A group of insurance “sales leaders” who filed for overtime wages under the Fair Labor Standards Act (FLSA) have been deemed by the 5th U.S. Circuit Court of Appeals to be employees rather than independent contractors, and therefore eligible for overtime pay. Hopkins v. Cornerstone America, No. 07-10952 (5th Cir. October 13, 2008). The court based its decision on the economic realities of the situation, and determined that the managers were economically dependent upon the company for which they worked, instead of being in business for themselves.

Cornerstone America, the sales and marketing division of Mid-West National Life Insurance Company of Tennessee, uses a “pyramid” system of sales agents, all of whom agree to work as independent contractors, with payment on a commission basis. Certain of the agents have been promoted to “sales leaders,” a management-level designation. In that position, the opportunity for personal sales diminishes, and income is earned primarily from overwrite commissions on sales made by subordinate agents. In the model used by Cornerstone, there is no formal relationship between the sales leaders and the sales agents. Instead, each sales agent contracts directly with Cornerstone; the company controls the hiring and firing of each agent, along with the assignment and promotion of each, regardless of sales leader group.

Although the sales leaders have a certain amount of flexibility with regard to their own working hours and daily routine, and although they all are designated as independent contractors who receive no employment benefits and very little corporate oversight, a group of those managers filed suit against Cornerstone and its parent companies, alleging that they were “employees” entitled to overtime wages. Both the plaintiffs and the company filed summary judgment motions on the issue of whether the sales leaders were employees or independent contractors. The district court found in favor of plaintiffs, and that decision was appealed to the Fifth Circuit.

The FLSA’s definition of “employee” is extremely broad, and includes some individuals who may not qualify as employees under traditional agency law principles. The Fifth Circuit’s approach to the question of whether the sales leaders are independent contractors or actual employees was premised on a five-factor analysis. To determine whether the workers are economically dependent upon Cornerstone, the court reviewed (1) the degree of control exercised by the company; (2) the extent of the relative investments of the workers and the company; (3) the degree to which the workers’ opportunity for profit or loss is determined by the company; (4) the skill and initiative required for performing the job; and (5) the permanency of the relationship. Under that analysis, the Fifth Circuit upheld the lower court’s determination that the sales leaders were employees, rather than independent contractors.

The court’s decision focused largely on the fact that the company exercises a substantial amount of control over the plaintiffs’ ability to earn income. Such control includes hiring, firing, and assigning sales agents, on whom the sales leaders’ income depends; advertising for new recruits; controlling the number of sales leads the leaders could receive; and limiting the types and price of insurance products the leaders could sell. In addition, Cornerstone precludes sales leaders from being involved in or owning any other businesses while employed with Cornerstone. These facts, in addition to the fact that most of the sales leaders have been with Cornerstone for a substantial period of time, creating more of a long-term employment relationship than a transient independent contractor relationship, led the court to its determination.

The court's opinion is a guide to employers who want to understand what the courts look for when making the determination of whether an individual is an "employee" v. an "independent contractor." In order to establish a true independent contractor relationship, the economic realities of the situation should show that the worker possesses some unique skill, and that he or she is allowed to control the methods and means by which that skill is exercised. If instead, the individual’s duties involve only a standard set of skills (in this case, business sense, salesmanship, and basic management skills), and the company is controlling the individual’s wages by limiting the method by which the individual can earn that wage, the courts are more likely to find a traditional employer/employee relationship. In this case, that determination may lead to unanticipated liability for overtime pay under the FLSA.