find that option to be worthwhile, it is by no means unheard of. FedEx tried a case to a jury in an IC misclassification case and won a jury verdict, as the overwhelming number of FedEx Ground drivers wanted to remain their own bosses. Although the verdict in that case was overturned on appeal due to faulty jury instructions, Uber claims that the overwhelming number of drivers want to be their own bosses and not Uber employees.

A court conference in this case is scheduled for September 15, 2016. Presumably, the parties will tell the court then how they wish to proceed.

How Can Other Companies Avoid Being “Uberized” by an IC Misclassification Class Action?

As we have stated in an earlier blog post commenting on the legal challenges confronting Uber, many companies that use independent contractors have resorted to IC Diagnostics™ to enhance their level of compliance and determine whether a group of 1099ers 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, re-documenting and re-implementing the independent contractor relationship; reclassifying 1099ers as W-2 employees; and redistributing 1099ers – as more fully described in our White Paper on the subject.

Companies that wish to retain an independent contractor business model generally elect to restructure, re-document, and re-implement their independent contractor relationships. While not all companies can eliminate most control and direction over workers treated as 1099ers, the overwhelming number can effectively restructure their independent contractor relationships to comply with federal and most state laws. If the independent contractor relationship can be effectively restructured to comply with such laws, the next step in the process is re-documentation.  What seems like a simple act of dotting your i’s and crossing your t’s, though, is anything but; indeed, many independent contractor statutes and most judicial and administrative decisions in this area are often counter-intuitive.

As we noted in our August 29, 2014 blog post entitled “Earthquake in the Independent Contractor Misclassification Field,” we concluded that FedEx Ground lost a key case because of its misplaced reliance on an independent contractor agreement and its policies and procedures that were good, but not good enough.  While FedEx is a savvy company, close scrutiny by a court found that the very documents FedEx created were sufficient in degree to lead the court to rule against FedEx. As we noted then in that blog post, “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.”

Of course, the implementation of a legitimate IC relationship is also essential. As shown in the Uber case, even when its contractual provisions were drafted in a manner intended to be consistent with independent contractor laws, evidence was introduced by the drivers in Uber’s motion for summary judgment that it failed to strictly follow in practice the contractual limitations on direction and control it had put into its independent contractor agreements.  There is no reason, however, why a company committed to complying with independent contractor laws cannot, when exercising both rigor and restraint, implement and carry out in practice an enhanced independent contractor relationship. Had Uber undertaken the above steps, I may have been spared the lawsuits it has worked so hard to defend and settle.

Written by Richard Reibstein.

Published by Richard Reibstein, Lisa Petkun and Andrew Rudolph

Posted in IC Compliance