Adolay: The consequences of improper employee classification

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By Amy J. Adolay

adolay-amy-mug.jpg Adolay

A dangerous yet continued way of thinking by some companies is that the company can enter into a contract with an individual and call it an independent contractor agreement, agree on how that agreement will be structured, and be protected from liability normally attributed to an employer. This misconception carries a potential for significant damages for the company and its decision-makers.

Improper classification of an employee as an independent contractor can lead to issues under a host of federal and state laws. For example, companies can expose themselves to minimum wage and overtime claims, wage payment claims under state law, benefits claims, liability for unemployment benefits, employment tax issues, workers’ compensation claims, occupational health and safety claims, and unfair labor practice claims.

Moreover, improper classification can lead to allegations that the individual was denied legal rights to medical leave under the Family and Medical Leave Act, disability rights under the Americans with Disabilities Act, and protection from discrimination and retaliation under Title VII of the Civil Rights Act, among other protections. Companies should keep in mind that individuals asserting these claims will be able to choose the laws under which they will challenge their classification.

For example, some individuals are electing to challenge their classification under Section 7 of the National Labor Relations Act, which applies to all non-governmental entities — including non-union companies — and guarantees employees the right to engage in certain protected, concerted activity. Individuals are choosing the NLRA as their vehicle to relief because the National Labor Relations Board can order reinstatement and back pay without the necessity of going to court, providing an inexpensive and quicker route to recovery.

Companies may wonder how the various federal and state bodies responsible for enforcing these laws will learn of potential violations. Often issues are reported by current or former independent contractors claiming misclassification. In addition, the U.S. Department of Labor will likely ask about a company’s independent contractor relationships when otherwise engaging with a company through an audit or investigation. The DOL has made independent contractor misclassification a high priority, as evidenced by its guidance issued in July 2015 concerning the Fair Labor Standards Act’s broad definition of “employ” as “to suffer or permit to work,” which results in most workers being employees. See U.S. Department of Labor, Wage and Hour Division, Administrator’s Interpretation No. 2015-1 (July 15, 2016).

To better achieve the DOL’s enforcement goals concerning independent contractor misclassification, the DOL has entered into partnerships with 37 states to combat misclassification through information sharing and coordinated enforcement. While Indiana has not entered into such a partnership with the DOL, when an individual complains of potential misclassification in Indiana, the complaint is shared with the Indiana Department of Workforce Development, the Indiana Department of Revenue, and the Indiana Worker’s Compensation Board. This means that a complaint of misclassification could have a domino effect, causing more agencies to be involved, more violations to be found and more financial and legal consequences for a company.

One complication for companies is that while the FLSA has its own definition of “employ,” each of the other applicable federal and state laws has its own definition and often its own body of case law interpreting whether a particular worker is an employee. Under the FLSA, an “economic reality test” is applied that focuses on five factors. The first factor is the degree of control exerted by the company over the worker. If the worker is an independent contractor, he or she must control meaningful aspects of the work performed. In other words, is the worker conducting his or her own business?

The second factor is the worker’s opportunity for profit or loss. This factor relates not to whether the worker can work more hours to make more money but rather whether the worker can make decisions using his or her managerial skill regarding such issues as hiring others, purchasing equipment and materials, advertising, and time management to affect the worker’s profit or loss.

The third factor is the worker’s investment. Does the worker have to make substantial financial investments or is the worker financially dependent upon the company and its financial investments?

Fourth, what is the permanence of the relationship? If a relationship is permanent or indefinite, this signals an employment relationship. An independent contractor typically works on a project basis for a company and does not work repeatedly, exclusively or continuously for the company.

Finally, does the work require business judgement, specialized skill and initiative? This factor is not focused on technical skills, but rather skills that indicate the person is running an independent business.

It is not uncommon for some business decision-makers to push back when an internal or external adviser suggests that an individual may be improperly classified as an independent contractor. While company representatives should be advised of the potential impact to the company in the event of misclassification, company representatives should also understand the individual ramifications of misclassification. Under some laws, individuals within a company can be personally liable for the consequences of misclassification.

For example, if an individual establishes that he or she should have been classified as an employee instead of an independent contractor and should have been paid overtime, those within the company who were in some way responsible for the company’s unlawful compensation decisions can be individually liable under the FLSA, resulting in significant financial responsibility for that individual.

The issue of independent contractor misclassification has been placed on the back burner by many companies for years. Given the increased awareness of the issue by individuals in the workforce, and the DOL’s and other agencies’ vigilant enforcement efforts on this front, companies would be well-served to move this issue to the top of their agendas. Companies should be proactive in auditing these relationships and determining whether independent contractor versus employee status changes are necessary or advisable to minimize the risk of liability down the road.•


Amy J. Adolay is a partner at Krieg DeVault LLP who focuses her practice on employment litigation and counseling. The opinions expressed are those of the author.

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