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Misclassification Misery
Published Tuesday, June 13, 2017

"An honest day’s work for an honest day’s pay” is a deceptively simple ideal. Whether on the federal or state level, wage laws are complex and tricky, and many employers, even those with vast resources, have run afoul of such laws and paid a hefty price.  

In the last two years alone, FedEx Ground has agreed to pay more than $480 million to settle two large class action lawsuits regarding the misclassification of workers as independent contractors in several states. Lyft is in the process of settling a similar class action brought in California for $27 million.  

Uber faces class action lawsuits in multiple states by drivers who allege they were misclassified as contractors and were not paid required overtime wages, tips and expenses. In August 2016, a federal district court rejected Uber’s offer to settle class actions in California and Massachusetts for $100 million because the court deemed the settlement on the whole as being not fair, adequate or reasonable.

This year, a NH-based construction company, Universal Drywall, agreed to a settlement of up to $500,000 with the Massachusetts Attorney General’s Office for misclassifying workers as subcontractors. In the same month, Lufthansa agreed to pay 33 aircraft workers in Maine $1.1 million to settle misclassification suits for unpaid overtime wages under federal and Maine law.

Misclassification of employees as independent contractors is on every list of the top wage and hour law violations. During the past decade, the federal government and many states, including NH and Massachusetts, have aggressively gone after businesses (large and small) for misusing the independent contractor status.

In addition to transportation and construction, many other industries have become susceptible to legal action for misclassification: automotive, cleaning and janitorial services, cable installers, couriers, moving services, IT consulting, healthcare, entertainment, home product installation, financial services and other professional services.  

When organizations engage individuals as independent contractors, they avoid the costs of employment such as payroll taxes, workers compensation coverage, overtime rates and employee benefits. These costs can be substantial and sometimes affect the viability of an enterprise, project or particular business model.

However, if the individual will be under the organization’s direction and control, the organization runs the risk of violating a variety of federal and state laws.

The class actions mentioned above generally seek damages for unpaid overtime rates, minimum wage violations, unreimbursed expenses incurred by the workers, lost value of employee benefits and failure to pay required taxes.

Defining an Employee
To further complicate the issue, there is no one way to determine if a worker should be treated as an employee or independent contractor.

Even if a worker is a legitimate independent contractor under one law, he or she may still be an employee under other laws. This is because there are different multi-factor tests for determining who is an employee depending on which law is being applied.

In its 2015 guidance on misclassification, the U.S. Department of Labor (U.S. DOL) stated that most workers are employees for purposes of the Fair Labor Standards Act (FLSA) and its requirements to pay minimum wage and overtime rates because of the FLSA’s language on who is an employee.

Under the FLSA, an employee is any individual who is employed by an employer, and to employ means to “suffer or permit to work.” This language, according to the U.S. DOL, was designed to provide the broadest scope of statutory coverage possible. As a result, many independent contractor misclassification cases seek unpaid overtime for each and every week the contractor worked more than 40 hours.    

However, such coverage is not unlimited. The courts developed an economic realities test to determine if a worker is exempt from the FLSA as an independent contractor. This test uses six categories to identify if the worker is economically dependent upon the employer or is a truly independent business:

• Whether the individual’s work is an integral part of the employer’s business;

• Does the worker’s managerial skill affect his or her opportunity for profit and loss;

• How does the worker’s investment compare with the employer’s investment;

• Does the work require special skill or initiative;

• Is the relationship permanent or indefinite; and

• What is the nature and degree of the employer’s control over the worker.  

For income tax purposes, the federal tax code does not define employee so the Internal Revenue Service (IRS) looks at approximately 20 factors under three major categories to determine a worker’s classification:  

• Control over how the worker does his or her job;

• Control over the business aspects of the worker’s job; and

•The nature of the relationship between the parties.

Neither the IRS nor U.S. DOL test requires that all of its factors be met, but the one common element under these tests is the right to control the manner and means of the worker’s services. This element has proven the most relevant in the FedEx class actions as well as the ongoing Uber litigation and other large misclassification lawsuits.

In the FedEx cases, some courts initially ruled in favor of FedEx based on evidence that FedEx and its ground delivery drivers intended to create an independent contractor arrangement, and the drivers had the ability to hire helpers and replacements, were responsible for acquiring their equipment and could sell their routes to other qualified contractors. Also, FedEx did not have the right to terminate the contractors at will. However FedEx lost these decisions on appeal because the appellate courts ruled that other facts revealed a substantial degree of control exercised by FedEx over the means and manner of the drivers’ services.

For example, the drivers were required to comply with FedEx’s instructions, policies and procedures, attend mandatory trainings, use specific signage and logos on the trucks, use specific paint color on the trucks and pay fees for use of FedEx’s mandated equipment and uniforms.

In a pending Indiana federal court lawsuit against Uber, Scroggins v. Uber Technologies, drivers are alleging they should have been paid as employees (and received minimum wage and overtime pay, rest and meal breaks, and expense reimbursement) because they lacked discretion in their relationship with Uber.

Uber set all fares, required all drivers to maintain an average customer star evaluation rating and had discretion to terminate drivers from their platform at will. In the O’Connor case, in which the court denied Uber’s proposed $100 million settlement, the court noted Uber’s exercise of control over many aspects of how the drivers worked, including how they had to dress, when they were required to text customers, how to treat customers (“greet every passenger with a big smile and fist bump”) and what music or programs can be played on their car radios (“soft jazz or NPR”).  

NH Tests
Separate from the federal tests, each state has its own set of factors and tests for independent contractor status under various laws, such as unemployment benefits eligibility, workers compensation coverage, and wage and hour compliance. New Hampshire has two main statutory tests:

1.  The NH Department of Labor (NH DOL) enforces the following seven-factor test for purposes of wage protection, workers compensation and minimum wage laws. Under the test, a person can qualify as an independent contractor if the person:

• Has a federal employer identification number or alternatively agrees in writing to carry out the responsibilities imposed on employers under state law.

• Has control and discretion over the means and manner of performing the work.

• Has control over the time when the work is performed. However, the employer and person can agree to completion schedule, range or maximum of work hours.

• Hires, pays and supervises their own assistants, if any.

• Holds themselves out to be in business for themself with continuing or recurring business liabilities or obligations.

• Is responsible for failure to complete the work; and

• Is not required to work exclusively for the employer.

Unlike the federal tests, all factors of the NH DOL test must be met.

2.  The NH Department of Employment Security (NH DES) enforces a three-factor test for purposes of unemployment insurance coverage. Again, all factors must be met, or the services are deemed employment for unemployment insurance purposes. The factors are:

• The individual is free from the organization’s control or direction over the performance of the services;

• Such service is either outside the usual course of the organization’s business or such service is performed outside of the organization’s places of business; and

• The individual is customarily engaged in an independently established trade, occupation, profession or business.

This is one of the more restrictive tests for determining independent contractor status and is often referred to as the “ABC test.”

Because of the differing tests, there are situations where a worker may be properly classified as an independent contractor for income tax and/or workers compensation purposes, but may be deemed an employee for unemployment insurance and/or overtime wages.

Potential Pitfalls
The fact that the employer issues the worker a Form 1099 for income tax purposes does not simply make the worker an independent contractor. A form 1099 is only the result of how the business classifies the worker, and is actually irrelevant for purposes of the other tests.  

It is still a violation of law to misclassify a worker as an independent contractor even if that’s what the individual wants. Independent contractor status is something for which the worker must qualify by meeting legal tests, and intent of the parties is only one factor to be considered under some of the tests.

While signing a written independent contractor agreement is not a guarantee of classification, having a written contract is one of the factors the IRS considers and can help to establish certain other factors of the independent contractor relationship, especially in close cases.

Requiring the worker to form a corporation or limited liability company for the purpose of performing the work of the employer will not, by itself, make the worker an independent contractor.

If a worker is misclassified as an independent contractor, there can be a variety of negative consequences for the organization: fines, unpaid tax liability, failure to pay proper wages, liability if the individual gets hurt on the job and attorneys’ fees and other litigation costs if workers sue and win.   

Use of independent contractors is common in almost all types of businesses. However, it is worth taking the time to assess the nature of the organization’s relationship with its independent contractors to determine if there is a risk of misclassification.

In particular, businesses in NH should use both the NH DOL and NH Employment Security tests as their guide and ensure that they can meet each factor of the tests.

If the decision is made to engage an individual as an independent contractor, the organization should work with legal counsel to draft a proper written agreement that memorializes the terms and condition of the engagement, paying careful attention to including the factors that establish the independent contractor classification.

Andrea Chatfield is an attorney with Cook, Little, Rosenblatt and Manson, p.l.l.c. in Manchester where she works with employers on employment law compliance matters. She can be reached at a.chatfield@clrm.com.

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