$8 Million Independent Contractor Misclassification Class Action Settlement

In October of 2010, I reported on a federal court decision certifying a class action of adult dancers that performed services at the Penthouse Executive Club in New York City; the dancers claimed they are “employees” under federal and state laws and had been misclassified as independent contractors (ICs). They had  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, required them to pay a “house fee” that sometimes exceeded $100 per night and deducted service charges for tips.  The claims also included alleged violations of state wage laws. Penthouse asserted as a defense that the adult dancers were ICs and therefore it did not violate any federal or state wage and hour laws that only cover “employees.”

Two and a half years later, following discovery of thousands of pages of documents including time, payroll and tip allocation records, tax documents, and financial records, responding to interrogatories and the taking of depositions of the Club’s managers, a proposed settlement has been reached following a third mediation session. The total cost of the settlement to the Club and their executives is $8,000,000.

That payout is proposed to be allocated among the 1,245 class members, their four sets of lawyers, and the settlement claims administrator.  The lawyers’ fees, subject to court approval, are capped at $2,175,000 (slightly over 27% of the $8 million fund).  Under the proposed settlement, each class member would receive a minimum payment of $3,727.79.  In an uncommon circumstance, one of the named class representatives has indicated that she opposes the proposed settlement.

Takeaways:

As noted in my prior blog post on this case, 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 and other types of wage claims 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.

Thus, in addition to the $8 million cost of this settlement, the business is likely to be faced with substantial additional costs of misclassification.  Another cost of this settlement, of course, is the business’s own legal fees; if the lawyers’ fees for the plaintiffs are as high as $2.175 million, it is likely that the defendants’ own legal fees will equal or exceed that amount as well, pushing the cost of the class action lawsuit to over $10,000,000.

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,” May 14, 2012, by the publisher 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.

Your comments are invited.

Written by Richard Reibstein.

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