Source: https://knowledge.leglobal.org/eic/country/united-states-of-america/trends-specific-cases-21/
Timestamp: 2019-04-25 08:11:57+00:00

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Recent years have seen vastly stepped-up enforcement efforts on the part of federal and state government agencies seeking to remedy revenue shortfalls in the wake of the economic downturn that began in 2008. All the while, the plaintiff’s bar has increasingly targeted employer use of independent contractors, and the number of class action law-suits alleging misclassification under federal and state laws has risen steeply. All these developments have placed companies who enter into independent contractor relation-ships at substantial risk of adverse findings and judgments.
In 2010, the IRS launched an intensified enforcement program involving widespread audits of businesses to uncover misclassification issues. A year later, the agency announced a new Voluntary Classification Settlement Program (“VCSP”), allowing em-ployers to voluntarily reclassify workers previously treated as independent contractors without incurring tax obligations or penalties for past misclassifications. Under the VCSP, employers receive immunity from IRS misclassification audits in exchange for payment of 10% of the employment tax liability for misclassified workers for one year. Interest and penalties are waived. To be eligible to participate in the VCSP, an employer must, among other matters, have consistently treated the affected workers as nonemployees in the past and have filed the required Forms1099 for these workers for at least the previous three years.
Participation in the VCSP has been relatively sparse, most likely because the VCSP resolves only an employer’s potential federal tax liability, but not any potential liability arising from misclassification under state tax, employee benefits, wage-and-hour, work-ers’ compensation and other employment-related laws. Concerned that participation in the program may highlight the existence of potential misclassification issues and invite further audits and lawsuits, many companies have remained wary.
In September 2011, the United States Department of Labor announced that it had entered into an unprecedented Memorandum of Understanding (“MOU”) with the IRS. The MOU provides the foundation for future cooperation and information sharing among the two agencies to facilitate enhanced enforcement of federal tax, wage-and-hour, workplace safety and benefits laws in response to alleged misclassification of employees.
Several states have likewise formed interagency and joint task forces to combat the per-ceived misclassification problem. The task forces are generally responsible for facilitating the sharing of information and resources among the relevant administrative agencies, developing joint investigative and enforcement strategies, and encouraging the report-ing of alleged violations. Agencies in at least 14 states have additionally signed MOUs with the federal Labor Department’s Wage-and-hour Division. At the same time, 34 state agencies now share information concerning misclassification issues with the IRS as part of the IRS Questionable Employment Tax Practices initiative, which aims to identify un-lawful employment tax practices.
As a result of this vastly improved communication and collaboration among different fed-eral and state agencies, a single audit by one agency may now result in investigations and enforcement actions at multiple levels under multiple different laws, each with its own potential penalties and other consequences. This means that misclassification of even a single position carries the risk of expansive agency enforcement. As agencies have inten-sified the publicity of enforcement proceedings, such actions now more easily attract the attention of the plaintiff’s bar, resulting in a greater risk of private lawsuits.
On December 19th, 2016 the Department of Labor (“DOL”) updated its Independent Contractor misalignment webpage, reissuing its resources on independent contractor misclassification and grouping these resources together with resources from other fed-eral and state agencies on the issue. Although no information provided is new, it signi-fies the DOL’s continued focus on the issue of independent contractor misclassification, bringing awareness to both workers and employers of this issue.
On July 15, 2015, in light of a perceived increase in misclassification of employees as independent contractors49 largely due to how businesses are being restructured of late, the Department of Labor (the government agency which enforces the FLSA) issued guide-lines regarding the application of the FLSA’s definition of employee as “to suffer or permit to work” standard to the identification of workers misclassified as independent contrac-tors. The DOL clarified that the factors found in the Economic Realities Test should be ap-plied in consideration of the broad scope of the FLSA’s “suffer or permit” standard, which was “specifically designed to ensure as broad a scope as coverage as possible”. The FLSA ‘s statutory definitions rejected the more narrow common law control test, in deference to the economic realities test which should read in line with the FLSA’s “suffer or permit” standard which “stretched the meaning of ‘employee’ to cover some parties who might not qualify as such under a strict application of traditional agency law principles”50. Thus the Economic Realities Test should be construed with awareness to the FLSA”s “overar-ching principle” of broad coverage for workers. The main analysis rests on whether the worker is economically dependent on the employer as opposed to in business for him/ her self. If the worker is economically dependent on the employer, then the worker is an employee.
Although the DOL guidelines, legally, contain nothing new, they signify a heightened focus on the concept of “economic dependence” in the employee v. independent contractor analysis, as well as confirmation that the issue of independent contractor misclassification is a key issue for the DOL, and one which employers should analyze with caution.
• “substantially controls the means and manner of performing the services” in conformity with regulatory requirements, or “the specifications of the service recipient or payor and any additional requirements” in the parties’ written IC agreement.
This bill has a narrow scope, limited to independent contractors who bill for services such as drivers and message couriers. The bill would have no impact on whether a worker was deemed employee or independent contractor under the FLSA. Similar bills have been proposed in the past, and no congressional action was taken54.
Other proposed bills relating to independent contractor misclassification include – the Fair Playing Field Act (introduced in 2010, and again in 2012, and 2013) 55, the Payroll Fraud Prevention Act (introduced in 2011, and again in 2013, and 2014) 56, and the Employment Misclassification Act (introduced in 2008, and again in 2010 and 2011)57. None of these bills have resulted in enactment.
As state agencies are collaborating with the federal government at increasing rates to curb misclassification, a significant number of state legislatures have also entered the fray by passing legislation. Some of the new laws are specific to certain industries where worker misclassification is perceived to have been particularly rampant. For example, in 2007, New Jersey passed the Construction Industry Independent Contractor Act.58 The statute creates a rebuttable presumption that full-time construction workers are employees and not independent contractors, for purposes of many New Jersey labor and employment statutes. Penalties for violations include suspension of the contractor’s registration, “stop-work” orders, and civil fines. Similar statutes have been enacted in Delaware,59 Maine,60 New York,61 Pennsylvania,62 as well as several additional states.
Other states have laws that apply more generally to all industries. California’s Inde-pendent Contractor Law, for example, which took effect in 2012, prohibits any form of “willful misclassification,” and makes it unlawful for employers to charge misclassified employees for business expenses and to make improper deductions from their pay. The statute not only imposes harsh penalties on violators, but also holds outside non-legal consultants jointly liable for “knowingly advis[ing] an employer to treat an individual as an independent contractor to avoid employee status” if it turns out the individual was not in fact an independent contractor.63 Other states that have enacted misclassifica-tion laws within the past decade include Colorado,64 Connecticut,65 Illinois,66 Louisiana,67 Maryland,68 Massachusetts,69 New Hampshire,70 and New Mexico.71 In September 2014 California also passed Assembly Bill No. 1897, adding a section to the Labor Code re-garding labor contracting and client liability72. This increases liability risk for companies that use workers supplied by “labor contractors” that fail to pay all wages due to the workers. The law requires client employers to “share with a labor contractor all civil legal responsibility and civil liability for all workers supplied by that labor contractor for . . .
the payment of wages and failure to secure workers’ compensation coverage .” Three key exclusions in the law include: 1) those exempt from overtime payment (executive, administrative, or professional employees), 2) business with workforces of less than 25 individuals or a workforce with less than 5 independent contractors, and 3) bona fide independent contractors supplied by a labor contractor.
Companies with a business structure, which either uses independent contractors to sup-plement its workforce or maintains a primarily independent contractor workforce, are increasingly targeted by plaintiffs’ class action lawyers. Both large and small business organizations have become targets. Although no industry is free from this type of law-suits some industries are more vulnerable than others. Industries that are particularly vulnerable include on-demand businesses, and Silicon Valley startups.
In March 2015 federal court judges in California issued two separate decisions in independent contractor misclassification class action lawsuits73. Both O’Connor v. Uber Technologies, Inc. and Cotter v. Lyft are class actions brought by drivers of the respective companies who allege that Uber and Lyft misclassified them as independent contractors instead of employees, depriving them of employee rights and benefits. In both cases the court denied motions and ruled that a jury would decide whether the workers are con-sidered independent contractors or employees. Moreover both courts concluded that some of the factors signaled an employee designation, while other factors signaled an independent contractor designation. Both companies allow the workers to determine when and how much they want to work, and whether to accept or reject rides. On the other hand, both companies expressly reserve the right to terminate the relationship if the driver’s user rating is deemed low or for any reason at all (a key employee status factor). As a result of these decisions, Uber, Lyft, and any “on demand” business (an increasingly popular business model) are at risk if they do not structure their employee–independent contractor relationship in a manner which remains in line with federal and state requirements. This however does not mean that companies cannot prevail on IC misclassification claims, as the Uber court noted that recent California cases found in favor of the employer, where “all the factors weighed and considered as a whole establish than an [individual] was an independent contractor and not an employee”.
In August 2014, the ninth circuit issued two decisions regarding Fedex Ground drivers class actions in Oregon73 and California74. The drivers sought unpaid wages, reimburse-ment of unpaid driving expenses and similar types of state law damages. The Ninth Cir-cuit looking at the two class actions together analyzed the Fedex Ground contract (Op-erating Agreement) that each driver entered into, in addition to standard Fedex policies and procedures. The Court concluded that the Fedex Ground drivers were employees and not independent contractors on grounds that: Fedex has the right to and ultimately controls driver appearance, can and does control driver vehicles, can and does control the time drivers work, can and does control when and how drivers deliver packages, and requires drivers to “conduct all business activities… with proper decorum at all times”. The significance of these decisions is that despite reliance on an explicit Independent Contractor Agreement, upon close scrutiny the Court found several key factors out of line with the legal standard for an independent contractor classification.
In June 2015 Fedex announced 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 for $228 million dollars”. To prevent a similar outcome companies should: 1) restructure the independent contractor relationship in a manner which still serves business objectives, 2) redraft independent contractor contracts in close consideration of federal and state laws regarding independent contractor misclas-sification, and 3) reimplement the employer – independent contractor relationship in a manner consistent with the restructure and redraft.
Many tax- and employment-related statutes implicated by misclassification distinguish between businesses that believe in good faith that they have correctly interpreted applicable classification standards and those that have willfully violated the law. However, this is not always the case. In Somers v. Converged Access, Inc.,75 the Massachusetts Supreme Court held that the state’s independent contractor law is a strict liability statute, which means it is irrelevant whether an employer who misclassified an employee acted in good faith. The plaintiff, a temporary worker, filed a private lawsuit alleging violation of the Massachusetts statute after the company failed to hire him for a permanent position.
The company argued that the plaintiff had sustained no damages, because he actually realized greater earnings than he would have had as an employee. The Supreme Court disagreed, observing that the plaintiff had not received the vacation, holiday, or overtime pay paid to employees. If the plaintiff could demonstrate that he was a misclassified employee, the Massachusetts statute would thus entitle him to recover treble damages for any lost wages and other benefits.
The seminal misclassification case under federal tax and benefits laws is Vizcaino v. Mi-crosoft Corporation.76 The case involved a group of workers Microsoft had classified as independent contractors and referred to as “freelancers.”The freelancers were compen-sated at an hourly rate that was higher than the wage paid to employees performing similar work, were paid through Microsoft’s accounts payable department rather than its payroll department, wore different badges and were not included in company functions. Despite these efforts to distinguish “freelancers” from regular employees, however, the IRS determined, following a classification audit, that the freelancers had been misclassi fied and were actually employees.
This conclusion prompted an ERISA class-action lawsuit by the freelancers, who demand-ed that Microsoft allow them to participate in a variety of employee benefits, including two of the company’s employer-sponsored ERISA retirement plans. On appeal, the fed-eral Ninth Circuit Court of Appeals noted that the freelancers could not be materially distinguished from Microsoft’s remaining workforce: they often worked on teams with regular employees, they performed the same functions, they shared the same supervi-sors, and they worked the same hours. Microsoft then conceded that the workers were employees under the common-law test. The company argued, however, that the plan administrator had correctly refused to award benefits under the retirement plans, because the workers had agreed in their independent contractor agreements that they were not entitled to participate.
The court disagreed. The mere fact that the agreements labeled the workers as “inde-pendent contractors” was not dispositive, the court held, and the agreements were ulti-mately based on a mutual mistake and unenforceable. Accordingly, Microsoft was direct-ed to fund the workers’ retirement benefits retroactively. The case continued through several appeals, but was ultimately settled for close to U.S. $97 million.
The Microsoft decision stands in sharp contrast to the decision by the federal Tenth Circuit Court of Appeals in Capital Cities/ABC, Inc. v. Ratcliff.77 Like the workers in Mic-rosoft, the plaintiffs in Ratcliff had signed independent contractor agreements affirm-ing that they were not entitled to participate in the company’s ERISA benefits plans. The court of appeals found that the agreements had been voluntarily executed and that it was therefore immaterial whether the workers could be deemed employees under common law. Since the workers had voluntarily relinquished their right to receive any benefits under the company’s employee benefit plans, the court held that the terms of the agreement controlled and should be given effect.
The inconsistent holdings in Microsoft and Ratcliff highlight the importance of context and jurisdiction when evaluating any independent contractor relationship in the United States.

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