On the heels of its newly-proposed overtime regulations, the U.S. Department of Labor (DOL) has issued new guidance which suggests that very few workers in the U.S. are properly classified as independent contractors. While the DOL official responsible for the guidance maintains that this is not a change in the Agency’s policies or regulations, statements like “an agreement between an employer and a worker designating or labeling the worker as an independent contractor … is not relevant to the analysis of the worker’s status” suggest otherwise.
In the Administrator’s Interpretation (No. 2015-1) issued on July 15, 2015, DOL Administrator David Weil contends that “ [m]isclassification of employees as independent contractors is found in an increasing number of workplaces in the United States….” He goes on to say that when such misclassification occurs:
“…the employees may not receive important workplace protections such as the minimum wage, overtime compensation, unemployment insurance, and workers’ compensation … [and it] results in lower tax revenues for government….”
To address this, he recommends a new perspective on the “economic realities” test used by courts — and employers alike — to determine whether an individual is an employee or a contractor. In this regard, Mr. Weil states that the Fair Labor Standards Act (FLSA) defines the word “employ” as “to suffer or permit to work.” He says that this extremely broad definition and the later court-developed economic realities test must, in essence, be combined and applied to each independent contractor working today to determine if there has been a misclassification under FLSA. As Mr. Weil describes it:
“In order to make the determination whether a worker is an employee or an independent contractor under the FLSA, courts use the multi-factorial “economic realities” test, which focuses on whether the worker is economically dependent on the employer or in business for him or herself. A worker who is economically dependent on an employer is suffered or permitted to work by the employer. Thus, applying the economic realities test in view of the expansive definition of ‘employ’ under the Act, most workers are employees under the FLSA.”
Economic Realities Test Reinterpreted
In order to determine whether a worker is “economically dependent” on an employer (and thus an employee), the DOL Administrator offers a new interpretation of six typical factors assessed in the economic realities test, i.e.:
- the extent to which the work performed is an integral part of the employer’s business;
- the worker’s opportunity for profit or loss depending on his or her managerial skill;
- the extent of the relative investments of the employer and the worker;
- whether the work performed requires special skills and initiative;
- the permanency of the relationship; and
- the degree of control exercised or retained by the employer.
By selectively choosing (and selectively quoting) prior case law, Mr. Weil crafts what we believe to be an entirely new interpretation of the test, while at the same time claiming that this interpretation has existed for years. The following is a brief synopsis of Mr. Weil’s view of the test’s six factors.
- Is the Work an Integral Part of the Employer’s Business?
In many jurisdictions, the application of this factor has been described as determining whether a worker’s services are central or vitally important to the business. In other words, if the worker’s services were so intertwined with the employer’s overall business, it suggests that the worker is subject to direction and control of the employer and, thus, an employee.
The new guidance seems to acknowledge this interpretation by giving basic examples “integral work” as including: 1) work performed by cake decorators for a business that sells custom-decorated cakes; and 2) harvesting cucumbers for a pickle business. However, Mr. Weil went a step further, stating (without any case citations) that work can be integral to a business “even if the work is just one component of the business and/or is performed by hundreds or thousands of other workers.” In support of this, he states:
“… a worker answering calls at a call center along with hundreds of others is performing work that is integral to the call center’s business even if that worker’s work is the same as and interchangeable with many others’ work. Moreover (and especially considering developments such as telework and flexible work schedules, for example), work can be integral to an employer’s business even if it is performed away from the employer’s premises, at the worker’s home, or on the premises of the employer’s customers.”
- Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
In many existing cases examining this factor, it has been interpreted and applied in a very simple, straightforward manner; i.e., if the worker can make a profit or suffer a loss, the worker may be an independent contractor. Employees, not independent contractors, are typically paid for their time and labor and have no liability for business expenses. Thus, those who do have such liability would generally satisfy this requirement.
The key to understanding the Administrator’s interpretation of this factor is understanding his use of the phrase “Worker’s Managerial Skill.” He states that in order to determine whether a worker is truly independent, “this factor should not focus on the worker’s ability to work more hours, but rather on whether the worker exercises managerial skills and whether those skills affect the worker’s opportunity for both profit and loss.” Examples of these managerial skills cited by the Administrator include decisions to hire others, purchase materials and equipment, advertise, rent space, negotiate contracts, and manage time tables.
- How Does the Worker’s Relative Investment Compare to the Employer’s Investment?
Prior to this guidance, it was fairly well-understood that this factor required that a truly independent contractor should make an investment (and therefore undertake at least some risk for a loss) in support of his/her business. Such investment might include the worker owning or leasing their equipment and tools for performing his/her work. Generally speaking, the greater the investment, the more likely the worker would be considered independent.
The Administrator, again, goes well beyond this prior analysis. He describes these investments as including money spent to further the independent contractor’s capacity to expand his/her business, reduce its cost structure, or extend the reach of his/her market. Moreover, he states that “[a]n analysis of the workers’ investment, even if that investment is substantial, without comparing it to the employer’s investment is not faithful to the ultimate determination of whether the worker is truly an independent business.” This suggests that even if the investment is large for the worker (given his/her annual sales volume, for example), if it is small in comparison to the size of the investment that the purported employer has made in its business, the DOL is less likely to find the worker to be truly independent.
- Does the Work Performed Require Special Skill and Initiative?
In the past, this factor has been interpreted as involving an analysis of the unique skill set of the worker. Stated differently, independent contractors have the technical skills necessary to do a particular job (like a carpenter knows how to build a bookcase) and do not need instruction or training from the hiring entity on how to perform their work. Under this view, workers were less likely to be considered independent contractors if they received such instruction or training.
This new guidance rejects this concept entirely. The Administrator states that “[a] worker’s business skills, judgment, and initiative, not his or her technical skills, will aid in determining whether the worker is economically independent.” Using the carpenter example, he states that:
“a highly skilled carpenter who provides a specialized service for a variety of area construction companies, for example, custom, handcrafted cabinets that are made-to-order, may be demonstrating the skill and initiative of an independent contractor if the carpenter markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill.”
- Is the Relationship between the Worker and the Employer Permanent or Indefinite?
This factor has generally been interpreted as meaning that a continuing relationship between the worker and employer suggests that an employment -- and not an independent contractor -- relationship exists.
While the new guidance concedes that permanency and indefiniteness in the relationship suggest that a worker is an employee, the Administrator states that “a lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship….” He goes on to explain that the key is whether the lack of permanence or indefiniteness is due to “operational characteristics intrinsic to the industry” or the worker’s “own business initiative.” In other words, the lack of a permanent or indefinite relationship with an employer is indicative of independent contractor status only if it results from the worker’s own independent business initiative (e.g., accepting work from other entities which prevents the worker from continuing the relationship with the first entity).
- What is the Nature and Degree of the Employer’s Control?
The most noteworthy difference between the new guidance and traditional interpretations of this factor is that the Administrator downplays its significance. While many court decisions on the question of misclassification turn on the nature and degree of an employer’s control over a worker (e.g., giving instructions, providing training, setting hours of work, requiring oral or written reports, etc.), the Administrator states that “the ‘control’ factor should not play an oversized role in the analysis of whether a worker is an employee or an independent contractor. All possibly relevant factors should be considered, and cases must not be evaluated based on the control factor alone.”
As with the other factors, he does not stop there. He adds that “[s]ome employers assert that the control that they exercise over workers is due to the nature of their business, regulatory requirements, or the desire to ensure that their customers are satisfied. However, control exercised over a worker, even for any or all of those reasons, still indicates that the worker is an employee.” In other words, regardless of the reason that an employer may regulate the behavior of a contractor (be it for quality control purposes or compliance with governmental regulation) it is still “control” that suggests an employment relationship.
While this publication is only an Administrator’s Interpretation and not a new law or regulation, it still presents a problem for companies that do business with independent contractors. First and foremost, the guidance provides insight into how the DOL will enforce the FLSA with respect to misclassification going forward. Second, courts will often defer to administrative agency opinions when confronted with cases that correspond to the issues addressed in these publications. In other words, the guidance can both change how the law is enforced and interpreted without ever being subjected to public or judicial scrutiny. Accordingly, all companies that do business with independent contractors should work closely with an experienced employment law attorney to weigh the risks associated with those relationships and to develop any necessary alternatives.
If you have any questions about this new guidance, please do not hesitate to call us.