The Death of the Individual Independent Contractor: A Growing Trend Points to an Uncertain Future
It should come as no surprise that the workplace environment is rapidly changing. In the past, many industries have routinely hired temporary or part time workers and called them independent contractors. After all, it is a lot easier and saves money. But those days may be changing. Changes in policy and stepped up enforcement now make it highly risky for any employer to classify any individual worker, even if hired part time or temporarily, as an independent contractor.
The use of contingent workers – temps, independent contractors, subcontractors and other nontraditional work roles – is routine in many industries. A study released in September 2014 concluded that there are more than 53 million Americans doing some type of freelance work, including 21.1 million independent contractors. A 2011 survey of the 200 largest companies estimates that this modern “contingent umbrella” workforce accounts for 22 percent of the average company’s workforce. The impact of these numbers is clear and has been stated in no uncertain terms: “traditional employment will no longer be the norm, replaced by contingent workers such as freelancers and part-time workers.”
Risks of a Contingent Workforce: Misclassification
There are consequences of this growing contingent workforce – namely the rampant misclassification of workers as independent contractors. Companies that misclassify independent contractors are faced with costly lawsuits and crippling retroactive penalties and fines. At the same time, the standards for classifying individuals as independent contractors are often vague, inconsistent and change frequently. Companies are scrambling to ensure compliance. Indeed, a company’s decision to hire a contractor or an employee involves taxes, labor and employment law, benefits, worker’s compensation, unemployment insurance and more. With so many different areas affected by this emerging contingent workforce, the U.S. Department of Labor (DOL), the Internal Revenue Services (IRS), the National Labor Relations Board (NLRB) and state workforce agencies are coming together to rid the workplace of misclassified independent contractors.
Based upon the numerous regulations, opinions and guidance issued by these agencies and recent court holdings, there appears to be a growing trend, making it increasingly more difficult to classify an individual as an independent contractor. Despite the demand for contingent workers, it appears that in a not so distant future there could be no such thing as an individual independent contractor. But that does not mean the contingent workplace will be entirely eliminated. Instead, employers looking to utilize independent contractors’ services will likely opt to contract with business entities rather than individuals.
Companies in almost every industry are at risk of individual workers being misclassified as independent contractors. The DOL, the IRS and state workforce agencies are currently targeting certain industries where misclassification is thought to be most prevalent. So which industries are on this workplace “hit list”? Forbes Magazine posits that, “based on public statements, press releases and congressional testimony by federal government officials over the last several years, the list includes janitorial services; construction; nursing; staffing; Internet services; transportation and trucking; cable companies; security; catering services; hotel/motel; oil and gas; landscaping; and car service/ limousines.” Moreover, recent trends in case law show that the exotic entertainment industry and on-demand services, such as the popular transportation company Uber, are at risk of having their workers reclassified as employees. Companies in all industries need to be aware that even a well-conceived independent contractor relationship may be open to question.
Misclassification Can Cost Millions in Damages
One example is the exotic entertainment industry. In the past decade, it has been hit particularly hard by this emerging trend, causing the entire industry’s business model to become unhinged. Recent years have seen the industry awash with successful lawsuits against international nude cabaret franchises and small clubs alike. In November 2012, a $13,000,000.00 settlement was approved by a California federal court in a nationwide class-action lawsuit initiated by women who worked as exotic dancers for the Spearmint Rhino adult nightclub. In addition to the financial hit to the 16 companies that were named in the lawsuit, the clubs agreed to no longer treat dancers as independent contractors or lessees, but as employees, shareholders, partners or some type of owner. More recently, a New York District Court approved a $15,000,000.00 settlement in a class action lawsuit against Rick’s Cabaret International brought by nearly 2,000 exotic dancers. In Arizona, over 120 dancers at Christie’s Cabaret have banded together in a class-action lawsuit, which claims that since 2011 clubs in Phoenix and Tempe and their corporate owners have illegally classified dancers as independent contractors. The case is in its early stages, and rulings are expected near the end of the year. If there is no settlement, the case could be before a jury in Spring 2016 and could possibly reshape Arizona’s interpretation of independent contractor relationships in this industry.
Another company hit by this emerging trend is the ever popular on demand car service, Uber. The company is currently facing two lawsuits in California federal courts over the misclassification of drivers. On September 1, 2015, a federal judge in San Francisco granted Uber drivers’ class-action status in one of the lawsuits, which claims the company treats drivers like employees without offering benefits and avoiding costs associated with payroll taxes. The second California lawsuit has not been certified as a class action, but alleges the same misclassification. California is not the only state looking to reclassify Uber drivers as employees. The company was hit with a proposed class action suit in a Pennsylvania state court with the same allegations of driver misclassification. The impact of these cases on the contingent workers industry cannot be ignored. Uber’s business model could be completely upended if drivers were classified as employees. And Uber is big, estimated to be worth some $40 billion with over 163,000 drivers who average $17 an hour in Los Angeles and Washington, D.C., and $23 an hour in San Francisco and New York. The impact of reclassification of drivers would be felt across the nation, not only by drivers but also by consumers and similar start-up companies.
Uber is not alone. Several popular app-based service providers like Lyft, Handy, Washio and Instacart have faced a mounting litigation challenge that goes to the core of this “on-demand” business model – the classification of their service providers as independent contractors. There have already been casualties, such as the on-demand home cleaning start-up Homejoy, which closed its doors in July citing the financial costs of four pending misclassification class action lawsuits.
The Department of Labor's Interpretation
Administrative guidelines reflect this trend against allowing individuals to serve as independent contractors. In July the DOL issued an administrator’s interpretation regarding the application of the Fair Labor Standards Act (FLSA) with respect to misclassification of workers as independent contractors. The DOL’s unequivocal opinion held that “most workers are employees” under the FLSA. The DOL guideline also downplays the significance of an employer’s exertion of control over the tasks performed by the worker, which signifies a major shift in policy.
In a recent ruling, the NLRB broadened the definition of “joint employer.” The Board concluded that sanitation company Browning-Ferris Industries (BFI) was a joint employer with Leadpoint, a company subcontracted by BFI to supply its individual workers. This decision could implode the traditional arms-length relationship that has prevailed between corporate titans such as McDonald’s and its neighborhood fast-food franchises. Even the Occupational Safety and Health Administration (OSHA) has directed its inspectors to consider whether principal employers might be at fault for the safety violations of their subcontractors.
The IRS has a Questionable Employment Tax Program and has entered into a Memorandum of Understanding with the Labor Department and 37 state agencies to identify “employment tax schemes and illegal [tax] practices.” There are also more than a dozen states that have multiagency misclassification task forces aimed at the coordinated enforcement of state wage and hour and unemployment tax laws.
Qualifying as an Independent Contractor Keeps Getting Harder
It is not easy to qualify as an independent contractor, in part because of the myriad and sometimes diverse regulations that apply. Companies who wish to analyze whether their non-employee workers are properly classified as independent contractors must now contend with:
- A new NLRB test,
- The traditional common law Right to Control Test (used for ERISA and federal discrimination law purposes), 
- The modified U.S. Treasury version of the traditional common law Right to Control Test (used for Affordable Care Act purposes),
- The federal court Economic Realities Test (used for Fair Labor Standards Act purposes), and
- The multitude of varying state law tests used for state wage and hour laws, workers compensation and unemployment purposes.
With all of these varying tests and case law, companies are being forced to reevaluate their independent contractor relationships. So what can a company do to limit its exposure to a misclassification claim? If a company wants to work with independent contractors, then hiring a lawyer makes a lot of sense. However, it may be wiser to avoid hiring any individual and calling them an independent contractor. Companies should consider contracting with business entities, rather than with individuals. Although doing business with a business entity does not guarantee that a court will not consider the employees of that entity to be employees of the contracting entity, it is a powerful consideration in favor of avoiding having the individual service providers treated as employees.
The modern American career landscape is changing. The growth of the freelance and independent contractor workforce during the next decade will undoubtedly usher in more new legislation, benefit considerations and technologies. At the same time, businesses will continue to struggle to keep up with shifting classification issues. One thing is clear – the traditional independent contractor relationship with individuals is at serious, all-time high risk.
About the author: Kraig J. Marton heads the employment law department at the Phoenix law firm of Jaburg & Wilk. He assists employers and employees in complying with the many laws affecting employers. He also assists health professionals and others with issues related to medical marijuana.