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- Artificial Intelligence Could Create Wage and Hour Risks for the Unwary
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- Employers Beware: Most Highly Compensated Employees Still Must Meet the FLSA’s Salary Basis Test to Be Exempt from Overtime Pay
- Sixth Circuit Set to Weigh in on the Current, Burdensome Two-Step Collective Action Standard
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In a world where a $105M settlement of an independent contractor misclassification lawsuit[i] is just another 9-figure headline, businesses cannot afford to take independent contractor misclassification risks lightly. The landscape surrounding the classification of employees versus independent contractors is continually evolving. This moving target poses a challenge for businesses throughout the United States and especially those operating in multiple states.
States like Illinois, California, New Jersey, and Connecticut have adopted the stringent “ABC Test” to determine the classification of employees versus independent contractors for wage and hour purposes. The ABC test generally requires each of the following to be met before an individual can be classified as an independent contractor.
- Prong A: The worker must be free from control and direction in the performance of their work, both according to the contract and in actual practice.
- Prong B: The work performed by the worker must be outside the usual course of the employer’s business. In some states, this prong can also be met if the work is performed outside all of the employer’s places of business.
- Prong C: The worker must be engaged in an independently established trade, occupation, profession, or business.
Increasing the risk, courts in states like Illinois have even held that these strict laws can apply to workers outside of the state if they perform any amount of work within the state.[ii]
Adding complexity to the situation, the U.S. Department of Labor is anticipated to soon publish a final independent contractor rule, following a lengthy comment period on its proposed rule, originally reported here. That final rule is anticipated to make it more challenging to classify individuals as independent contractors under the Fair Labor Standards Act (“FLSA”). In short, compliance has never been more crucial.
Five Tips for Success
To help employers navigate these challenges, we present five “outside-of-the-box” tips for employers that could find themselves subject to the ABC Test. Some of these strategies may push the proverbial envelope and should be approached with caution and with the guidance of experienced legal counsel.
1. Clearly Define or Redefine the Core of Your Business
- Objective: Establish that the work performed by independent contractors is “outside the usual course of the employer’s business.”
- How to Implement:
(1) Segment and Define Services: Divide your services into clearly defined categories. For instance, a residential and commercial contracting firm properly classified a historic restoration specialist as an independent contractor. The firm previously defined itself as focusing on historic restoration but later “evolved into a general contracting firm” doing general remodeling and construction. While it still advertised historic restoration as a capability, it only engaged in that work sparingly as specialty work through use of an independent contractor.[iii] Similarly, a tech support company might employ full-time workers for inbound support calls and independent contractors for special projects or less frequent tasks.
(2) Update Work Descriptions: Make sure the job descriptions for your employees and scope of work descriptions for your contractors distinctly outline their roles and functions, showing the two groups perform fundamentally different tasks.
Note: How a business defines itself is still just one of the potential considerations under the second prong of the ABC Test. For example, courts often consider whether the individual was “necessary” or “incidental” to the employer’s business. This inquiry frequently comes down to a “common-sense observation of the nature of the businesses.”[iv]
2. Utilize Strategic Corporate Structuring
- Objective: Divide business divisions into separate legal entities to (i) provide a clearer demarcation of what business is in the “usual course” for the employer and (ii) limit liability when there is large-scale misclassification risk (and related brand reputation risk).[v]
- How to Implement:
(1) Subsidiaries and Affiliates: Establish subsidiaries or affiliates for various business operations. For example, a tech company might have a subsidiary for software development and a subsidiary for customer support services. If a customer support services client needs cybersecurity assistance, that subsidiary might hire a cybersecurity specialist as an independent contractor. This approach may help you demonstrate that contractors are not involved in the core business operations but rather in a separate entity altogether, while also shielding the broader business from potentially crippling liability.
(2) Legal Review: Consult with a legal advisor specializing in corporate structuring and employment law to ensure that the divisions will stand up under legal scrutiny, including tests regarding the interrelation of parents and subsidiaries. Likewise, consult with legal advisors specializing in tax law and other areas to ensure compliance with the law and to explore potential tax benefits and risks.
3. Implement a Standardized Review Process
- Objective: Implement a standardized vetting/contract review process before a consulting or independent contractor agreement may be signed.
- How to Implement:
(1) Collect Information: Train your ground-level employees to collect and input essential information from potential 1099 contractors as part of the contract review and approval process.
(2) Review: Train select employees to review the collected data for signs of misclassification. Alternatively, utilize program-based and/or AI-based processes to scan for red flags. If red flags appear, require further review by your legal team – whether in-house or outside counsel.
4. Continuously Monitor and Audit
- Objective: Regularly ensure that your current contractors still satisfy the ABC Test or any other applicable independent contractor classification test.
- How to Implement:
(1) Regular Audits: Use internal or third-party auditors, such as outside counsel, to review your independent contractor relationships, practices, and policies at a regular cadence (e.g., yearly).
(2) Update Contracts: Keep your contracts up-to-date to reflect any changes in law or the relationship between the parties.
5. Cross-State Compliance Strategy
- Objective: Ensure compliance across all states where your business operates.
- How to Implement:
(1) State-Specific Policies: Develop state-specific policies and contracts that consider each state’s unique requirements. In some instances, business efficiency could dictate that you tailor your practices to the most restrictive state where you operate.
(2) Legal Consultation: Engage in continuous legal consultation to monitor state legislation and adjust your compliance strategy accordingly.
In this evolving legal landscape where the rules can change in the blink of an eye, employers must be proactive to avoid misclassifying independent contractors. By clearly defining your business scope, utilizing strategic corporate structuring, implementing standardized contract review processes, conducting regular audits, and adopting a cross-state compliance strategy, you may be able to significantly reduce your risk of costly independent contractor misclassification claims.
As always, consult with a legal advisor to ensure that you are meeting all state and federal requirements concerning your specific situations. This blog post is for informational purposes only and should not be construed as legal advice.
[i] U.S. Securities and Exchange Commission. “Form 8-K: Flowers Foods, Inc.” SEC.gov, Accessed September 13, 2023. https://www.sec.gov/ix?doc=/Archives/edgar/data/1128928/000119312523226784/d533690d8k.htm
[ii] See, e.g., Tsybikov v. Dovgal, No. 19 C 3334, 2023 WL 4029823, at *2 (N.D. Ill. June 15, 2023).
[iii] Great N. Constr., Inc. v. Dep’t of Labor, 204 Vt. 1, 161 A.3d 1207 (2016).
[iv] Vazquez v. Jan-Pro Franchising Int’l, Inc., 923 F.3d 575, 597 (9th Cir.), reh’g granted, opinion withdrawn, 930 F.3d 1107 (9th Cir. 2019), and on reh’g, 939 F.3d 1045 (9th Cir. 2019), certified question answered, 10 Cal. 5th 944, 478 P.3d 1207 (2021), and opinion reinstated in part on reh’g, 939 F.3d 1050 (9th Cir. 2019).
[v] See, e.g., In re Enter. Rent-A-Car Wage & Hour Emp. Pracs. Litig., 683 F.3d 462, 471 (3d Cir. 2012) (affirming summary judgment finding that parent entity was not liable for subsidiaries’ alleged wage and hour law violations).