Are You Really Sure You Have Hired an Independent Contractor?

blog1

Employee or independent contractor?  That question has been at the root of employment decisions and litigation for years.  The U.S. Department of Labor’s Wage and Hour Division (DOL) has now made its position clear: employers better be sure they are dealing with a genuine independent contractor before classifying a worker as such.

On July 15, 2015, the DOL issued an Administrator’s Interpretation (AI) that aims to curb independent contractor classifications.  In a nutshell, the AI concludes that “most workers are employees.”  The distinction is of course critical: unlike employees, independent contractors are not subject to the Fair Labor Standards Act’s overtime and minimum wage requirements and could be denied unemployment insurance and workers’ compensation benefits among other benefits of employment.  Employers who misclassify employees as independent contractors therefore risk violating the Fair Labor Standards Act (FLSA) and other state and federal laws.

The DOL’s Position

In concluding that most workers are employees, the AI focuses on the FLSA’s “very broad definition of employment.”  The FLSA defines “employ” as “to suffer or permit work.”  In examining that definition, courts have utilized the “economic realities” test to determine whether a worker is an employee or independent contractor.  When boiled down, the AI offers guidance on how to apply the economic realities test so as to define more workers as employees.

The economic realities test analyzes the following factors:

Whether the work being performed is an integral part of the employer’s business
Whether the worker’s managerial skills affect the worker’s opportunity for profit or loss;
Both the employer’s and the worker’s respective investments into facilities, equipment, etc.;
The amount of special skill and initiative the work requires;
The degree of permanency of the worker and employer relationship; and
The nature and degree of control the employer exercises over the employee.
The AI does not seek to change these factors, but rather directs that the factors be examined in totality to decide the ultimate question: whether a worker is truly in business for him or herself or is economically dependent on the employer.  According to the AI, no single factor should be given undue weight, but rather a qualitative rather than quantitative analysis should be applied.  The AI also rejects as irrelevant the parties’ understanding of the relationship or whether any agreement exists between the parties about how the worker should be classified.  The AI then provides examples of how to analyze each factor against “the overarching principle that the FLSA should be liberally construed to provide broad coverage for workers.”  Below are some brief summaries of the AI’s view on each factor.

Integral work.  While sticking to the notion that no single factor is determinative, the AI acknowledges that this particular factor is “compelling.”  The AI states that work can be integral to a business even if it is just one component of the business and/or thousands of other workers perform the same work.  It highlights a worker answering calls at a call center as an example of someone performing integral work, which is indicative of an employee.

Possibility of profit or loss.  This factor does not turn on whether a worker has the opportunity to work more or less hours, but rather whether he or she performs work that affects his or her opportunity for profit of loss beyond a current job.  The AI highlights that a worker who is truly in business for her or himself “faces the possibility of experiencing a loss.”  Examples of work indicative of an independent contractor are decisions to hire others, purchase materials and equipment, advertise, and rent space, as each of these factors could result in loss for the worker.

Worker’s/Employer’s investments.  This factor overlaps somewhat with the profit/loss factor in that, as the AI points out, a worker who makes some investment faces the possibility of a loss.  But the factor does not just look to the worker’s investment, but rather at the worker’s investment relative to the employer’s investment.  This factor, along with the examples the AI highlights, seems particularly skewed toward an employee classification because employers will almost always invest more into a business than either an employee or independent contractor.  But that does not matter according to the AI.  Incredibly, the AI even cites an example where a worker’s $35,000 to $40,000 investment was insufficient for an independent contractor classification in light of the employer’s substantially larger investment!

Special skill/initiative.   This factor focuses on a worker’s business skill, judgment, and initiative rather than her or his technical skills.  For example, it inquires whether the worker markets his services, determines when to order materials and how much to order, and determines which orders to fill.  By contrast, it dismisses highly advanced technical skill that does not involve independent judgment beyond the job site.

Permanency of the work relationship.  The AI seems particularly keen on interpreting this factor in favor of an employee classification.  It first states that independent contractors normally look to eschew permanent relationships whereas employees embrace them.  But it then warns that a lack of permanence in the relationship only indicates an independent contractor relationship where it is the result of the worker’s “independent business initiative” rather than “operational characteristics intrinsic to the community.”  In other words, if the relationship is permanent or at least ongoing for an indefinite period, it probably points to an employee finding.  But if the relationship is temporary, it still points to an employee finding unless the worker preferred it that way for business reasons.

Nature and degree of control exercised.  The AI attempts to downplay this factor’s significance, saying it “should not play an oversized role in the analysis of whether a worker is an employee or independent contractor.”  Nevertheless, a company’s exercise of substantial control over a worker is indicative of an employee finding.  And neither regulatory requirements nor a company’s desire to ensure customer satisfaction (e.g., by regulating how a worker dresses) are sufficient reasons to exert control over independent contractors.  If an employer exercises such control, it points toward the worker being an employee.

Take Away for Employers

Read in its entirety, the AI reflects the DOL’s unabashed attempt to significantly reduce independent contractor classifications.  That’s the bad news.  The good news is that the AI is only an interpretation rather than a regulation.  That is to say, it is not binding law.  It is not subject to the notice and public comment requirements that new DOL regulations must first go through.  It merely reflects the DOL’s current interpretation of independent contractor/employee classification law.  But there figures to be considerable discussion and possibly litigation over the amount of deference courts are required to give the AI.  Typically, courts do look to such administrative interpretations for guidance.  And at the very least it shows how the DOL views the issue and how it may decide misclassification claims it faces moving forward.

Employers who utilize independent contractors or who are considering classifying workers as such should review the AI carefully and make sure they fully understand how the DOL views workers.  Improperly classifying employees as independent contractors could result in substantial exposure for failure to pay minimum wages and overtime, failure to keep proper employment records, and several other violations of the FLSA and other statutes.  And the DOL has now made it clear that confronting misclassification issues head-on is at the forefront of its agenda.

Lukas Clary, Attorney at Law  |  Weintraub Tobin