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Use of Independent Contractors Presents Significant Legal and Business Risks

The benefits to businesses of classifying workers as independent contractors (and not employees) are many: lower taxes, greater freedom from government regulation, exemption from many laws governing the workplace, and potentially lower labor costs. The border between contractors and employees is blurry, however, and businesses must be careful to avoid misclassification, as significant liabilities may arise from getting it wrong: unpaid wages, liquidated damages, back taxes, disqualification of benefit plans, overtime liability, contributions to retirement plans, social security and FICA payments, and even criminal penalties (in rare circumstances).

In recent years, federal, state and local governments have ramped up enforcement efforts in this area, and lawsuits challenging workers’ classifications under the Fair Labor Standards Act (“FLSA”) and comparable state laws have become common. Plaintiffs’ lawyers have seized on the confusion caused by the multi-factored tests used under various statutes to evaluate whether a worker is an independent contractor or an employee. Few clear answers exist.

As part of its increased enforcement efforts in this area, the U.S. Department of Labor’s Wage and Hour Division recently announced that it will issue administrative guidance regarding the criteria that must be met to properly classify workers as independent contractors.  The guidance is expected some time this summer, and will likely seek to amend or expound upon the “economic realities” test that courts generally use to evaluate contractor status.  It is too early to tell whether the DOL’s guidance will make the analysis of the standards more or less clear, but the agency explained that the guidelines will seek to apply a “holistic process of assessment.”

“It is too early to tell whether the DOL’s guidance will make the analysis of the standards more or less clear, but the agency explained that the guidelines will seek to apply a holistic process of assessment.”

The “economic realities” test, in its current form, examines six factors:

1)      The extent to which the work performed is integral to the employer’s business;

2)      Whether the worker’s managerial skills affect his/her opportunity for profit and loss;

3)      The relative investments in facilities/equipment by worker and the employer;

4)      The worker’s skill and initiative;

5)      The permanency of the worker’s relationship with the employer; and

6)      The nature and degree of control exercised by the employer.

None of these factors are controlling, and courts are ultimately seeking to determine whether a worker is in business for him or herself, or whether the worker is economically dependent on the business. Simply having an agreement stating that a worker is an independent contractor is immaterial – the reality of the working relationship, not the label, is determinative.

The financial risks of misclassification are real: FedEx agreed to pay $228 million to settle a California lawsuit in which courts had determined that the company’s drivers were misclassified as independent contractors. Lowe’s also settled a claim involving the classification of its home improvement contractors for $10 million.

Fortune 500 companies are not the only targets, as similar misclassification lawsuits have been filed—and settled—against small and mid-market companies in a myriad of industries, including manufacturing, finance, wholesale, telemarketing, trucking and transportation, retail, janitorial, and many others.

A lawsuit filed by current or former independent contractors is not the only risk, as the DOL has aggressively sought to enforce independent contractor standards through investigations and audits, which may ultimately give rise to lawsuits filed by the DOL. Indeed, the DOL has requested budget increases for more than 300 new full-time enforcement positions, and has awarded $10.2 million to 19 states for worker misclassification detection and enforcement.

The administrator for the DOL’s wage and hour division plainly explained the agency’s goal when he recently wrote that, “we need to create ripple effects that impact compliance far beyond workplaces where we physically conduct investigations, or organizations to which we provide outreach directly. We need to continue to find ways to make our investigations of one employer resonate throughout that particular sector and influence the behaviors of employers across the entire industry…”

While it is difficult to predict the detail and scope of the DOL’s anticipated guidance on independent contractors, we expect that the agency’s viewpoint will be consistent with its stated intent to aggressively enforce independent contractor classifications. Businesses should be sure to carefully evaluate the DOL’s guidance and then review the classification of independent contractors in light of the new and existing standards.

Robert Whitman
Robert Whitman

Adam-Smiley-SmallRobert S. Whitman is a partner in the Labor & Employment department of Seyfarth Shaw LLP in New York. He can be reached at [email protected]. Adam J. Smiley is an associate in the Labor & Employment department of Seyfarth Shaw LLP in New York.  He can be reached at [email protected].



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