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Home | BakerHostetler

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The Department of Labor announced a new test for determining independent contractor status under the Fair Labor Standards Act (FLSA).

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The test describes specific facts that may result in a misclassification finding.

Businesses using independent contractors should review their relationships and contract terms in light of the new final rule.

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’Tis the season for things to drop. Some things that drop are big, some not so big.

On New Year's Eve, we saw the ball drop in New York. Fun <a href="https://www.timessquarenyc.org/times-square-new-years-eve/nye-history-times-square-ball" target="_blank" rel="noreferrer noopener">fact</a>: The ball is a geodesic sphere, 12 feet in diameter, weighing 11,875 pounds. That’s big.

Since New Year’s Day, you’ve probably dropped lots of things – pens, soap, a piece of toast, your phone. Most of these smaller drops have little impact, especially if you have a good phone case and apply the three-second rule to your toast. Fun <a href="https://www.oklahoman.com/story/lifestyle/health-fitness/2018/11/27/bodywork-can-you-trust-the-three-second-rule-for-food/60486306007/" target="_blank" rel="noreferrer noopener">fact</a>: Researchers at Rutgers University conducted a study testing four different foods dropped on four different surfaces to see how much bacteria they picked up. The answer is you’d rather not know.

On Tuesday, something else dropped. The Department of Labor (DOL) released its <a href="https://public-inspection.federalregister.gov/2024-00067.pdf" target="_blank" rel="noreferrer noopener">final rule</a> for determining independent contractor or employee status under the Fair Labor Standards Act (FLSA). The rule is being published in the Federal Register today and will take effect March 11, 2024.

Is the dropping of that rule a big drop or a little drop? The answer likely depends on whether your dispute is being decided by the DOL (big drop) or the courts (little drop).

And to be clear, by dropped, I mean announced. The DOL did not retract its proposed rule. Fun <a href="https://en.wikipedia.org/wiki/Contronym" target="_blank" rel="noreferrer noopener">fact</a>: A contronym is a word that is also the opposite of itself.

Let’s examine the new rule; then we will look at its practical effect.

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In October 2022, the DOL published a proposed rule. The DOL proposed a six-factor balancing test, with a miscellaneous seventh factor called “Additional factors.” These factors looked a lot like the factors historically applied by the courts and the DOL, but the proposed rule made changes in how each factor would be evaluated, essentially putting its finger on the scale to lean each factor toward a finding of employee status.

The DOL received more than 50,000 public comments about the proposed rule. By law, the DOL had to consider those comments and then decide whether to modify the proposed rule.

Like the proposed rule, the final rule contains a six-factor balancing test, contains factors similar to those traditionally applied by the courts and the agency, and places its fingers on the scale in an effort to nudge each factor toward a finding of employee status.

But the DOL made several changes from the proposed rule that make the final rule more fair and more reasonable for businesses. The DOL is still placing its fingers on the scale, but more gently than in the proposed rule.

The final rule begins with a simple acknowledgment – that the proper test for determining employee status under the FLSA is the economic realities test. The DOL explains this test as an effort to determine “whether the worker is either economically dependent on the potential employer for work or in business for themself.” So far, that is mostly consistent with decades of FLSA case law.

The purpose of the new rule is to announce how the DOL will make that determination. Here are the factors the DOL will consider:

(1)&nbsp;&nbsp; Opportunity for profit or loss depending on managerial skill.

(2) &nbsp; Investments by the worker and the potential employer.

(3) &nbsp; Degree of permanence of the work relationship.

(5) &nbsp; Extent to which the work performed is an integral part of the potential employer’s business.

These are the same factors as in the proposed rule, and they are similar to the factors already used by most courts.

What Do Businesses Need To Know?

The final rule includes commentary about each factor. In the commentary, the DOL explains how it will evaluate each factor. The guidance is helpful in that it lists specific facts that will tip the scales for each factor. The guidance is not helpful in that the DOL’s treatment of these facts tilts the scales more toward as finding of employee status.

In factor one, “Opportunity for profit or loss depending on managerial skill,” the DOL lists the following facts as potentially relevant:

Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided.

Whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed.

Whether the worker engages in marketing, advertising or other efforts to expand their business or secure more work.

Whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.

The DOL then provides a counter example that businesses offering gig work need to know: “Some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status under this factor.”

Businesses offering gig shift work for independent contractors should consider how worker pay is calculated and, in light of this commentary, it might be appropriate to make proactive changes in compensation methods.

Factor two evaluates “Investments by the worker and the potential employer.”

This factor considers “whether any investments by a worker are capital or entrepreneurial in nature.” The final rule helpfully explains that the types of investments supporting independent contractor status “generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach.”

The proposed rule had said that investments by the contractor should be compared with investments by the hiring party. Commenters pointed out that a contractor’s investment in its business will generally pale in comparison with the hiring party’s investment in its business. In the final rule, the DOL backed off of its initial position slightly. The final rule says that relative investments should still be considered, but not necessarily in economic terms alone. For example, if the contractor makes “similar types of investments” as the hiring party, even if on a smaller scale, that can support contractor status.

Under previous guidance, only the&nbsp;amount&nbsp;of a contractor’s investment would be considered, without any comparison to the hiring party’s investments. The new concept of relative investments makes it harder to establish contractor status under this factor.

Factor three evaluates the “Degree of permanence of the work relationship.”

This factor weighs in favor of employment if the work is “indefinite in duration, continuous, or exclusive of work for other employers.” On the other hand, this factor points toward contractor status if the work is “definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple entities.”

Businesses should define their relationships and contractual terms with this factor in mind.

Factor four examines the “Nature and degree of control.”

The right to control how work is performed is, of course, the primary test for determining employee status under many other laws. Here, it is a factor but not the sole factor. The DOL points out that “reserved control” by the hiring party, even if not exercised, weighs in favor of employee status.

The commentary lists several facts relevant to determining control, including whether the potential employer:

Limits the worker’s ability to work for others.

Uses “technological means to supervise the performance of the work (such as by means of a device or electronically).”

Reserves the right to supervise or discipline workers.

Places demands or restrictions on workers that do not allow them to work for others or work when they choose.

Controls economic aspects of the working relationship, including control over prices or rates for services and the marketing of the services or products provided by the worker.

In the proposed rule, the DOL had indicated that control imposed for the purpose of complying with laws could be considered relevant control. That initial commentary did not comport with existing law, and the final rule modifies it – but in the narrowest way possible.

In the final rule, control exerted “for the sole purpose of complying” with a “specific applicable” law is not relevant to the control analysis. But actions that “go beyond compliance” may be indicative of employee status if these actions “instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards.”

This commentary is problematic. Businesses routinely have health and safety programs that go beyond the minimum legal requirements. Requiring contractors to comply with these health and safety requirements could be treated by the DOL as evidence of employee status.

Businesses should review their independent contractor agreements and consider redrafting sections that impose contractual requirements that are based on legal requirements. Consider whether the control being exerted needs to be dialed back to more closely adhere to the “specific applicable” requirements of the relevant law.

The reference to “technological means to supervise” may be a concern. Businesses using geolocation or surveillance of independent contractors should pay close attention to this component of the control factor.

Factor five is the “Extent to which the work performed is an integral part of the potential employer’s business.”

The final rule advises that this factor does not look at whether the individual worker is integral to the hiring party’s business, but rather whether the “function they perform” is an integral part of the business.

There are historical arguments that this factor misapplies Supreme Court precedent and that whether the work is “integral” is not the right question. Rather, under the alternative view, the relevant question should be whether the work is “integrated” into the hiring party’s business.

Factor six considers “Skill and initiative.”

This factor considers (a) whether the worker uses specialized skills to perform the work and (b) whether those skills contribute to business-like initiative.

For example, if the worker is dependent on training from the hiring party, this factor will lean toward employee status. But if the worker brings specialized skills to the relationship, this factor will lean toward contractor status. The final rule urges that the worker’s specialized skill should relate to “business-like initiative.” That phrase is not defined.

The final rule concedes that these six factors are not exhaustive. The rule notes that “additional factors may be relevant” in helping to determine the ultimate issue, which is always “whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.”

What Is the Practical Effect of the Final Rule?

Here’s where we look at whether the dropping of the rule is a big drop or a little drop.

If your business is being audited or investigated by the DOL, it’s a big drop. Not because the rule is a radical departure from past practice in all respects; it is not, except that it does introduce some troubling new commentary. But the published rule is a big deal because the DOL is going to apply its test. The final rule is specific enough that it provides a road map for businesses being audited or investigated by the DOL. The DOL is telling us the facts and factors it considers most relevant, and businesses can structure their arguments to fit within these parameters. Business can also modify their relationships and contracts proactively, taking these factors into account.

On the other hand, if your dispute is in the courts, the new rule probably will not make much difference. Here’s why.

Why Federal Courts Might Ignore the Final Rule

The economic realities test is well-established and long-standing. The specific factors used by the courts differ slightly by circuit, but they align pretty closely, and the differences from court to court are generally immaterial. Some courts combine two factors into one, but the elements of the test are pretty much the same.

Because the courts have decades of experience applying the economic realities test and because the courts have already decided on the factors to be examined, the courts do not need agency guidance to tell them how to interpret the FLSA.

The courts are therefore unlikely to grant a lot of deference to the DOL’s new interpretation of an old law.

Remember also that the Trump DOL issued a new final rule on the same subject about three years ago. This new final rule overrides the previous final rule, which turned out not to be so final. This 2024 final rule, therefore, is the third version of the FLSA test since 2020. We had the pre-Trump rule, the Trump rule and now the Biden DOL’s final rule. The courts have not been modifying their long-standing tests as political winds shift at the DOL.

The courts are likely to continue to apply the multifactor tests that they have already articulated. There is a good chance that the courts will pay no deference to the new rule.

Will the Final Rule Be Challenged in Court?

Yes. There are a number of arguments as to why the final rule may be invalid.

One likely argument is that the final rule is arbitrary and capricious in numerous respects and therefore in violation of the Administrative Procedure Act.

A second likely argument is that the DOL lacks authority to issue a final rule because of the Federal Vacancies Reform Act and the Appointments Clause of the U.S. Constitution. Acting Secretary of Labor Julie Su has not been confirmed by the Senate, and there are substantial legal questions as to whether she may lawfully act in her capacity as Acting Secretary. In September 2023, the General Accounting Office issued a finding that she may lawfully serve in that role, but that view will almost certainly be challenged in the courts. The final rule could be a nullity.

What Should Businesses Do?

1. Focus on the policy decisions reflected in the final rule.

The final rule reflects a policy decision by the current DOL to crack down on what it perceives as excessive misclassification of independent contractors. The DOL has undertaken many enforcement actions in the past few years, and it issues press releases to celebrate its victories and to publicize settlements.

The DOL will continue to look for worker misclassification and will continue to pursue alleged wrongdoers.

The most egregious cases – which are those most likely to be targeted – often are not close calls, and those workers might be deemed misclassified under any version of the test. For the closer calls, though, a business’s ability to navigate through the newly articulated test will likely make a big difference if the DOL alleges misclassification.

2. Evaluate whether your independent contractors might be misclassified.

How extensively do you use independent contractors? Do they have other clients? Do they advertise their services? Do you direct or control their work? Do you have the right to control their work?

Consider the factors in the final rule. The commentary provides a useful road map, listing factors that may be considered in a misclassification analysis. Consider the IRS right-to-control test <a href="https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee" target="_blank" rel="noreferrer noopener">factors</a>. Consider the National Labor Relations Act right-to-control <a href="https://www.bakerlaw.com/insights/nlrb-atlanta-opera-decision-unlikely-to-have-major-impact-on-independent-contractor-classification-disputes/" target="_blank" rel="noreferrer noopener">factors</a>.

Check your agreements. Could they be strengthened? The beginning of the year is a great time to roll out new template independent contractor agreements. If you make extensive use of independent contractors, consider individual arbitration agreements with class action waivers.

There are a lot of steps that businesses can take to reduce their risk profile for potential independent contractor misclassification claims. Taking proactive measures is always better than waiting until you get sued.

Every business that retains independent contractors has a responsibility to make sure they are doing so properly, within the bounds of the law. With the new final rule and the DOL’s focus on combating misclassification, there is no time like the present.

Businesses don’t need to drop everything now that the new rule has dropped. But there is an opportunity to be proactive here and protect your business. So please, don’t drop the ball.

Our&nbsp;<a href="https://www.bakerlaw.com/services/labor-and-employment/contingent-workforce/" target="_blank" rel="noreferrer noopener">Contingent Workforce Practice Team</a>&nbsp;is prepared and equipped to help you navigate all this.

The DOL’s New Independent Contractor Test Just Dropped; Now What?

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