With an increasing number of misclassification suits filed against high profile companies such as Uber and FedEx, many businesses are concerned that they will be the next to make headlines. Every business that uses independent contractors has potential exposure for worker misclassification litigation.
Worker classification issues are not new, but have become more prevalent for businesses in the “gig economy” which are modeled around non-traditional work arrangements. Additionally, the U.S. Department of Labor (DOL) and various states’ departments of labor are aggressively pursuing worker misclassification suits.
Whether workers are classified as independent contractors or employees makes a dramatic difference. If they are employees, they are entitled to overtime, expense reimbursement, leave, workers’ compensation and unemployment, among other benefits; if they are independent contractors, they are not entitled to any of these benefits or the legal rights that are afforded to employees. The distinction also has significant tax implications. Misclassifying employees creates exposure for retroactive payment of such benefits.
Saying that exposure for misclassification is significant is an understatement. Earlier this year, the ride-sharing company, Uber, settled two class action lawsuits brought by drivers in California and Massachusetts who alleged that they were misclassified as independent contractors. The suits settled for $100 million, allowing Uber to continue to treat those drivers as independent contractors. The settlement left unanswered the million-dollar-question (or more accurately, the billion-dollar-question) of whether its drivers are employees or independent contractors. Uber now faces yet another class action brought by its drivers in states other than California and Massachusetts who challenge their classification as independent contractors.
More recently, a competing ride-sharing company, Lyft, settled a similar driver misclassification class action suit for $27 million.
Additionally, FedEx recently announced a settlement of a class action suit brought by drivers it had classified as independent contractors for $240 million. FedEx has faced a number of blows in recent cases where the court concluded that its drivers were misclassified as independent contractors in California and Kansas.
Given the high exposure for worker misclassification and the increase in misclassification litigation, it is important that businesses correctly classify their workers.
Our Current Classification System
For decades, the courts have applied an “economic realities” test to determine whether a worker is an employee or independent contractor under the Fair Labor Standards Act (FLSA). This test has six factors:
- Whether work is an integral part of the putative employer’s business
- Whether the worker’s managerial skill affect the worker’s opportunity for profit or loss
- Comparing the relative investment to the putative employer’s investment
- Whether the work performed requires special skill and initiative
- Whether the relationship between the worker and the putative employer is permanent or indefinite
- The nature and degree of the putative employer’s control
The courts have traditionally held that no single factor is determinative. However, recently, the DOL Wage and Hour Administrator issued an interpretation regarding the classification of independent contractors and employees under the FLSA and the Family Medical Leave Act (FMLA). The Administrator’s interpretation did not add any new factors to the test, but seeks to allocate more weight to some factors over others—a significant shift from the courts’ long-standing application of the test.
For example, with respect to the first factor, the Administrator seeks to give significantly heightened weight to whether a worker performs activities that are integral to the business, referring to this factor as “compelling.” The Administrator also seems to broadly construe the term “integral,” considering activities performed off the business’ premises or at workers’ homes to be integral.
Regarding the second factor, the Administrator explains that a worker’s managerial skill will often affect opportunity for profit or loss beyond the current job, such as by leading to additional business from other parties or by reducing the opportunity for future work. For example, a worker’s decision to hire other workers, purchase materials and equipment, advertise, rent space and manage schedules may reflect managerial skills that will affect his or her opportunity for profit or loss beyond a current job. The Administrator accords a worker’s ability to work more hours and a worker’s substantive skills no weight, looking only at a worker’s managerial skills.
As for the third factor, the Administrator opines that the worker’s investment must be significant relative to the employer’s investment in its overall business in order for the worker to be an independent contractor – not just the particular job performed by the worker. This is a departure from the courts’ historical application of this factor.
Moving on to the fourth factor, the Administrator opines that even workers with specialized skills are not independent contractors unless they exercise business skills, judgment or initiative in operating an independent business. However, historically, the courts have focused on a worker’s skills to provide services.
As for the fifth factor, it seems the Administrator takes the position that the worker must have a degree of input as to when the working relationship ends for the worker to be an independent contractor.
Finally, with respect to the sixth factor, the degree of control over the worker, the Administrator gives this factor minimal weight. This is contrary to decades of case law that gave control a great deal of weight.
The Administrator essentially disregards items that the courts have historically treated as significant, such as whether the worker controls his own hours, has little or no supervision and decides what tools and equipment to buy. The Administrator also did not allow public comment (as typically has been done with proposed changes).
The Administrator concludes that “most workers are employees under the FLSA.” This aggressive interpretation broadly expanded the FLSA, which is the federal legislation governing wage and hour law for employees, including minimum wage and overtime. It also expands the reach of the FMLA, to which the Administrator’s interpretation also applies.
Other administrative bodies and statutes look at similar factors to address worker classification.
If courts adopt this guidance, it presents considerable exposure for misclassification suits to businesses using workers misclassified as independent contractors. Even if the courts do not adopt this guidance, the guidance alone will provide increased motivation for workers to allege misclassification claims.
Thinking Ahead: Should There Be A Third Classification?
Our economy has changed significantly since traditional employee and independent contractor classifications came about. Many of today’s businesses across various industries are modeled upon non-traditional work arrangements. For example, ride-sharing companies, such as Uber and Lyft, and grocery shopping company, Instacart, primarily use independent contractors to perform their services.
The prevalence of worker classification issues in the “gig economy” has prompted some to consider a new type of classification to keep up with our new world.
Some have contemplated a third, hybrid classification, which allows businesses to maintain some control in exchange for paying certain expenses and workers’ compensation, while at the same time not being deemed an “employer” of such workers. While this has been implemented in other countries such as Canada, Germany and France, we will have to see if the U.S. follows suit.
Minimizing The Risk of Misclassification
Proper worker classification is critical. Classifying workers as independent contracts is often financially attractive to businesses, who can avoid paying for taxes and benefits for such workers. However, businesses must be mindful not to be short-sited to save some money now, only to pay big dollars for litigation, penalties and fees later. Here are a few tips to help businesses proactively reduce the chances of worker misclassification:
- Become familiar with the factors to determine whether a worker is an independent contractor or employee
- Conduct an audit of your current workforce to identify and remedy potential misclassifications and take action
- Avoid using independent contractors for work that is integral to your business or beware that using such designated workers for your core business could lead to misclassification
- Avoid using independent contractors to perform the same work as employees
- When engaging an independent contractor, consider engaging such individuals who have their own businesses and work with other businesses, which can help show that they are independent contractors
- Pay attention to how much control you exert over workers that you have classified as independent contractors
- Understand that simply referring to a worker as an “independent contractor” does not make them so. Similarly, having an “independent contractor agreement” will not prevent a court from finding that a worker is an employee
A tremendous number of misclassification suits with vast exposure continue to be filed against many businesses. Much of these suits can be attributed to our changing economy. While we may eventually adopt a new worker classification system, for now, it is critical for employers to proactively manage this exposure by carefully assessing their workforces.