Yesterday, June 12, FedEx announced in papers filed with the SEC that its Ground Division “has reached an agreement in principle with [drivers] in the independent contractor litigation that is pending in …California [federal court] to settle the matter for $228 million.” The proposed agreement, which has not yet been filed in court, is subject to judicial approval. This proposed settlement comes nine months after the U.S. Court of Appeals for the Ninth Circuit ruled in appeals from federal district courts in California and Oregon that, as a matter of law, the drivers whom FedEx Ground treated as independent contractors (ICs) were employees and, therefore, FedEx had misclassified them and denied them rights and benefits under law.

In our blog post on August 29, 2014 entitled “Earthquake in the Independent Contractor Misclassification Field,” we noted that FedEx Ground has been at the epicenter of the crackdown on IC misclassification by government regulators, state legislators, and plaintiffs’ class action lawyers since 2007. But in 2010, FedEx Ground won a significant court decision involving the IC status of its Ground Division drivers in an opinion by a federal district court judge presiding over dozens of IC misclassification cases in a “multi-district litigation.” But all changed on August 27, 2014, when the Ninth Circuit Court of Appeals reversed that lower court decision in cases involving drivers in California and Oregon.

This settlement covers 2,300 drivers in California who had filed class action claims for a variety of alleged violations under federal and state law, including claims for reimbursement of business expenses, unpaid overtime, failure to provide meal and rest periods, reimbursement of deductions in pay, and non-payment of termination pay. The drivers also sought litigation costs and attorneys’ fees in their court complaint. Alexander v. FedEx Ground Package System, No. 3:05-cv-00038-EMC (N.D. Calif.).

In its June 12, 2015 SEC filing, FedEx stated that it “faced a unique challenge in defending this case given the decision of the Ninth Circuit Court of Appeals last summer.” It noted that the settlement “resolves claims dating back to 2000 that concern a [business] model FedEx Ground no longer operates.”

Where Did FedEx Ground Fail?

In the case of FedEx Ground, the Ninth Circuit was not won over by FedEx’s argument that it lacked control over the drivers’ jobs. FedEx pointed out that the FedEx IC agreement permits a driver to delegate to other drivers, take on additional routes, or sell his route to a third party. But the Court noted that FedEx may refuse to let a driver take on additional routes or sell his route to a third party, and FedEx’s senior managers have the authority to reject proposed replacement drivers based on failure to meet FedEx standards such as grooming requirements. The Court concluded that a lack of control over certain parts of the drivers’ roles was not sufficient to “counteract the extensive control [FedEx] does exercise.”

The Kansas Supreme Court last year reached a similar conclusion, but it was not as mellow in its critique of the contract used by the company. The Kansas court characterized the IC agreement as a “brilliantly drafted contract creating the constraints of an employment relationship with [the drivers] in the guise of an independent contractor model – because FedEx not only has the right to control, but has close to absolute actual control over [the drivers] based upon interpretation and obfuscation.” Said in fewer words but with even more imagery by the Court: “FedEx established an employment relationship with its delivery drivers but dressed that relationship in independent contractor clothing.”

The Impact of This Settlement on FedEx – and Others Using ICs

This settlement by FedEx Ground resolves only the claims by its drivers in California. IC misclassification claims have been brought against it in other states, some of which have already been resolved, such as a lawsuit it settled for $5.8 million with FedEx Ground drivers inMaine. FedEx may choose to resolve cases that remain pending or have not been reported as having fully resolved in other state venues, such as those in KansasMissouriMassachusetts,Florida and Oregon that have been the subject of our monthly IC misclassification updates on this site.

FedEx Ground has not only been plagued by driver misclassification lawsuits over the years but also by state attorney generals and state workforce agencies in New YorkMontana,Massachusetts, and other states for allegedly unpaid unemployment insurance taxes.

FedEx Ground also faces unionization efforts in Connecticut and other locations following decisions by the National Labor Relations Board (NLRB) that its Ground Division and Home Delivery drivers are employees and not independent contractors under the federal labor laws.

As we noted following the Ninth Circuit decisions last August, this setback for FedEx Ground is likely to reinvigorate the crackdown against companies using ICs to supplement their workforce or are built on an IC business model, where the IC relationship is not structured, documented, or implemented in a manner that complies with state or federal IC laws.

Lessons For Other Companies Using ICs

IC misclassification can, as we observed in our White Paper on the subject, be the result ofintentional violations of the labor, tax, and employee benefits laws or, as is quite common,unintentional or misplaced failures to comply with applicable state and federal laws governing the use of ICs. Many businesses face a situation similar to FedEx Ground – a company that sought to comply with the law but did not fully satisfy the requirements. So, what lessons can be learned from this $228 million settlement and the other recent setbacks suffered by FedEx Ground?

1.  A failure to properly structure, document, and implement independent contractor relationships can and should be avoided

The laws in almost all states allow companies to contract with individuals or businesses to provide services to customers and clients of the company, yet many companies that do so fail to take steps to properly structure, document, and implement their IC relationships to fully comply with those laws.

Prudent businesses that use independent contractors or pay workers on a 1099 basis address the issue of IC compliance before being served with a class action summons and complaint andbefore receiving a notice from a state unemployment, wage, or workers compensation office, the IRS, or the NLRB inquiring about workers whose wages are reported on a Form 1099 but may well be employees misclassified as ICs.

As noted above, FedEx Ground lost before the appellate courts because of a misplaced reliance on an IC agreement and its policies and procedures that were good, but by no means good enough.  A quick review of the language in the FedEx IC agreement and the policies and procedures issued by FedEx would give one the impression that FedEx and its lawyers knew what to write and how to write it, but close scrutiny by the courts found one fallacy after another – sufficient in degree to lead to rulings against the company. By their very nature, therefore, IC agreements and policies and procedures that are not drafted in a state-of-the-art manner, free from language that can be used against the company, can cause businesses that use ICs not only to face legal challenges they may otherwise have been able to avoid but, once sued, they may well have been able to win.

This and similar class action lawsuits illustrate the value of using, in advance of a legal challenge, a methodology to evaluate whether an existing or proposed IC relationship can be legitimately structured as such, and if so, whether it needs to be restructured, re-documented, and re-implemented to maximize the likelihood that those workers will be regarded by the courts and government regulators as ICs and not employees. Some companies have used IC Diagnostics™ to enhance their level of IC compliance and determine whether a group of workers not being treated as employees would pass the applicable legal tests for IC status under governing state and federal law. That process also offers a number of practical, alternative solutions to enhance compliance with those laws, such as reclassification and redistribution.

2.  Retaining contractors who operate in the form of business entities, such as LLCs, do not necessarily insulate companies from IC misclassification exposure

A common misconception by many businesses is that contracting with an LLC, corporation, or other form of business entity eliminates the possibility of misclassification liability. While FedEx Ground observed in its comments to its June 12, 2015 SEC filing that it was settling a case that involved “a model FedEx Ground no longer operates,” its current business practice is not necessarily free from legal exposure. Beginning a few years ago, FedEx announced that it was converting to a new business model where it would only contract with incorporated Independent Service Providers (ISPs) who operate three or more routes in the same geographical area. Yet, last year, the Kansas Supreme Court ruled that “the employer/employee relationship between FedEx and a full-time delivery driver . . . is not terminated or altered when the driver acquires an additional route for which he or she is not the driver.” Drivers who “acquire more than one service area from FedEx” are also employees, the court held.

In January of this year, Lowe’s Home Centers settled an IC misclassification class action brought by home improvement contractors comprised of both individuals and small businesses. The $6.5 million settlement includes payments not only to individuals but also to LLCs and other forms of business entities.

Some state laws expressly carve out from their definitions of “employee” a business entity where the hiring party does not exercise direction or control over the performance of the services and meets other requirements. Companies that wish to minimize IC misclassification liability wisely do not rely solely on the fact that the IC has chosen to operate as a business entity. Structuring, documenting, and implementing a compliant IC relationship is still the key.

3.  There are “hidden costs” of class action settlements as well as other misclassification exposures that can arise after settlement

FedEx has invested heavily in its legal defense of dozens of IC misclassification lawsuits as well as audits, investigations, and proceedings by state and federal regulatory agencies. These “hidden costs” are not reflected in settlements such as the one just entered into by FedEx in California. Typically, class action settlements include legal fees that can range as high as 25-33% of the amounts paid to the class members, and oftentimes the legal fees paid by the companies defending such lawsuits equal or exceed the amount of fees paid to the plaintiffs’ class action lawyers.

The costs of worker misclassification do not always terminate once a class action is settled and all monies are paid to the workers involved, their counsel, and the lawyers representing the business being sued.  Companies that settle class action cases may also be facing claims for unpaid payroll and unemployment taxes at the state and federal levels and unpaid workers compensation premiums – although there may be defenses to those types of claims.

Finally, settlements in one state can provoke new lawsuits in other jurisdictions or create pressure to settle other outstanding IC misclassification claims. Plainly, the most prudent path is to enhance compliance when the potential for IC misclassification exposure first becomes evident to a business that is based on an IC business model or uses ICs to supplement its workforce.

This is particularly meaningful to start-up companies in the on demand, sharing, or gig economy. Businesses like Uber, Lyft and an array of other tech businesses are quickly finding that they, too, are targets of class actionsregulatory enforcement, and labor organizing by those who believe that such start-ups are not complying with federal and state IC laws. They are quickly rivaling FedEx Ground as a lightning rod for those seeking to crack down on IC misclassification. The hidden costs of such misclassification lawsuits and administrative proceedings are undoubtedly increasing.

4.  Companies that can financially survive class action IC misclassification settlements or judgments in court or before an administrative agency need not necessarily reclassify the workers as employees

FedEx is a Fortune 100 company, so it can absorb the $228 million settlement. FedEx is a good example of a company that chose to revise its business model while in the midst of legal challenges. While it is too early to tell if its actions to restructure, re-document, and re-implement its IC/ISP relationships will survive legal scrutiny, it wisely choose not to stand pat.

On the other hand, many companies treat the costly termination of a class action lawsuit or an adverse determination by a regulatory agency as imparting upon them an obligation to treat the workers in question as employees on a going-forward basis. This overlooks the fact that many businesses can adopt an IC model, even after the commencement or termination of a class action lawsuit or an adverse regulatory ruling, that may well survive future scrutiny under federal and most state laws. How? By undertaking bona fide restructuring, re-documentation, and implementation of new, state-of-the-art IC compliance practices. This is one of the reasons some businesses have resorted to methodologies such as IC Diagnostics™ even after they have become the target of legal challenges.

While efforts today to enhance IC compliance cannot eliminate past exposure to misclassification liability, any changes that enhance compliance with the IC laws going forward will not only minimize or avoid future liability but also lessen the likelihood that the business will become a target for class action lawyers and government agencies.