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Department of Labor’s Recent Interpretation Dramatically Changes the Independent Contractor Classification

Labor & Employment Law Alert Kerry M. Mohan, Sean M. Scullen, Michael Aldana

On the heels of its highly anticipated proposed revisions to the "white collar" overtime exemptions in the Fair Labor Standards Act (FLSA),1 the Department of Labor (DOL) recently issued an Administrative Interpretation (AI) that addresses the issue of independent contractors and their status as "employees" under the FLSA. In its guidance, the DOL noted its position that "most workers are employees under the FLSA" and that independent contractor classification is overused and improper in most cases. While an AI does not have the force of law, it is a strong indication of the DOL’s enforcement position and could limit employers' ability to utilize the independent contractor classification moving forward depending on the amount of deference given to the guidance by the courts.

The DOL's View On Independent Contractors

Claiming that employers have misclassified employees as independent contractors on an increasing basis to cut costs and avoid paying minimum wage, overtime compensation, unemployment insurance, and workers' compensation, the DOL's guidance seeks to move away from the prior focus on "control" and instead impose a revised "economic realities" test to determine whether an individual is an employee or independent contractor under the FLSA. The "economic realities" test focuses on "whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor)." Thus, the guidance suggests that the label an employer gives an individual, or an agreement stating an individual is an "independent contractor," is not determinative of "the economic realities of the working relationship and is not relevant to the analysis of the worker's status."

The Economic Realities Test

To evaluate the "economic realities," the DOL looks to the following six factors to determine whether the individual has sufficient economic independence to operate a business on his or her own or is economically dependent on the employer to be an employee:

  1. The extent to which the work performed is integral to the employer's business: This factor focuses on whether an individual performs work that the employer is in the business of providing. Consequently, the fact that the work is "just one component" of an overall operation, can be performed by "hundreds or thousands of other workers," or can be performed away from the employer's premises is not dispositive. Of particular importance is whether work that was once performed by employees is now performed by independent contractors. If so, the DOL notes that it will consider that work to be integral and the individuals likely to be employees.
  2. Whether the worker's managerial skills affect his or her opportunity for profit or loss: Rejecting the argument that an individual's ability to work more or fewer hours at their discretion equates to opportunity for profit or loss, the AI focuses on the individual's "managerial skills" and whether "those skills affect the worker's opportunity for both profit and loss." For instance, the DOL will consider if an individual uses "managerial skills" to obtain numerous clients, as opposed to one, and thus to determine whether the individual is in business for him or herself or is instead economically dependent on a single employer.
  3. The relative investments in facilities/equipment by the worker and the employer: Ignoring the fact that an employer's investment in facilities and equipment is exponentially more than an individual's, the DOL argues that this factor should involve a comparison between the individual's investment and the employer's overall investment. Thus, if an individual's investment is "relatively minor" compared to the employer's, the DOL will consider that to weigh in favor of the individual being an employee as opposed to an individual contractor.
  4. The worker's skill and initiative: This factor focuses on an individual's "business skill, judgment, and initiative," as opposed to his or her technical skills. Thus, the individual's business acumen in operating an independent business, not certifications or experience, would be controlling in evaluating this factor.
  5. The permanency of the worker's relationship with the employer: Speaking out of both sides of its mouth, the DOL states that "permanence or indefiniteness . . . suggest that the worker is an employee," but the "lack of permanent or indefiniteness does not automatically suggest an independent contractor relationship." Moreover, the DOL states that "permanence or indefiniteness" can exist even if the working relationship lasts only weeks or months, instead of years. In other words, unless the individual knowingly works for a limited time period or a set number of projects, the DOL will likely find him or her to be an employee.
  6. The nature and degree of control exercised by the employer: As previously noted, the DOL has reduced this factor's significance, stating that the amount of control, or lack thereof, "should not play an oversized role in the analysis." Accordingly, the DOL has attempted to minimize the fact that an individual may be working offsite, at home, at his or her own hours, and/or with little to zero supervision in evaluating whether an individual is an independent contractor or employee.

Although the DOL claims that no one factor is controlling, and additional factors pertinent to the specific factual situation may also be considered, the DOL's interpretation is clearly slanted in a manner intended to limit those who can be classified as "independent contractors." Indeed, the DOL's interpretation states:

The very broad definition of employment under the FLSA as "to suffer or permit to work" and the Act's intended expansive coverage for workers must be considered when applying the economic realities factors to determine whether a worker is an employee or an independent contractor.

Employers can expect in connection with a DOL audit or in litigation (whether the DOL is suing the employer directly or merely interceding in misclassification claims) that the DOL's determination of "employee" versus "independent contractor" will almost always fall in favor of employee status.

What Does This Mean For Employers?

Coming only weeks after the DOL's proposed changes to FLSA's overtime rules, the DOL's latest AI makes clear its broader policy and enforcement goals: to cover as many workers as possible under the umbrella of the FLSA. Aggressive enforcement will not only have a significant impact on the way companies do business, but could lead to numerous class and collective actions alleging that workers have been misclassified as independent contractors.

Because the DOL's AI is merely interpretive guidance and does not carry the weight of a statute or regulation, it remains unclear as to whether, and to what extent, the AI will influence court ruling in misclassification cases. Nonetheless, the DOL's AI is clear: It intends to limit employers' ability to classify individuals as independent contractors, increasing the number of individuals covered by the FLSA's minimum wage, and overtime protections. Accordingly, employers who utilize independent contractors should thoughtfully consider the AI and be prepared to defend their use against allegations of misclassification. The DOL, plaintiff's lawyers, and other governmental entities could seek back wages related to minimum wage and/or overtime payments, employee benefits, and/or other protections provided to employees by Federal and state laws.

For more information or assistance complying with the FLSA or related state wage and hour laws, please contact Kerry M. Mohan at (608) 283-2620/kerry.mohan@quarles.com, Sean M. Scullen at (414) 277-5421/sean.scullen@quarles.com, Michael Aldana at (414) 277-5151/michael.aldana@quarles.com, or your Quarles & Brady attorney.