Exclusive Interview with Colin Barnacle, Partner, Nelson Mullins

“Classifying More Workers As Independent Contractors Gives Competitive Advantage, But Risky Too”

 

"Classifying more workers as independent contractors undoubtedly comes with a competitive advantage. And the associated degree of risk will increase or decrease depending on the location of the employer’s bases of operations, the regulatory schemes of the relevant states, the number of lower-wage workers employed, and the employer’s ability to manage the potential legal risk (including considerations of managing risks as part of fundraising or other transactional assessments)," says Colin Barnacle, Partner, Nelson Mullins. In an exclusive interview with HR.com, Colin discusses worker classification challenges, wage reforms and federal adoption of the ABC Test, and more.

Experts from the interview:

Q: How has Covid-19 impacted the gig economy? What is going to be the implication of this economy on the future of work and businesses?

Colin: Covid-19 had a transformational, and potentially long-lasting, impact on the gig economy. Despite decreases in travel and state bans on many or most in-home services by independent contractors, the gig economy increased by 33% to $1.6 trillion in 2020, according to one survey.  

If nothing else, because of the wide-spread layoffs and general economic insecurity for many during the pandemic, Covid-19 increased workers’ willingness to try out gig economy work to supplement other wages or income. And the shutdowns also changed the demand for gig economy services in unexpected ways. For instance, with the global reduction in travel, demand for passenger transportation services decreased. Meanwhile, the demand for food and grocery delivery services flourished as people sought to stay home and flatten the pandemic curve.     
 

The gig economy has a dual impact on the future of work and business. Gig economy jobs, like any form of self-employment, can be a double-edged sword for workers and businesses alike. For workers, gig economy jobs offer the flexibility to turn the app on (or off) on-demand and the ability to provide services on the workers’ own terms to varying extents. As more workers take gig economy jobs, we will likely see more pressure on employers to offer flexibility as a benefit. And while gig economy workers infrequently classify as “highly compensated,” the availability and convenience of gig economy work to supplement income should have a generally negative pressure on wages.

Q: What sort of new challenges will this work culture bring to the worker classification space?  

Colin: Gig economy work, when the subject of a worker classification challenge, inherently complicates the definition of when a worker is “working” and when they are on their own time. For most traditional employers, an employee is typically responsible for working during their shift while on the employer’s premises. When employers remove both defined shifts and employer-owned premises, employers may become subject to minimum wage or unpaid overtime claims or may face more negligence suits for employees who get into an accident while on a company conference call. Gig economy work also adds another layer of uncertainty to the already grey “employee” versus “independent contractor” analysis. Prevalent questions regarding control, ability to perform services for multiple companies, and others will need to be analyzed on a case-by-case basis to determine which side of the fence the worker sits.

Q: What are the risks and responsibilities associated with hiring independent contractors? 

Colin: It depends on whether independent contractors are hired as part of a traditionally independent function or in lieu of traditional employees. Hiring (properly classified) independent contractors have classically had few risks or responsibilities for the hiring entity beyond the simple requirements of contract law (e.g., paying the invoice after the contractor completes their services). So when an office manager calls a plumber to unclog a drain, the hiring entity would not typically be responsible for payment of employment taxes, or for the plumber’s negligence while driving to the office, or even for workers’ compensation if the plumber is injured while unclogging the drain.  

This massive decrease in responsibility for hiring entities explains why companies have moved toward hiring more workers as independent contractors. But the short-term cost reductions of converting employees into independent contractors can come with a long-term increase in legal risks. The degree of risk changes depending on possible future federal action and current state and local law. The risks associated with misclassifying employees as independent contractors are significant – particularly for potential federal and state unpaid overtime claims, along with the risk of collective and class actions.  As noted above, employers must take great care to analyze the “employee” versus “independent contractor” factors prior to making any classification decisions.

Q: DOL (for the purpose of wage) and IRS's (for the purpose of payroll tax) definition of an employee, the ABC Test and individual state legislations, etc., today there are several policies that govern classifications. What are the key factors that employers be mindful of while classifying employees and independent contractors so that they do not misclassify?

Colin: It depends on the company’s jurisdiction (or the jurisdiction for a given office or remote worker) and the specific application. As absurd as it seems, the same worker could be an independent contractor for FLSA and federal tax purposes and an employee for state minimum wage and employment tax purposes. The traditional common law control test focused on the company’s ability to prescribe (or provide) the means to do the job as opposed to merely prescribing the ends. For instance, in the plumber example, the office manager would not require the plumber to use a certain type of wrench to unclog the drain, only that the plumber needs to unclog the drain.  

Because worker classification is a complex area that varies significantly by jurisdiction (complicated further by the mixed bag of less-than-clear laws, rules, and decisions), it is helpful to start by considering what makes a worker almost certainly an independent contractor:  The ABC Test provides three criteria that, if all plainly met, should give a company a strong basis to classify the worker as an independent contractor. A typical formulation of the test provides that all workers are presumed employees unless: the worker (A) “is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact”; (B) “performs work that is outside the usual course of the hiring entity’s business”; and (C) “is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.” So a plumber hired to fix a clog is a clear independent contractor, but whether an Uber driver meets that test is far cloudier.

When a worker does not meet this test, the analysis becomes more complex and employers need to consider the variety of potentially applicable federal and state laws and regulations. For instance, classification under the FLSA requires courts to apply the multi-factor “economic realities” test, with typical formulations of the test having between five and seven factors.¹ A common formulation states six factors: (1) the degree of the company’s right to control the manner (or means) of the worker’s performance; (2) the worker’s opportunity for profit or loss depending on their own skill; (3) the extent of a worker’s investment in equipment or materials required for the task, or employment of helpers; (4) whether the service requires a special skill; (5)  the degree of permanence of the relationship; and (6) the extent to which the service is integral to the company’s business.  

Different federal or state courts’ interpretations of that test may apply broader or narrower versions of the test. Some courts continue to emphasize the employer’s right to control (echoing the common law control test) as the most important factor, while others may equally weigh factors or determine that a factor is weighed more heavily in one circumstance and less heavily in another.  

The IRS revised its own classification guidance in late 2019 and described a multi-factor test of its own. While an analysis of classification under the IRS rule would be unlikely to be controlled outside of an IRS audit (and under Virginia state law, which recently adopted the IRS classification test), the guidance contains a useful analytical framework for employers.² 

Q: What are the risks associated with misclassifying workers as independent contractors?

Colin: Misclassification risks range from potential administrative complaints and hearings or individual lawsuits to more extensive regulatory investigations or massive multi-state bet-the-company class actions. Administrative complaints can include informal hearings over allegations of unpaid wages (such as “Berman” hearings in California) or workers’ compensation or unemployment related claims. Similarly, individual lawsuits alleging misclassification are typically low stakes. At the greater end of the risk spectrum, regulatory investigations can include audits by the DOL Wage and Hour Division or the IRS and equivalent state-level agencies, and can bring civil penalties, tax consequences, and other remedial action. 

Some states may provide exclusive jurisdiction to state officials to enforce certain classification laws, while others may provide incentives like statutory penalties and attorney’s fees to incentivize private individuals to sue on behalf of the state. Representative suits like these and other class and collective actions can pose an existential threat to a company depending on the scope and scale of the business and the number (and location) of workers classified as independent contractors.

Companies may also face classification challenges in other areas of law, whether that comes from third-party tort suits challenging independent contractor classifications as a means to hold the company liable for a purported contractor’s tort, or by a worker challenging the classification as a means of seeking the protections (and presumably damages for a violation) of Title VII or other federal or state workplace fairness laws that do not apply to independent contractors. 

Q: What is the status of the Trump Administration's Independent Contractor Rule, since the Biden Administration had announced plans to rescind the rule? What should be employers be mindful of when classifying workers?

Colin: The Department of Labor withdrew the Trump-era Independent Contractor Rule on May 5, 2021. In some states (like California) where state-wide worker regulations far exceed the scope of federal authority, these regulatory shifts are mere political rhetoric. Full of sound and fury, but signifying nothing. The inverse change in policy occurred back in 2017, when the Trump Administration rescinded a 2015 interpretive letter from then-Wage and Hour Division Administrator David Weil stating that “most workers are employees under the FLSA’s broad definitions.”³ Based on Secretary Walsh’s public comments echoing this language, the Department of Labor will probably reinstate this or issue similar interpretive guidance or regulations.

For employers, worker classification is an exercise in self-awareness and risk tolerance best undertaken with the benefit of legal counsel. Following the ABC Test even when not legally required is nearly certain to eliminate legal challenges down the road, but at the cost of having to bear the cost of potentially unnecessary administrative costs and the other burdens inherent to the employer-employee relationship. That structure may make sense for employers with major operations in ABC-Test states like California, as uniformity of application offers advantages over a potentially complex state-by-state analysis of permissible classifications of workers. And disparate classifications of workers doing the same work in different states can weaken the justification for these classifications and sets up potential legal difficulties.  

But classifying more workers as independent contractors undoubtedly comes with a competitive advantage. And the associated degree of risk will increase or decrease depending on the location of the employer’s bases of operations, the regulatory schemes of the relevant states, the number of lower-wage workers employed, and the employer’s ability to manage the potential legal risk (including considerations of managing risks as part of fundraising or other transactional assessments).  

Q: What sort of changes do you expect from the Biden Administration on this front in the future?

Colin: Given the Democrats’ tenuous majority in Congress and the intraparty disagreements on policy, divining the likelihood of legislative or even regulatory action is difficult. While the left-wing of the party is calling for wage reforms and federal adoption of the ABC Test, the reluctance of legislators to adopt an increased minimum wage has shown that legislative action is probably unlikely. Further, the passage of Proposition 22 during the 2020 presidential election in California (an Uber-, Lyft-, and DoorDash-sponsored ballot measure definitively classifying app-based drivers as independent contractors, not employees under the ABC Test) with a state-wide margin of 17 points showed both a path for state-focused legislation and the popular support for such measures, even in typically-liberal California.  

Although Labor Secretary Marty Walsh made news last month when he suggested that “in a lot of cases” gig economy workers should be classified as employees, he made few efforts to regulate companies like Uber or Lyft as Mayor of Boston outside of calling for higher fees (from an environmental and traffic-reduction perspective, rather than to support any particular worker classification). Generally, given Secretary Walsh’s support for Weil, we should expect a re-invigoration of Weil’s withdrawn 2015 guidance.  

Although it would amount to a tectonic shift in federal classification policy, the DOL could issue guidance or regulations adopting a federal ABC Test. In his 2015 guidance, then-Administrator Weil relied heavily on “the broad ‘suffer or permit to work’ standard of the FLSA” to conclude that “most” workers are employees under the FLSA.  In analyzing the same “suffer or permit to work” language in 2018, the California Supreme Court found that a longstanding definition of “to employ” as to “suffer or permit to work” justified imposition of the ABC Test for worker classification. The state legislature then codified the ruling in 2019, clarifying that it applied broadly to all California employees.  

Changing the “economic realities” multi-factor test into an ABC Test would amount to a radical shift in policy, in part because the ABC Test creates a presumption of employee status and shifts the burden of proving proper classification onto the employer and in part because courts would struggle to reconcile case law addressing various factors with the new standard. And for non-core policy goals, the Biden Administration has seemingly expressed a preference for legislative action over executive change, making regulatory action less likely. We may see that calculus shifts if the balance in Congress changes or roadblocks prevents the passage of popular legislation.  

Q: What are the common mistakes that companies do when it comes to classifying workers?

Colin: With the wide variety of shifting federal, state, and local standards, companies often receive bad advice in their decision-making process and outright misinformation about applicable risks. Companies need to know that they cannot rely on business customs in court. They also cannot rely on contract language to determine proper classification status. Instead, companies need to look at all aspects of the relationship with the worker to determine the proper classification.  

Because neither the business circumstances nor the legal backdrop relevant to classification is static, we recommend that companies regularly re-evaluate existing classification policies to reflect changes in workers’ roles and changes in applicable law (especially when expanding or relocating the business).     

Footnotes
¹ The Trump Administration finalized a rule on January 6, 2021 that never took effect but would have revised the economic realities test to emphasize two “core factors” as weighed more heavily than others: (1) the nature and degree of control over the work; and (2) the individual’s opportunity for profit or loss.  The rule also included three “additional” factors that were weighted less than the core factors: (3) the amount of skill required for the work; (4) the degree of performance of the working relationship between the individual and the potential employer; and (5) whether the work is part of an integrated unit of protection.

² The IRS guidance described three categories of “evidence of the degree of control and independence” and therefore the facts demonstrating proper classification of a worker.  The three categories related to: (1) behavioral facts; (2) financial facts; and (3) relationship facts.  The guidance further breaks down these categories into: (1) four subcategories of behavioral facts (facts relating to: (i) the type of instructions given, (ii) the degree of instruction, (iii) the evaluation systems, and (iv) training); (2) five subcategories of facts about relative financial control (facts relating to: (i) the significance of investment of the company and the worker, (ii) the degree of unreimbursed expenses, (iii) the opportunity for profit or loss, (iv) the services available to the market, and (v) the method of payment); and finally (3) four subcategories of relationship facts: (facts relating to: (i) the parties’ written contract(s); (ii) availability of employee benefits; (iii) the permanency of the relationship; and (iv) whether services provided are a key business activity).

³ Secretary Walsh has favored re-appointing Weil as the DOL Wage and Hour Division Administrator.  His 2015 guidance document analyzed long-standing precedent on the definition of to employ under the FLSA (“to suffer or permit to work”) and the court-developed multi-factor “economic realities” test, finding that courts should continue to include more workers as employees.  He advocated that Congress had rejected the common law control test in passing the FLSA.
 

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