Quirky Question # 153:

Our company has independent-contractor consultants in many states. Our headquarters is in Minnesota. We know that we could be sued in any of the states where we have independent contractors, and that many of those states apply their own legal tests to determine whether an individual is an independent contractor or employee. To get a little predictability, and hopefully, minimize our liability, we’d like to include a choice of law provision in our independent contractor agreements designating Minnesota as the controlling law. Will that provision be enforceable if we get sued in a state other than Minnesota?

Nicole's Analysis:

You’re smart to be concerned about disputes over the status of your independent contractors, since signs point to significant changes in the existing legal landscape. At least two bills currently pending in the United States Congress are directed at the misclassification of employees as independent contractors. The Employee Misclassification Prevention Act, reintroduced in the House and Senate in April of this year, would (among other things) amend the Fair Labor Standards Act to require employers to: (1) keep records of non-employees who perform labor or services for pay; and (2) provide notice to each employee and non-employee of their classification as employee or non-employee, the significance of that classification, and their ability to contact the Department of Labor for further information.

The Taxpayer Responsibility, Accountability, and Consistency Act of 2009, also pending in the House and Senate, would limit employers’ ability to rely on section 530 of the Revenue Act of 1978, known as the “safe harbor” provision, by eliminating reliance on industry standards and/or judicial precedents as a “reasonable basis” for misclassifying an individual as a non-employee.

In addition to proposed legislative changes, the Department of Labor’s budget for fiscal year 2011 allocates significant funds to address independent contractor misclassifications. In one proposed program, the Departments of Labor and the Treasury would work together to eliminate legal incentives for employers to misclassify their employees. The budget predicts the program would increase Treasury receipts by more than $7 billion over 10 years. The budget earmarks $25 million to hire 100 new enforcement personnel to target employee misclassification and would establish grants encouraging states to also address this issue.

Against this backdrop, it’s a good idea to reexamine your company’s independent contractor relationships to ensure you have not improperly classified employees as independent contractors. You may need to modify your existing agreements to reinforce the individuals’ status as independent contractors. And that brings me back to your original question: whether courts will enforce a choice of law provision designating a particular state as the controlling law in independent-contractor disputes. My short answer: yes, but only in disputes requiring the court to interpret or enforce the contract. If contractors bring claims under state or federal statutes, the court will determine their status as independent contracts under the applicable statute.

Many companies elect to include choice of law provisions in their independent-contractor agreements, hoping when and if a contractor sues the dispute will be decided under the laws of the designated state. The potential benefits of such provisions are twofold. First, companies who operate in multiple states will get predictability in lawsuits with independent contractors. Second, companies hope to have their disputes decided under the laws of more “business friendly” states. After all, what company wouldn’t want to avoid a lawsuit under California law?

Generally, when interpreting or enforcing a contract, courts will enforce the parties’ agreement with respect to choice of law. Absent unusual circumstances (such as when a party has grounds to argue duress in the formation of the contract), disputes arising under the agreement likely will be decided under the law designated in the agreement. See, e.g., Gillespie v. Colonial Life & Accident Ins. Co., 2009 U.S. Dist. LEXIS 26310, at *10 (W. D. Pa. Mar. 3, 2009) (applying law designated in choice of law provision to determine whether arbitration agreement with independent contractor was unconscionable). For example, assume an independent contractor agreement sets forth the parties’ agreement with respect to how the independent contractor will be compensated. If a dispute arises regarding payments to the independent contractor, that dispute likely would be decided under the laws of the state designated in the choice of law provision. However, in the likely event an independent contractor brings state or federal statutory claims, such as wage and hour or discrimination claims, courts have held that the applicable statute determines whether the plaintiff is an employee or independent contractor, regardless of the parties’ agreement with respect to choice of law.

In a recent decision from the 9th Circuit Court of Appeals, Narayan v. EGL, Inc., three independent-contractor drivers sued the transportation company they contracted with, alleging they were employees who were improperly denied benefits conferred upon them by the California Labor Code. ___ F.3d ___, available at 2010 U.S. App. LEXIS 14279 (9th Cir. Jul. 13, 2010). They sought, among other things, unpaid overtime compensation and payment for missed meal and rest breaks. The defendant transportation company had its headquarters in Texas. The plaintiff drivers were residents of California and provided freight pick-up and delivery services within California. All three signed agreements with the transportation company for “Leased Equipment and Independent Contractor Services.” The agreements specifically provided that the parties intended to create a “vendor/vendee relationship” and that there was no employment relationship between the parties.

The transportation company moved for summary judgment, arguing the drivers were independent contractors, not employees, according to the parties’ agreements and, therefore, not entitled to the protections afforded by the California Labor Code. The district court agreed, applying Texas law pursuant to a choice of law provision in the agreements. It held a declaration in the agreements that the drivers were independent contractors rather than employees compelled the holding, under Texas law, that they were independent contractors as a matter of law.

Under California law, such declarations are not controlling as to whether an individual is an employee or independent contractor. (Such declarations also are not controlling in cases challenging an independent contractor’s status under the federal Fair Labor Standards Act. See, e.g., Zavala v. Wal-Mart Stores, Inc., 393 F. Supp. 2d 295, 330 n.27 (D.N.J. 2005) (“Contract disclaimers, which provide that a particular entity is/is not an employer or is/is not an independent contractor or employee, generally do not decide the issue.”)). California (like most states) applies a multi-factor test to determine whether an individual is an employee or independent contractor. Under these tests, the parties’ intent typically is one of many factors considered.

The Ninth Circuit Court of Appeals reversed the district court’s holding that the drivers were independent contractors as a matter of law. It held the agreements’ choice of law clause, which designated Texas as the law under which the agreements “shall be interpreted and enforced,” applied only to the “interpretation and enforcement of the contract itself” and did not “encompass all disputes between the parties.” Narayan, 2010 U.S. App. LEXIS 14279, at *7 (internal citations omitted). The drivers’ claims for overtime pay and other benefits under the California Labor Code required the court to resolve whether they were employees under the applicable statutes. According to the court, “[w]hile the contracts will likely be used as evidence to provide or disprove the statutory claims, the claims do not arise out of the contract, involve the interpretation of any contract, or otherwise require there to be a contract.” Id. at *8. The court went on to deny the transportation company’s motion for summary judgment, finding enough indicia of an employment relationship to permit a reasonable jury to find the drivers were employees.

A recent case from the Third Circuit Court of Appeals reinforces that choice of law clauses don’t apply in cases involving statutory challenges to an independent contractor’s status. CBS Corp. v. FCC considered whether the doctrine of respondeat superior could be applied to hold CBS liable for the actions of Janet Jackson and Justin Timberlake leading to the infamous “wardrobe malfunction” during the 2004 Super Bowl halftime show. 535 F.3d 167 (3d Cir. 2008), vacated on other grounds, 129 S. Ct. 2176 (2009). Since respondeat superior liability is limited to the conduct of employees acting within the scope of their employment, CBS would avoid liability if Jackson and Timberlake were held to be independent contractors. CBS argued that New York law should apply because its agreements with Jackson and Timberlake included choice of law provisions requiring application of New York law. The court disagreed, holding that “federal law” should be applied since the issue arose under a federal regulatory scheme. The court observed, “[t]o hold otherwise would create opportunities for broadcasters to evade liability for broadcast indecency through artful drafting of contracts.” Id. at 191. The court went on to find that Jackson and Timberlake were not employees of CBS. See also Bell v. Atl. Trucking Co., 2009 U.S. Dist. LEXIS 114342, at *13 (M. D. Fla. Dec. 7, 2009) (noting, in dicta, whether individual was contractor or employee under Federal Arbitration Act would be decided under federal common law, despite choice of law provision designating South Carolina law).

The Narayan and CBS v. FCC cases demonstrate that companies aren’t likely to benefit from their choice of law provisions in any case where independent contractors bring statutory claims challenging their status as independent contractors. Given the limited utility of such provisions, employers should take care that their independent contractors are properly classified as such under the laws of all applicable states, as well as federal law.