Hunton Employment & Labor Law Perspectives : Employment Lawyers & Attorneys : Hunton & Williams Law Firm : Labor Law Legislative Updates

Under the Act, an individual who performs services in the construction industry for pay is an independent contractor for purposes of workers’ compensation, unemployment compensation, and improper classification of employees only if: (1) the individual has a written contract to perform such services; (2) the individual is free from control or direction over the performance of such services both under the contract of service and in fact; and (3) as to such services, the individual is “customarily engaged in an independently established trade, occupation, profession or business.”  An individual fits this last category only if:

1. the individual possesses the essential tools, equipment, and other assets necessary to perform the services independent of the person for whom the services are performed;
2. the individual’s arrangement with the person for whom the services are performed is such that the individual will realize a profit or suffer a loss as a result of performing the services;
3. the individual performs the services through a business in which the individual has a proprietary interest;
4. the individual maintains a business location that is separate from the location of the person for whom the services are being performed;
5. the individual previously performed the same or similar services for any other person in accordance with criteria (1) through (4) while free from direction or control over the performance of the services, or, the individual holds himself out to other persons as available and able, and in fact is available and able, to perform the same or similar services in accordance with criteria (1) through (4) while free from direction or control over performance of the services; and
6. the individual maintains liability insurance of at least $50,000 during the term of the contract.

The Act broadly defines “construction” as erection, reconstruction, demolition, alteration, modification, custom fabrication, building, assembling, site preparation, or repair work done on any real property or premises under contract, whether or not the work is for a public body and paid for from public funds.  Under the Act, each misclassified worker is considered a separate offense, and administrative penalties may be up to $1,000 for the first violation, and $2,500 for each subsequent violation.  The Act also makes it a misdemeanor for a contractor to intentionally misclassify an employee as an independent contractor, and violations of the Act can lead to stop-work orders requiring the cessation of work by misclassified individuals within 24 hours.  The Act will take effect 120 days after enactment.

The passage of this Act is part of a growing movement by states to crack down on what is perceived by lawmakers to be widespread worker misclassification, particularly in the construction industry, but also more generally.  Employers should pay close attention to pending and proposed state legislation and seek the advice of counsel in order to determine how such legislation might affect their worker classification practices.

Employees v. Independent Contractors

In his Complaint, the Attorney General points to several details of FedEx drivers’ jobs that allegedly support his assertion that the drivers are not independent contractors.  Specifically, the Complaint alleges that drivers are required to wear uniforms, comply with FedEx standards regarding the appearance of their trucks, and submit driver logs and other records on a daily basis.  Additionally, the Attorney General alleges that FedEx monitors the performance of the drivers daily, retains the right to discharge drivers, and maintains a contractor operations department, which is the equivalent of a human resource department for the drivers.  Based on these allegations, Attorney General Conway contends that FedEx exercises extensive control over its drivers and as a result the drivers should be classified as employees rather than independent contractors.

Legal Consequences of Misclassification

The Kentucky lawsuit goes on to contend that because of FedEx’s alleged misclassification of its drivers, FedEx has violated several Kentucky laws.  The Complaint claims that FedEx failed to file the required reports and make the proper contributions for its drivers under Kentucky unemployment insurance law and additionally, failed to provide workers compensation for its drivers as required by Kentucky workers compensation law.  Furthermore, the Kentucky lawsuit contends that FedEx did not withhold the necessary payroll tax amounts required for employees of Kentucky and also acted in violation of the Kentucky Consumer Protection Act, which prohibits deceptive acts or practices when conducting business.

FedEx’s Response

FedEx has responded to the Kentucky lawsuit by citing previous legal decisions that held in its favor.  A spokesman for FedEx explained that the claims in the Kentucky lawsuit conflict with rulings by the United States Courts of Appeals, the Internal Revenue Service and a jury in Washington State Court, all of which validated the company’s position that FedEx drivers are properly classified as independent contractors.  Attorney General Conway disagrees with these previous rulings and noted that laws are different in different states. 

What Are Employers To Do?

This case is yet another example of the predicted increase in scrutiny regarding the employment status of workers.  As noted in several of our earlier posts, federal and state legislative bodies along with enforcement agencies have expanded their efforts to challenge employers’ decisions regarding the classification of individuals as independent contractors.  For example, Congress continues to develop and support new legislation to target employers who classify their workers as independent contractors, such as the Employee Misclassification Prevention Act and the Fair Playing Field Act.  These new legislative and enforcement efforts compound the complexity posed by conflicting legal decisions and varying state laws.  Considering these developments, employers should carefully review the classification of their workers in light of both federal and state laws.

Currently, the Internal Revenue Code provides a safeharbor for employers to avoid penalties or at least suffer lighter penalties when they misclassify employees as independent contractors as long as there is a reasonable basis for the classification.  And, given the IRS’s current moratorium on issuing guidance on worker classification issues, employers can almost always provide a rationale for their classification decision because the absence of substantial guidance allows employers to be creative in developing their reasonable basis defense.  According to Senator Kerry’s website, the proposed legislation will reduce the use of the safeharbor by:

• Ending the moratorium on IRS guidance on worker classification issues and requiring the Secretary of Treasury to issue prospective guidance;
• Amending the tax code provisions to clarify that the reduced penalty is not available where employers fail to comply with IRS/Treasury guidance;
• Requiring business owners who use independent contractors to provide each contractor a written statement regarding the contractor’s tax obligations, the labor and employment law protections that do not apply to independent contractors, and the right of the contractor to seek a status determination from the IRS; and
• Requiring the Secretary of Treasury to issue annual reports on worker misclassification.

The White House quickly gave its strong endorsement to the proposed legislation.  According to Vice President Biden, “[S]topping worker misclassification is a priority for the President’s Middle Class Task Force. . . . The legislation is timely, as misclassification is an increasing problem, one that puts employers who properly classify their workers at a disadvantage in the marketplace and costs the government billions of dollars in unpaid taxes.  I urge the Congress to stand up for workers and create a level playing field for law-abiding businesses by supporting this bill.” 

The proposal of The Fair Playing Field Act of 2010, along with the White House’s heightened interest in misclassification issues, underscores the need for employers to closely examine their independent contractor relationships and, to the extent necessary, take corrective action now before they find themselves the subject of a government investigation or a private lawsuit. 

The district court had identified three possible tests: the “common law agency” test (focusing on the hiring party’s right to control the manner and means by which the product is accomplished), the “economic realities” test (a fact-specific inquiry focusing on the economic realities of the situation, as its name suggests), and the “common law hybrid” test (a combination of the other tests, taking multiple factors into account).  The appellate court said that the three tests are functionally equivalent.  Even if their different formulations suggest variations in practical application, the controlling test is the common law test, as pronounced by the Supreme Court in Nationwide Mutual insurance Co. v. Darden.  That test applies “whenever an employment statute defines the term ‘employee’ in the way ERISA does, and the statute in question does not otherwise suggest that the common law test would be inappropriate.”  The Supreme Court identified 12 factors to consider, including whether the hiring party has the right to assign additional projects to the hired party, the extent of the hired party’s discretion over when and how long to work, and the tax treatment of the hired party. 

Applying those factors, both courts found the plaintiff/appellant in this case to be an independent contractor based on the overall picture presented by her situation.  She was free to operate her business as she saw fit, could decide when and where to work (and in fact, paid rent on her own office), was paid on commission only, reported herself as self-employed to the IRS, and sold products other than those offered by the defendant. 

Now that the court has clarified the appropriate standard, hiring parties in the Ninth Circuit should reevaluate their hired parties to ensure they are classified appropriately.

According to the Committee, the witnesses for the hearing will be:

• Seth Harris, the Deputy Secretary of Labor
• Colleen Gardner, the Commissioner of New York State’s DOL
• Frank Battaglino, the Owner of Metro Test and Balance, a contractor in Maryland
• Catherine Ruckelshaus, the Co-Director of the National Employment Law Project
• Gary Uber, the Co-Founder of Family Private Care, a referral service for home health caregivers

Though we do not know what position Mr. Battaglino and Mr. Uber (the two business owners on the panel) will take on the proposed legislation, Mr. Harris, Ms. Gardner, and Ms. Ruckelshaus will likely provide testimony in support of the legislation.  Mr. Harris is the Obama Administration’s representative on the issue, and the Administration has made employee misclassification one of its top employment-related priorities.  Ms. Gardner is currently the Commissioner of New York State’s DOL, an agency that has aggressively pursued employee misclassification enforcement in previous years.  Ms. Ruckelshaus’s employer, the National Employment Law Project, is a national advocacy group for low wage workers that, on June 15, issued a report purporting to measure the fiscal impact of independent contractor misclassification.

The Committee’s decision to hold a hearing on the Employee Misclassification Prevention Act represents a continuation of the Administration’s and Congress’s heightened interest in the independent contractor misclassification issue.  This trend has been discussed in many of our prior posts.  In light of these developments and the likelihood that the Act will garner sufficient votes in both houses of Congress, employers who use independent contractors should promptly conduct an audit of its independent contractors to ensure that they can withstand an investigation by a government agency or a legal challenge by an individual worker.

Many employers believe that including language in a contract stating that a worker is an independent contractor will end the classification inquiry.  The inquiry, however, will extend beyond the contract language since determination as to whether a worker is properly classified as an independent contractor is based on multiple factors.  While written contracts and job titles are certainly important factors to consider when assessing whether an independent contractor has been properly classified, a thorough audit should focus on all the facts and circumstances surrounding the worker’s specific job functions and the relationship between the worker and the company.  Examples of questions that should be asked during an audit include: 

• Does the company have the right to control the means and methods of the work or just the work result?
• How, when and where does the worker perform the work?
• Who provides the equipment?
• To whom does the worker report?
• Does the company have a right to determine which workers can perform the services?
• How is the worker paid?
• How does the worker earn vacation and benefits? 
• Are the services performed by the worker traditionally services that are performed by employees? 

While an employer should always review its job classifications at the outset of a new employment relationship or new job classification, employers should also reexamine such classifications periodically to ensure continued compliance with the various applicable laws.

Employers who violate the notice and/or recordkeeping requirements or misclassify a worker would be subject to a civil penalty of up to $1,100 per worker for a first offense and up to $5,000 per worker for willful or repeated violations.  Employers who misclassify workers and violate the minimum wage and overtime requirements would be subject to treble damages.  The proposed legislation also contains broad anti-retaliation/discrimination provisions.

To enforce the Act’s provisions, the Department of Labor would be directed to perform targeted audits focusing on employers in industries that frequently misclassify employees.  The Department of Labor and Internal Revenue Service would be permitted to refer incidents of misclassification to each other.  The states would be directed to increase their own penalties for worker misclassification, conduct audits for the purpose of identifying employers who misclassify workers, and report the results of the audits to the Department of Labor on a quarterly basis. 

While the EMPA is in the earliest stages of consideration by both houses of Congress, its introduction is significant because it follows introduction of the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (“TRAC”) (H.R. 3408, S. 2882), which would revise the Revenue Act of 1978’s safe harbor provision (the safe harbor provision allows an employer to treat a worker as a contractor if certain requirements are met), make it more difficult for employers to classify workers as independent contractors, and significantly increase employer penalties in the event of misclassification.  It also follows President Obama’s proposed budget for 2011, which includes significant funding for the U.S. Department of Labor’s Wage and Hour Division to increase the Division’s number of investigators, train investigators to detect misclassification of workers, and focus on industries where misclassification is most prevalent.  In sum, the EMPA serves as a reminder that curtailing employers’ use of independent contractors remains a significant issue in Congress.  Employers who have not yet done so would be well-advised to review their independent contractor relationships and ensure that they are on the up and up before the Department of Labor and/or a corresponding state agency does it for them. 

Although the proposed regulation is unlikely to be limited to independent contractor classifications, this all comes on the heels of renewed DOL efforts to crack down on the misclassification of employees as independent contractors.  During a Live Q&A Session to discuss the new Regulatory Agenda, Nancy Leppink, Deputy Administrator of WHD, was asked whether WHD is concerned that the implementation of rules tightening worker classification enforcement will upset the benefits associated with employing independent contractors.  Ms. Leppink responded by essentially parroting a DOL fact sheet on the proposal, which states that “updating the recordkeeping requirements to promote transparency is expected to encourage greater levels of compliance by employers, to enhance awareness among workers of their status as employees or independent contractors . . . and to facilitate DOL enforcement.”

Some of the issues that DOL will need to consider as it formulates the rule include:

• Whether any industries will be exempted from the classification analysis and enhanced recordkeeping requirements.
• Whether the classification analysis is to be conducted on a position-by-position or a worker-by-worker basis.
• The required content of analysis disclosures to workers and whether each worker will have to be formally notified of his or her FLSA status and how it was determined.
• What the proposed retention requirements for classification analysis will be in light of the Lilly Ledbetter Act.

If the proposed rule is implemented, employers will almost certainly be required to expend substantial amounts of time re-analyzing worker classifications and drafting new documents to comply, ultimately generating a significant amount of paperwork.  DOL plans to issue a formal Notice of Proposed Rulemaking for this rule in August, at which time employers will have an opportunity to submit comments on the proposed rule. Stay tuned for more information in August. In the meantime, employers should examine their current worker classifications to protect and prepare themselves.

Misclassification of employees as independent contractors is expected to cost the Treasury Department over $7 billion in lost payroll tax revenue over the next ten years.  To help make up for this shortfall, the proposed budget includes a joint proposal by the Departments of Labor and Treasury.  The joint proposal, a $25 million initiative, would enhance the ability of both agencies to penalize employers who misclassify their employees and would attempt to eliminate or reduce opportunities under current law for employers to misclassify workers.  The initiative also provides for competitive grants to boost states’ incentives to address the problem, as well as the hiring of 100 new enforcement personnel to target worker misclassification. 

The President’s proposal also is likely to build momentum for legislation, already introduced called the Taxpayer Responsibility, Accountability, and Consistency Act of 2009, that would revise the Revenue Act of 1978’s safe harbor provision (which allows an employer to treat a worker as a contractor if certain requirements are met) to make it more difficult for employers to classify workers as independent contractors for employment tax purposes.  The legislation also would significantly increase employer penalties in the event of misclassification.  In addition, states also are enacting new laws to impose harsher penalties for misclassification.  Colorado, for example, passed a law in 2009 that included penalties of up to $5,000 per employee for the first offense and up to $25,000 per employee for subsequent violations.  Other states have passed similar laws.

In light of these developments, which continue a trend that has been building for the past several years, employers will need to be vigilant to ensure that their independent contractor relationships will pass muster.  Misclassifying an employee as an independent contractor will be a very costly mistake. 

Civil litigation over employment status is becoming increasingly common, perhaps because more employers are relying on contingent arrangements, economic conditions make it more difficult to find traditional full time employment, and more individuals and attorneys are aware of the issue following high profile verdicts, settlements, and fines.

Although enforcement of various laws by state and federal agencies has been spotty in the past, there are signs that enforcement efforts will increase.  With the economy in decline, there has been a heightened focus on capturing more revenue through employment taxes, which often is a reason why companies seek independent contractor arrangements.  A recent study by the U.S. Government Accountability Office, commissioned by several Congressional committees, called upon the U.S. Department of Labor and the Internal Revenue Service to step up their efforts to police classification of workers as independent contractors.

Some cases come to the attention of government agencies through routine audits, some come through complaints, and some come through other action on the part of the individual, such as filing a claim for unemployment benefits.  Increasingly, state and federal agencies are sharing information and coordinating their enforcement efforts.  In light of the discussion above, companies that utilize independent contractor arrangements can expect to encounter more challenges, and more intensive scrutiny, than they have in the past. 

More federal laws related to classification of contractors are likely on the way.  There is a bill in Congress (H.R. 3408: “The Taxpayer Responsibility, Accountability and Consistency Act of 2009”) that would increase penalties for misclassification and eliminate or sharply curtail the “safe harbor” provisions of Section 530 of the Revenue Code, which currently allows businesses to avoid tax penalties if they have a good faith reason to believe that a worker is an independent contractor, even if ultimately found to be an employee as a matter of law.  Within the past two years, there have been several other bills introduced in the House and Senate that would amend the Revenue Code and the Fair Labor Standards Act to make it more difficult to properly classify workers as independent contractors and to increase penalties for doing so incorrectly. 

Courts and government agencies use a variety of legal tests to determine whether a worker is properly classified.  These tests can vary according to what law is allegedly violated, and it is conceivable that a worker could be deemed an independent contractor for purposes of one statute but not for another.  Under any test, however, simply agreeing on a status such as “independent contractor” or “temporary worker” does not establish a non-employment relationship.  Instead, the proper classification is determined according to the specific facts of a particular case.  Depending on the test applied, factors considered can include:  who has the right to control the means and manner of performance; who provides the tools and equipment needed for the work; where the work is performed; whether the work is part of the recipient’s core business; whether the worker can bring in assistants or subcontract the work; and whether the worker is economically dependent on a single entity, or whether the worker is truly “independent” such that his or her work would continue for other clients if one relationship were discontinued.

The Labor and Employment Team at Hunton & Williams has ample experience litigating issues related to contingent workers, before state and federal agencies and in courts across the country.  We regularly take on difficult cases for clients in this area and provide preventive guidance to avoid litigation or enforcement where that is an option. 

Any company that is considering such an arrangement, however, should be advised of the costs and risks that can accompany a contingent worker or contractor, including:  significant transaction and administrative costs; reduced quality or efficiency; compromised security of intellectual and other property; liability for wage and hour violations; obligations for employee benefits; assessments of back taxes and penalties; and damages for various types of employment-related claims.  Incorrect classification can lead to significant adverse consequences, particularly if multiple workers are involved.  A number of large and sophisticated companies have been forced to pay staggering amounts to resolve cases alleging misclassification of workers.

What can you do to avoid an adverse outcome with respect to contingent workers?  Getting the right legal guidance is paramount.  Once your objectives and concerns have been properly identified, there are likely a number of ways to address them.  Properly structured contingent worker arrangements will account for all types of risk.  In some instances, it may become clear that hiring an employee on a part time or full time basis is more desirable than engaging a contingent worker, once all the costs and benefits are fully considered.

The Labor and Employment Team at Hunton & Williams has a task force focusing on issues related to contingent workforces and independent contractor relationships.  We would be glad to discuss with you how you can best accomplish your business objectives while minimizing your risks.  This may include proactive planning for future engagements of contractors, or perhaps an audit of current engagements to determine whether they can withstand challenge by a government agency or individual claimant.  The most important thing is to gain awareness of the risks and to seek ways to address them before they become liabilities.

The GAO conducted the study to examine: the extent of misclassification of workers as independent contractors; actions the DOL and IRS have taken to address the issue, including coordination of efforts; and options that could help address the issue.  Among the reasons noted for conducting the study were the need to ensure that workers “receive the protections and benefits to which they are entitled” and that employers pay all required taxes.

The report identified a number of options to address the issue, almost all of which would have a significant impact on companies who use outside contractors:  clarify the distinctions between employees and contractors under federal law; allow workers to challenge classifications in U.S. Tax Court; define misclassification as a violation of the Fair Labor Standards Act; narrow the “safe harbor” provisions in Section 530 of the Tax Code for misclassification; require service recipients to withhold taxes for contractors; improve compliance programs; and enhance coordination between agencies for enforcement and sharing of data.

The GAO report undoubtedly portends greater activity on the part of the DOL and IRS with respect to enforcement of existing laws, and possibly new legislation on the part of Congress.  Bills addressing this issue were introduced in the previous session of Congress but did not reach a vote.  They are likely to be re-introduced sometime in the near future.

This is a loud and clear wake up call for all businesses that use contract workers to review their arrangements with legal counsel and ensure:  (1) that workers classified and paid as independent contractors will not be deemed employees under applicable labor and tax laws; (2) that proper documentation is in place to maximize the likelihood of a favorable outcome in the event of an audit or other challenge; and (3) that potential exposure is addressed with respect to back pay for minimum wage, overtime, liquidated damages, unpaid taxes, and penalties in the event of a finding of misclassification.

The Labor and Employment Team at Hunton & Williams has a task force focusing on issues related to joint employment, contingent workforces, and independent contractor relationships.  We would be glad to provide a copy of the GAO report and to provide guidance on this important topic.