A recent Eleventh U.S. Circuit Court of Appeals decision issued a strong admonition to employers: the misclassification of workers as independent contractors rather than employees may have serious financial and operational repercussions for businesses.
As one Florida employer just learned, such outcomes may include lengthy and expensive Fair Labor Standards Act (FLSA) litigation resulting in the certification of a class of more than 500 workers entitled to years of unpaid overtime wages. In Scantland v. Jeffry Knight Inc., the Eleventh Circuit reversed a district court decision granting summary judgment to Knight and held that, if all justifiable inferences were drawn in their favor, a group of cable installers who brought a collective action under the FLSA against Knight were statutory employees, not independent contractors.1
Courts in the Eleventh Circuit apply the now-familiar six-factor economic realities test to determine whether workers are properly classified as employees or independent contractors for purposes of the FLSA. Although the six factors are not exclusive and no one factor is dominant, each serves as a guidepost in assessing whether a worker is so dependent upon his or her employer so as to come within the protection of the FLSA or sufficiently independent so as to fall outside the reach of the mandatory provisions of the statute.2
In making classification determinations, businesses should evaluate material facts relevant to each criterion through the lens of "economic dependence" to assess whether the relationship with each worker is more analogous to the "usual path" of employee or independent contractor.3 The factors are:
- the nature and degree of the alleged employer's control as to the manner in which work is to be performed
- the alleged employee's opportunity for profit or loss depending upon his managerial skill
- the alleged employee's investment in equipment or materials required for his task or his employment of workers (i.e., subcontractors)
- whether the service rendered requires a special skill
- the degree of permanency and duration of the working relationship
- the extent to which the service rendered is an integral part of the alleged employer's business4
Applying these factors, the district court held Knight's degree of control over the manner in which work was performed, the opportunity for profit and loss, the plaintiffs' investment in materials, and the presence of special skill substantially outweighed the factors of duration and the nature of the service rendered in favor of independent contractor status.5 Notably, the court considered the provisions of Knight's independent contractor agreements against the six factors in examining the plaintiffs' economic dependence on Knight.6
Amicus Brief from the Secretary of Labor
Presumably in conjunction with the Department of Labor's Misclassification Initiative launched in 2011 under the auspices of Vice President Joseph Biden's Middle Class Task Force, the secretary of labor weighed in heavily on this case once it reached the Eleventh Circuit, sending a powerful reminder to employers about the Department of Labor's heightened and continued commitment to prosecuting misclassification actions.
Citing a substantial interest in the protection of workers and the proper judicial interpretation of the scope of the employment relationship under the FLSA, the secretary submitted an amicus brief to the Eleventh Circuit in support of the plaintiffs, arguing the district court "lost sight of that ultimate inquiry of economic dependence and the reality of the cable installers' relationship with Knight."7
Ultimately, the Eleventh Circuit held that the district court erred in concluding the cable installers were independent contractors and not employees.8 Despite the fact that Knight's independent contractor agreements left the performance of work to the plaintiffs' "exclusive discretion, supervision and control," their testimony showed otherwise.9
The court's observation here is a key practice point for employers. The cable installers were required to report to Knight their arrival to and departure from assigned jobs, received constant site checks, could not refuse jobs without threat of termination, and were subject to uncontestable fines for not meeting job specifications.10 The court held that because Knight controlled the plaintiffs' work assignments and schedules, and closely monitored the quality of their work, there was a significant degree of control.11 The terms and conditions set forth in the independent contractor agreements were by no means dispositive.
Further, the cable installers did not have the opportunity to control their profit or loss, as Knight determined the rates they were paid for jobs.12 The duration factor also weighed in favor of employee status because the independent contractor agreements were for one-year terms, automatically renewed, and were terminable only upon 30 days' notice.13
The Eleventh Circuit also held the service rendered by the cable installers was an integral part of Knight's business, and, indeed, was the "backbone" of Knight's entire operation.14 The plaintiffs' investment in equipment and their special skills only weakly favored independent contractor status.15
Protection Against Worker Misclassification
Scantland should prompt employers to re-evaluate their current practices in respect to employees, independent contractors and consultants. Here are some proactive measures employers should take to protect themselves from the potentially costly consequences of worker misclassification:
- Independent contractor agreements. Agreements should be for a limited duration without automatic renewal provisions and terminable on short notice for any reason whatsoever, and by either party. In Scantland, that the cable installers' independent contractor agreements were automatically renewed and terminable only upon 30 days' notice suggested "substantial permanence of relationship."16
Also consider including language in independent contractor agreements affirming that the engaged personnel has prior experience and the necessary qualifications to carry out the job. That Knight hired workers with no experience who underwent significant company training undermined the workers' purported economic independence.17
- Penalty policies. The usual penalty to be assessed for an independent contractor's failure to follow specifications is the actual cost of the damages. In Scantland, the Eleventh Circuit held that Knight's assessment of flat fees to the cable installers for not meeting job specifications, which sometimes exceeded the actual value of the job completed, were more consistent with the "disciplining of employees," and thus weighed in favor of employee status under the FLSA.18
Any indicia of the traditional employer/employee relationship should be carefully examined to determine appropriate operational alternatives for independent contractors and consultants.
- Workplace practices. Evaluate whether actual practices are consistent with the provisions of any independent contractor agreement, and, more importantly, follow the "usual path" of an independent contractor. Independent contractors must be permitted to undertake other employment, determine generally their hours of work and not be unduly restricted by employer policies and procedures typically reserved for employees.
- Review of IRS compliance. In addition to the litigation costs associated with worker misclassification, the IRS may impose significant penalties for an employer's failure to pay appropriate employment taxes. In conjunction with the Department of Labor's Misclassification Initiative, the IRS and the Department of Labor entered into a 2011 memorandum of understanding designed to enable the agencies to work together and share information to reduce the prevalence of employee misclassification and improve compliance with federal labor laws.
Employers should be aware that the IRS has a Classification Settlement Program for employers currently under examination, and, as of 2011, now offers a Voluntary Classification Settlement Program for employers who meet certain eligibility criteria. The voluntary program allows employers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. The voluntary program is not, however, available to employers contesting the classification of a class or classes of workers from a previous audit by the IRS or Department of Labor.
- Hire employees for integral business functions. Although employers may want to avoid the costs of hiring employees (e.g., employment taxes, unemployment insurance, liability insurance, overtime pay, etc.), if employers must exercise significant control over a worker's performance due to the nature of the business, they should hire employees to render such integral services.
As Scantland demonstrates, misclassification of workers can prove much more costly, resulting in years of back overtime payments and other penalties, not to mention attorneys' fees and costs incurred in defending misclassification actions.
A version of this alert originally appeared in the Fulton County Daily Report on August 13, 2013.