Yesterday, the U.S. Labor Department issued a proposed regulation addressing the classification criteria of workers as independent contractors or employees under the Fair Labor Standards Act (FLSA). Unlike regulations with hard and fast rules, this proposed regulation is in the nature of an administrative interpretation articulating the Labor Department’s view of the law. It analyzes decades of court decisions and seeks to issue a uniform interpretation of those cases for the courts to apply in the future. Yet at the same time, the proposed regulation includes a 90-page preamble that acknowledges that the courts have, with few exceptions, uniformly applied the test for independent contractor status under the FLSA. The proposed rule, therefore, if issued in final form, would provide little guidance to the public or the courts. But it will shine a brighter light on the issue of independent contractor misclassification. Companies would be wise to enhance their independent contractor compliance, such as in the manner noted in the “Takeaway” below.
The Proposed Regulation – What It Says
The first part of the proposed regulation would rescind all inconsistent or conflicting administrative rulings, interpretations, practices, and enforcement policies of the Labor Department relating to the classification of independent contractors and employees. This approach appears to be a means to eliminate rulings and opinion letters issued by prior administrations that viewed this issue differently. No list of such rulings is provided. So the public has no way of knowing if a prior ruling or opinion letter remains valid.
The next part of the proposed rule recites the time-honored principle under the FLSA that a worker is an independent contractor only if he or she is, as a matter of economic reality, “in business for him- or herself.” The proposed regulation then lists five factors to be examined, but states the five factors “are not exhaustive and no single factor is dispositive.” Essentially, the proposed rule provides five factors to be considered, but it acknowledges any factor related to the relationship between an individual and potential employer may be relevant. Notably, the courts under the FLSA have considered dozens of factors bearing on independent contractor status, and the proposed regulation therefore validates this type of broad judicial inquiry.
Of the five factors, the Labor Department’s proposed regulation refers to two as “core factors”: (1) the nature and degree of the individual’s control over his/her work; and (2) the individual’s opportunity for profit or loss. The regulation states these two core factors “are the most probative as to whether or not an individual is an economically dependent ‘employee,’ … and each is therefore afforded greater weight in the analysis than is any other factor.” While the proposed rule does not create a legal presumption, it does say that if both core factors point toward the same classification, whether employee or independent contractor, “there is a substantial likelihood that is the individual’s accurate classification.”
This is not a new way to analyze independent contractor status under the FLSA; rather, it is consistent with current jurisprudence. As the Department of Labor states in its lengthy preamble, “whenever [a federal] court found … that the potential employer predominantly controlled the work, that court concluded that the worker is an employee . . . ; conversely, whenever the court of appeals found … that the worker predominantly controlled the work, that court nearly always concluded that the worker is an independent contractor.” Similarly, the Labor Department observed in the preamble that “[t]his trend is also true, indeed even more so, for the opportunity for profit or loss factor.” Thus, the proposed rule merely recites what the courts have nearly uniformly held for many decades.
Under the control factor, the proposed rule restates many of the same conclusions that most courts have already articulated – that the following types of activities do “not constitute control that makes the individual more or less likely to be an employee under the Act”:
- requiring an individual to comply with specific legal obligations,
- satisfy health and safety standards,
- carry insurance,
- meet contractually agreed-upon deadlines or quality control standards, or
- satisfy other similar terms that are typical of contractual relationships between businesses (as opposed to employment relationships).
While the proposed regulation notes that requiring the individual to work exclusively for one company demonstrates control (which is consistent with court decisions), it considerably overstates the law when it says that requiring the individual, directly or indirectly, to work exclusively for a potential employer weighs in favor of the individual being an employee under the FLSA. Many legitimate independent contractors, for example, commit to one or more projects that require a concentrated, full-time undertaking to produce deliverables within a tight timeframe; that is hardly the type of control that should support employee status.
The profit or loss factor expands the manner courts have considered a worker’s investment. Some have examined only the worker’s financial investment. However, the proposed regulation would follow newer court decisions that also have examined the manner in which profits are maximized by the individual’s initiative.
Next, the proposed regulation addresses the three “other” factors: (1) the amount of skill required for the work; (2) the degree of permanence of the working relationship; and (3) whether the work is part of an integrated unit of production.
The amount of skill required factor fails to mention that many legitimate independent contractors do not have what some may refer to as a elevated skillset, yet they may have little or no economic dependence on a business. While some may think that taxi drivers, for example, do not have a high degree of skill, a number are very skillful and operate their own taxi business as independent contractors, as the courts have found over the years. Likewise, a doctor working for a hospital has elevated skills, but that does not make him or her an independent contractor if the hospital directs and controls his work while he or she works at a fixed salary in a hospital.
The degree of permanence factor in the proposed regulation failed to recognize that many independent contractor relationships are at least semi-permanent by choice of the worker: for example, a gardener who provides service weekly to a homeowner for 20 years; a distributor who chooses to operate his or her own business distributing another company’s products exclusively; and a tutor who provides frequent tutoring to the same family’s children throughout their school years.
The final factor recasts what the Labor Department currently states in its Fact Sheet 13 as “the extent to which the services rendered are an integral part of the principal’s business.” In the proposed rule, this factor is now characterized as whether the work “is part of an integrated unit of production.” As the proposed rule states: “This factor is different from the concept of the importance or centrality of the individual’s work to the potential employer’s business.” In this manner, the Department of Labor is seeking to change the focus of this factor, which historically has been given little weight by the courts anyway.
Finally, the proposed regulation addresses the “primacy of actual practice.” It states that a company’s actual practice is more significant than what is written in a purported independent contractor’s contract.
Analysis – What the Proposed Regulation Means
The Labor Department’s proposed regulation is perplexing. The rationale for the rule, as stated in its preamble, is that the courts have not applied uniform tests for determining independent contractor status. However, as noted above, the preamble acknowledges that virtually every time a court concludes that the two core factors favor one status, they rule in favor of that status. So in effect, the rationale for the rule is defied by its own analysis of court cases.
The proposed regulation is more in the nature of an opinion letter or Administrator’s Interpretation. It does not lay down new or clear-cut rules, but simply explains what each of the five factors mean to the Labor Department. The explanation in the preamble of each of the five factors is, however, extremely helpful by pointing out how the courts sometimes merge one factor with another.
This proposed rule may never become final if the upcoming election brings a new administration and a change in Congressional majority. There also is likely to be a legal challenge to the rule, if it were to become final, as there was to the Labor Department’s joint employer rule, which was recently stricken down by a federal court judge.
Of course, the Labor Department’s proposed rule has no application to the independent contractor status of workers under other federal laws, such as ERISA and the National Labor Relations Act, which have different classification tests. It also has no application to the classification of workers under state independent contractor tests, most of which vary considerably from the test under the FLSA.
Independent contractor compliance and misclassification has been front-page news of late due to the reformulation of the independent contractor test in California and now the U.S. Labor Department’s issuance of its proposed rule. It is even part of Vice President Biden’s platform. State workforce agencies and plaintiffs’ class action lawyers have continued to focus on companies that are out of compliance with federal and state independent contractor laws.
Many companies that utilize a number of independent contractors may be vulnerable to misclassification liability if they are not in a heightened state of compliance with applicable federal and state laws. Some companies have resorted to a process such as IC Diagnostics™ to elevate their level of compliance with independent contractor laws. Companies willing to reevaluate their compliance in this area can, consistent with their current business model, restructure, re-document, and re-implement their independent contractor relationships in a manner that is customized and sustainable.