In a move that seeks to fundamentally change and limit who can be considered an independent contractor under the Fair Labor Standards Act (FLSA), the federal Department of Labor issued a memo on July 15 drastically revising the test for such classification. Under the new guidance, the DOL concludes that “most workers are employees under the FLSA’s broad definitions,” and then provides an interpretation of the standard that would disqualify many workers from independent contractor status that are currently so classified. If this interpretation is adopted by courts (which is unclear) and applied by the DOL in its investigations and enforcement actions (almost certainly), large segments of the workforce currently treated as independent contractors will likely be held to be employees, which has significant payroll, compensation, and other legal implications for companies who currently rely on independent contractors for their business.
Background and Summary
The FLSA is the federal statute setting forth minimum wage and overtime requirements. It defines “employ” as “to suffer or permit to work,” a frustratingly vague definition which has been subject to much debate and interpretation in the decades since the statute’s enactment. The DOL and certain courts have used an “economic realities” test to determine whether an individual is “employed” under the FLSA or, in this context, is properly classified as an independent contractor. The economic realities test historically looks at multiple factors, with none being dispositive, and a significant body of case law has developed providing guidance to businesses as to who qualifies as an independent contractor.
The DOL purports to change this established test, not through a new test or new regulations which would require public comment and scrutiny, but through a dramatic reinterpretation. The most significant changes are as follows:
Whether work is an integral part of an employer’s business: Seeking to adopt a version of the “ABC” test used in some states, the DOL will now give added weight to whether a worker is performing functions integral to an employer’s business. If the answer is “yes,” the DOL considers such evidence to be “compelling” that the worker is an employee and not a contractor. The DOL further explained that “integral work” can be “just one component of the business,” giving it a broad interpretation that would capture more workers currently considered independent contractors. The takeaway for this factor is the DOL has both expanded the definition of “integral work” and will give it greater weight.
The nature and degree of a putative employer’s control: Historically, the control – or lack thereof – a business had over an independent contractor has been an, if not the most, important factor in analyzing status. The DOL memo gives this factor minimal weight and seeks to devalue its significance in the overall analysis. Thus, for example, workers who have little supervision and physically work outside the employer’s place of business are now more likely to be determined by the DOL to be employees based on the revised test. This is major departure from past precedent.
Whether work performed requires special skill or initiative: As previously applied, courts and the DOL would look at whether the work performed required “skill or initiative” and – if “yes” – that was a significant factor in concluding that the worker was an independent contractor. Now, according to the DOL, the factor requires more, and an examination of whether the worker uses “business skills, judgment, or initiative.” This insertion of “business” suggests the inquiry should be on the worker’s business acumen, as opposed to the traditional look at the skills he or she possessed.
Whether a worker’s skills affects the opportunity for profit or loss: Historically, this factor has focused on all methods by which individuals can affect their profit or loss, with particular emphasis on individuals’ skill. Now, the DOL has shifted the analysis to focus on individuals’ “managerial” ability to affect profit or loss, as opposed to skill or other methods. This is another example where the DOL has modified a factor to focus on managerial and business acumen, rather than specialized skill of the individual, which disregards the reality that contractors in business for themselves may not want management responsibilities.
Business’s Investment v. Worker Investment: The DOL’s memorandum provides that the analysis of this factor should be a comparison of the business’s investment with the worker’s investment. The DOL expects the worker’s investment to be “significant,” even when compared to the business’s investment, and a worker’s investment in tools and equipment will not necessarily be treated as a business investment.
Implications for Employers
The DOL’s new interpretation of who qualifies as an independent contractor calls into question most independent contractor arrangements. While there remains the question of whether courts will adopt this analysis either in cases brought by the DOL or private party plaintiffs (and some federal courts have previously rejected other efforts by the DOL of perceived overreach in its interpretation of statutes), the DOL will clearly be applying it in their enforcement actions and investigations. If nothing else, this memoranda will be quoted liberally by plaintiffs’ lawyers in briefs and arguments to courts, and provide another source for courts to find workers misclassified as independent contractors. Over the past several years, independent contractor misclassification claims have become a hot button issue for federal and state governments, as well as plaintiff class action lawyers, and this interpretation will only fuel that trend.
Businesses with meaningful reliance on independent contractors should strongly consider consulting with legal counsel to assess how this interpretation impacts the classification. Businesses may wish to re-evaluate these arrangements or seek to alter them to better conform with the DOL’s revised guidance. Businesses will also want to consider other measures to limit exposure. If you would like more information, please contact Jonathan S. Krause at 215.569.4496 or JKrause@klehr.com.