THE DOL’S PLAN TO STAMP OUT MISCLASSIFICATION OF EMPLOYEES AS INDEPENDENT CONTRACTORS
On July 15th, 2015, the U.S Department of Labor Wage and Hour Division (DOL) issued a sweeping informational memorandum (“Administrator’s Interpretation No. 2015-1” (link 1)), announcing its long-anticipated plan to make changes to the Fair and Labor Standards Act. The DOL’s efforts to curtail misclassification come in response to the growing problem of “misclassification of employees as independent contractors,” which they attribute in part to the “larger restructuring of business organizations.” The memo provides additional guidance to the public regarding the “Economic Realities Factors” and how they play into FLSA’s broad definition of employment (link 2). The distinction is of interest because independent contractors are not subject to state minimum wage and overtime protection laws, including coverage by worker’s compensation, right to family leave, unemployment insurance, right to unionize, and protection against employer retaliation.
The Economic Realities Test
The “Economic Realities Test” is a set of factors used by federal courts to determine whether a worker should be classified as an employee or independent contractor. The question is whether the worker is economically dependent on the employer. A worker that is found to be economically independent is more likely classified as an “independent contractor.”
The DOL breaks down its interpretation of each factor as follows:
- The extent to which the work performed is an integral part of the employer’s business. An employer who performs work that is “integral to the employer’s business” is more likely to be “economically dependent” on the employer and thus likely to fall under the category of “employee.” As courts have held, this determination is dependent on the nature of the work performed by the worker and whether such work is primary to business operations with respect to the industry.
- The worker’s opportunity for profit or loss depending on his or her managerial skill. A worker is more likely to be classified as an employee if his or her managerial skill “can affect his or her profit and loss.” This determination is based on, among other factors, the worker’s freedom to solicit new clients, advertise services, reduce costs, and choose when and where assignments will be perform.
- The extent of the relative investments of the employer and the worker. Does the worker bear a risk of loss? Investments are part of an independent business’s operating expense. A worker who has the ability to invest in expansion, make decisions about its cost structure, or extend his market reach demonstrates that he is on “similar footing” as the employer in terms of economic independence. Courts look not only to whether the worker has made an investment, but to the “relative investment of the worker in comparison to employer’s investment;” thus, if the worker’s investment does little to further a business beyond that particular job, then it is unlikely to provide support for an independent contractor classification
- Whether the work performed requires special skills and initiative. A showing of “special skills” by a worker, taken on its own, is insufficient to render independent contractor classification. A worker’s specialized skills are not necessarily indicative of independent contractor status unless “such skills are exercised in an independent manner.” Accordingly, a worker’s highly specialized technical skills must be paired with the ability to exercise “managerial and business skills.”
- The permanency of the relationship. “Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee.” An independent contractor will typically work on a non-continuous basis for the duration of an assignment, whereas an employee will work “until they quit or are terminated.” However, the key is being able to establish that the lack of permanence is due to the independent business initiative of the worker or the “operational characteristics that are intrinsic to the industry.”
- The degree of control exercised or retained by the employer. In our ever-changing technological environment, employers are now able to remotely “maintain stringent control over aspects of the workers’ jobs,” an advancement that the DOL suggests may encourage employers to misclassify workers as independent contractors. Where a worker controls “meaningful aspects of the work performed such that it is possible to view the workers as a person conducting his or her own business,” it is indicative of an employment relationship. Thus, the level of control that a worker exerts must be analyzed as part of determining whether a worker is “economically dependent on the employer.” Control may be manifested in several ways, including the ability to control the number of clients or to negotiate wage rate, schedule, and other elements of the relationship.
What Does this Mean for Employers?
The application of the “Economics Realities Test” in the context of the Act’s expansive view of “employ” has led to the finding that “most workers are employees under the FLSA.” While it remains to be seen whether courts will adhere to the DOL’s interpretation, employers are best-advised to understand it, in case courts use the DOL guidance in determining a worker’s classification.
The DOL’s interpretation points to the increasingly aggressive pursuit of enforcement actions against companies that use independent contractors. California, perhaps more so than any other state, has led in the efforts to eliminate misclassification of workers. In May of 2011, Governor Jerry Brown signed A.B 459 (link 3), a bill which called for the prohibition of willful misclassification and attached to each violation a heavy civil penalty ranging from $5,000-$25,000. This was followed by the passage of A.B 1897 (link 4), earlier last year, which extended liability to client employers who obtained workers from third party labor contractors.
On the legal front, the Ninth Circuit ruled earlier last year that FedEx had misclassified its drivers (link5) as independent contractors; not long thereafter, Fedex agreed to settle the matter for $228 million—one of the largest settlement cases in history. In June of this year, the California’s labor commissioner ruled that an Uber driver was an employee, and not a contractor. While the decision is not binding on all Uber drivers, it is anticipated to spark additional lawsuits. Already, three Uber drivers claiming to have been misclassified secured class-action status against Uber (link 6) on September 2nd. The decision by U.S District Judge Edward Chen to grant class-action status allows for the inclusion of all drivers who have contracted with Uber directly in California since 2009.
With federal agencies and courts increasing their scrutiny, the issue of worker misclassification continues to extend and intensify. Employer and business owners are prudent to carefully consider any contractor relationships to determine whether the classification meets the current standards established by the DOL and other reviewing agencies and courts.