The Department of Labor's "Economic Realities" Test Affects Your Workforce

By of Simpson Delmore Greene LLP posted in Employment Law-Employer on Thursday, October 1, 2015.

The Department of Labor's "Economic Realities" Test Affects Your Workforce: Time to Review the Status of Your Workers

Summary: Earlier this summer, the Department of Labor ("DOL") issued an Administrator's Interpretation (No. 2015-1) that utilized the "economic realities" test to conclude that "most workers classified as independent contractors are employees" under the Fair Labor Standards Act's ("FLSA") broad definitions. While the economic realities test is not yet binding case law on the courts, the test employs six factors that we expect California courts and administrative agencies will use to assess misclassification claims. Employers should carefully review their workers' employment status as the DOL embarks on more enforcement actions and plaintiff's attorneys continue to pursue substantial awards, fees, and penalties.

Discussion: The DOL relies upon the "economic realities" test to determine whether a worker has been misclassified as an independent contractor, which is based on the FLSA's "suffer or permit" standard. This means that any worker who is "economically dependent on an employer is suffered or permitted to work by the employer," and thus should be classified as an employee.

The DOL outlines the following factors in the "economic realities" to determine a worker's employment status:

1. Integral to the Employer's Business

The first factor is whether the worker's performance is an "integral part of the employer's business." The DOL concludes that if a worker performs services that the company is in the business of providing, the worker is more likely to be considered an employee. The Interpretation provides an example of a construction company that frames residential homes as its primary business. Because carpenters are integral to the employer's business, they are employees. Conversely, if the construction company contracts with a software developer to create construction bid software, the developer would not be an employee because software development is not the company's primary business. For companies that provide a variety of products or services, this factor may be problematic. The bottom line is that if your company uses an independent contractor that performs the same or similar job functions as your company employees, then that worker is likely misclassified under the DOL's economic realities test.

2. Managerial Skill Affecting Profit or Loss

The second factor the DOL considers is whether the individual's "managerial skill" affects his or her opportunity for profit or loss. A worker who has the opportunity to hire others or purchase equipment and materials in order to increase his or her profit is more likely to be considered an independent contractor. Conversely, a worker who increases his or her compensation by working more hours and exercises minimal managerial skill is likely an employee. The DOL Interpretation provides an example of a cleaning service where a worker does not schedule his own cleaning assignments or solicit work from other clients, but rather performs cleaning assignments as determined by the company. In such scenarios, the worker does not exercise managerial skill that affects his profit or loss, as his earnings fluctuate based on his completion of the scheduled hours of work. The DOL makes clear that this lack of managerial skill is indicative of an employment relationship between the worker and the company. If your company dictates the "what, where, when, and how" of a worker's daily schedule, then that worker is more likely an employee.

3. Investment Comparison

In the third factor, the DOL examines the nature and extent of the relative investment of the employer and worker in determining the worker's employment status. The DOL's Interpretation provides the same example of a worker at a cleaning service. The worker occasionally brings some of his own preferred cleaning supplies to certain jobs, but he uses the company's insurance, vehicle, equipment, and supplies. The company invests in advertising and client solicitation. In this scenario, an employment relationship exists because of the relatively minimal investment of the worker (preferred cleaning supplies) compared to the employer's investment (insurance, vehicle, supplies, and advertising). The DOL surmises that the worker's investment in cleaning supplies does little to further a business beyond that particular job; whereas, the company's investment furthers its broader business purposes. Accordingly, we advise employers to carefully audit the level of financial support they provide independent contractors.

4. Special Skill and Initiative

Furthermore, the DOL's Interpretation also suggests that courts and administrative agencies should examine the worker's business skills, judgment, and initiative, rather than his or her technical skills, to determine whether the worker is economically independent. The Interpretation provides an example of a carpenter who does not make any independent judgments at the job site beyond the work that he is doing for that job; he does not determine the sequence of work, order additional materials, or think about bidding the next job, but rather is told when and where to perform specific tasks. In this scenario, the carpenter, although highly-skilled, is not demonstrating the skill and initiative of an independent contractor (such as managerial and business skills). The DOL concludes that he is simply providing his skilled labor and therefore performs his duties in an employment relationship. The DOL's assessment of this factor challenges many independent contractor relationships where a specific skill set is desired by the company: employment recruiters; IT professionals; technical writers; marketing and advertising professionals; and skilled construction workers.

5. Permanent or Indefinite Relationship

The permanency of the relationship between the worker and the company is also a factor in the classification assessment. A long-term relationship between the parties suggests the worker is an employee. For example, an editor who has worked for an established publishing house for several years and whose work is completed in accordance with the publishing house's specifications is most likely in an employment relationship regardless of the freedom and autonomy the company states the editor retains. According to the DOL, an independent contractor, "typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer." Often, companies confuse autonomy and freedom as indicators of an independent contractor relationship: "We don't care how many hours you work as long as the work gets done . . . but you have to show up the office to perform the work the way we specify." Under the economic realities test, it is important that your company pays particular attention to the direction and responsibilities provided to independent contractors.

6. Nature and Degree of Employer's Control

The final factor in the DOL's economic realities test (and historically the most important) analyzes whether the worker controls meaningful aspects of the work performed such that it is possible to view the worker as a person conducting his or her own business. The DOL specifically states that the "control" factor should not play an outsized role in the analysis of whether a worker is an employee or an independent contractor. The reason for this is to guard against employers who willfully do not inquire about the working conditions of their employees. For example, an employer's lack of control over workers is not particularly telling if the workers work from home. In such cases, the employer permits the offsite work and forsakes direct supervision. The DOL notes that an employer cannot willfully shirk control to avoid an employment relationship.

Concluding Thoughts and Recommended Action

The most important aspect of the DOL's Interpretation is the conclusion: "most workers are employees under the FLSA's broad definition." While the DOL's opinion is the trend in judicial opinions, the Interpretation is not yet binding authority on California or federal courts. Regardless, we expect courts as well as state and federal agencies to give deference to the Interpretation and its reasoning. As such, companies should review their independent contractor relationships against the interpretations in the memorandum and re-evaluate those relationships vulnerable to the DOL's broad interpretation.

Based on the Interpretation, we recommend the following:

Do not assume all workers may be classified as independent contractors. Regularly review the classification given the current law and changing work duties and circumstances of the workers;

Ensure all agreements with contractors contain specific indemnity provisions addressing wage and hour liability and are general in how the work is to be performed;

Permit the contractor to take other jobs and expressly state this freedom in the agreement;

Ensure the is contractor responsible for his or her tools, equipment or supplies;

Terminate contractors only for material breach or with proper notice under the contract terms;

Train your employees to communicate properly with contractors and ensure they are not directing the means of how contractors perform their work;

Review whether the contractor has a separate business license, insurance coverage, and contracts with other businesses;

Ensure contractors do not perform functions that are integral to your business or involve direct service to your customers.