This article was posted as a Client Alert by Pepper Hamilton LLP on July 15, 2015 and is republished here.
Earlier today, July 15, the Wage and Hour Administrator of the U.S. Department of Labor, Dr. David Weil, announced a new “Administrator’s Interpretation” addressing the misclassification of employees as independent contractors under the federal Fair Labor Standards Act (FLSA). The 15-page Interpretation sets forth the test to be used by the Labor Department in enforcing its wage and hour laws against companies that classify workers as independent contractors. It is anticipated that this announcement will cause reverberations in the business and legal communities — and, plainly, that is one of the objectives of Dr. Weil, who is the chief enforcement officer of the nation’s minimum wage and overtime laws.
But a close examination of the Interpretation reveals that, legally, it contains nothing new, different or dramatic. In fact, the new Interpretation does little more than restate the same six factors that have historically been applied by the Labor Department and that can still be found on its website. The main difference between the new Interpretation and the Labor Department’s prior enforcement policy is that there is a greater emphasis on a worker’s “economic dependence” on the business that has engaged his or her services.
Although advocates of expanded employee rights will undoubtedly laud the Labor Department for its bold action in announcing the new guidelines, they should readily acknowledge that nothing in the law has really changed. Indeed, this new Interpretation cannot change the law; it simply sets forth the Labor Department’s position on the test used by the courts in determining independent contractor status under the federal overtime and minimum wage laws.
However, from a practical standpoint, the new Interpretation signals a renewed emphasis by the Labor Department on cracking down on companies that it believes are misclassifying employees as independent contractors. Coming on the heels of a number of recent court decisions in high-profile class actions against Uber and Lyft, as well as a $228 million misclassification settlement by FedEx in June 2015, companies that utilize independent contractors as part of their business models or to supplement their workforces have more reason than ever to enhance their compliance with the laws governing independent contractors. The tools needed to heighten compliance are discussed in the “Takeaways” section after our “Analysis” of the new Interpretation.
The July 15 Administrator’s Interpretation notes that, under the FLSA, the test that has been applied by the courts in deciding cases involving alleged employee misclassification is the “economic realities” test, not the common law “control” test used by the courts in interpreting other federal laws (such as the Internal Revenue Code). The Interpretation notes that this test “focuses on whether the worker is economically dependent on the employer or is in business for him or herself.” The guidance then concludes that a “worker who is economically dependent on an employer” satisfies the test for employee status. This position is reinforced by the Interpretation’s statement that the administrative goal is to determine “whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor).” This is where the Administrator’s Interpretation, however, appears to depart from existing court decisions.
Although economic dependence is undoubtedly an important factor used by the courts in determining employee status under the FLSA, it is not the linchpin of the test. It appears, though, that economic dependence may have become the Labor Department’s litmus test for determining independent contractor vs. employee status. If a worker paid on a 1099 basis willingly chooses to provide services to only one company, the Labor Department apparently will regard that individual as an employee, concluding that he or she is “economically dependent” on that business.
The Interpretation sets forth six factors that the Labor Department includes in its “economic realities” test. These are essentially the same six factors that the Labor Department has used for decades and has published in various locations on its website, including a Fact Sheet last revised in May 2014.
The first factor in the new Interpretation is whether the work is an integral part of the employer’s business. This is similar to the same first factor listed in the Labor Department’s 2014 Fact Sheet. Likewise, the new Interpretation repeats part of what the Labor Department says in its Fact Sheet on this factor, stating, “If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer.”
The Interpretation, however, adds something new, stating, “A true independent contractor’s work, on the other hand, is unlikely to be integral to the employer’s business.” Courts may well take issue with this add-on. There are many situations where a company retains a small firm with a few employees to perform work that is integral to its business — yet few would argue that the small business is anything other than an independent contractor. Should the result be any different if the small business is a one-person shop? Evidently, the Labor Department believes it should be. As noted in a footnote to the Interpretation, however, some courts do not consider this factor in determining a worker’s status as an employee or independent contractor.
The second factor is whether a worker’s managerial skill affects the worker’s opportunity for profit or loss. This is the same as the second factor in the 2014 Fact Sheet. The new Interpretation states that a worker’s ability to work more hours and the amount of work available from the employer “have nothing to do with the worker’s managerial skill.” Examples of what is regarded as significant to the Labor Department are “a worker’s decision to hire others, purchase materials and equipment, advertise, rent space, and manage time tables.”
The third factor is how the worker’s relative investment compares to the employer’s investment. This is similar to the language in the third factor listed in the Fact Sheet. The new Interpretation states that “the worker’s investment should not be relatively minor compared with that of the employer.” As a practical matter, though, it is rare that the investment of even the most genuine of independent contractors will ever compare favorably to the investment by the business that retains him or her. Presumably, the courts will examine investments in light of the relative size of the company and the worker classified as an independent contractor.
The fourth factor is whether the work performed requires special skill and initiative. This is the same as the fourth factor in the Fact Sheet.
The fifth factor is whether the relationship between the worker and the employer is permanent or indefinite. This is also the fifth factor in the 2014 Fact Sheet. The Interpretation notes, however, that “a lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship.” The same could be said for a bona fide independent contractor who willingly chooses to provide services to a single business, even though he or she could choose to work with other businesses. Thus, it will be challenging for businesses to ascertain precisely what the Labor Department’s position is on this factor.
The sixth factor is the nature and degree of the employer’s control. This is the same final factor listed in the Fact Sheet, but this factor is where the Interpretation departs the most from the Labor Department’s previous guidance. Whereas the Labor Department had noted in the 2014 Fact Sheet that this factor includes who sets the pay rate and work hours, who determines how the work is performed, and whether the worker is free to work for others and hire helpers, the new Interpretation takes a different view of this factor. It states that “workers’ control over the hours when they work is not indicative of independent contractor status.” (Emphasis added.) This is not only a change from the Labor Department’s past enforcement position, but it also appears to deviate from most court decisions that treat the worker’s setting of his or her own hours as a factor favoring independent contractor status. The new Interpretation also does not mention whether a worker’s ability to work for others or hire helpers will be considered in determining independent contractor vs. employee status, yet these facts have historically been treated as important by the courts.
In this sixth factor, the Interpretation addresses, to a limited extent, the use of on-demand workers by tech companies in the sharing economy, such as Uber, Lyft, Homejoy, TaskRabbit, Handy, and Postmates. It states, “Technological advances and enhanced monitoring mechanisms may encourage companies to engage workers not as employees yet maintain stringent control over aspects of the workers’ jobs, from their schedules, to the way that they dress, to the tasks that they carry out.” The courts generally examine control by separating the right to control the end-product of the services (which the Interpretation refers to as “tasks”) from control over how to perform the services — with only the latter being of major significance in determining independent contractor status. After all, all independent contractors are, by definition, retained to perform the tasks necessary to produce the desired services, but they are not supposed to be directed as to “how” to perform such services. That important distinction, though, is not included in the new Interpretation.
Perhaps the biggest difference between the new Interpretation and the 2014 Fact Sheet is the Interpretation’s reliance on six factors, to the virtual exclusion of all others. In the Fact Sheet, the Labor Department acknowledged that “[t]he Supreme Court has indicated that there is no single rule or test for determining whether an individual is an employee or independent contractor for purposes of the FLSA.” The Fact Sheet then continued, “The [Supreme] Court has held that the totality of the working relationship is determinative, meaning that all facts relevant to the relationship between the worker and the employer must be considered.” (Emphasis added.) It appears that the Labor Department is now seeking to streamline the determination of independent contractor status by limiting its attention to the six factors listed in the Interpretation. While that is contrary to Supreme Court decisions on the issue, it nonetheless sets forth the Labor Department’s position with regard to its future enforcement initiatives.
This new Interpretation is clearly intended to send a message to both businesses and workers that the Labor Department plans to continue its crackdown on independent contractor misclassification. At the same time, the first page of the Interpretation acknowledges that legitimate independent contractor relationships “can be advantageous for workers and businesses.” Although the Interpretation notes that some businesses have “intentionally misclassified [workers] as a means to cut costs and avoid compliance with labor laws,” it omits any mention of those businesses that may be unintentionally misclassifying employees as independent contractors. This is the area where the bulk of misclassification occurs — companies that may not be in full compliance with independent contractor laws yet are not intentionally seeking to violate such laws. What can those companies do?
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 the six factors listed in the Interpretation, as well as dozens of additional 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 an array of differing state laws that are not governed by the Interpretation issued today.