By: Noah A. FinkelCamille A. OlsonLouisa J. Johnson, and John R. Skelton

For decades, companies have wrestled with whether certain workers must be treated as employees subject to various employment laws and company rules or whether they are appropriately classified as independent contractors with different terms of engagement, work, and pay and tax consequences. Amid a changing economy and evolving business models, companies continue to consider the application of an alphabet soup of federal employment statutes plus the laws of the states in which they do business, many of which contain different definitions of “employee” and conversely “independent contractor,” few of which provide clear guidance on how to meet the definition of independent contractor status.

The FLSA has been a leading source of this uncertainty. Because the FLSA’s text does not provide a clear definition, it largely has been up to the courts to define “employee” under the FLSA, and thus determine which workers are subject to the FLSA’s minimum wage and overtime provisions and which are not. All courts have used an elastic, multi-factor test, but unsurprisingly, the circuits have diverged on what those factors are, what those factors mean, and how those factors should be applied. Meanwhile, the Wage-Hour Division of the U.S. Department of Labor, which is charged with enforcing and interpreting the FLSA, has been relatively silent, issuing only individual worker specific opinion letters, a fact sheet, a since-withdrawn Administrator Interpretation, and regulations applicable only to logging and sharecropping.

Today, however, the DOL issued for the first time proposed interpretations, to be codified as a rule, defining employee versus independent contractor under the FLSA. The interpretations, if finalized in or close to their proposed form, would provide clearer guidance for companies and, in many cases, could minimize the chances that courts apply the FLSA definition of employee to workers who seemingly should be allowed to be treated as contractors. As discussed below, however, DOL interpretations are not controlling law and do not give license to companies to classify all workers as contractors. There remain several hurdles to the DOL’s proposal becoming a final rule, the DOL’s proposal still would result in a good number of workers having to be classified as employees, and other federal and especially state laws may nevertheless cause a company to classify a worker as an employee for other purposes.

What the DOL’s Proposal Does

Those hoping for a bright-line rule on who is an employee and who isn’t will be disappointed by the DOL’s proposal, because it still involves a several factor test.  Those hoping for the common law right to control test (which is used by the IRS) also will be disappointed, because the DOL didn’t adopt it either.  The DOL believes Supreme Court precedence requires it to continue to adhere to the “economic realities” test. That said, the DOL’s proposal would clarify how to apply the factors under the economic realities test in a more clear and modern way to determine whether a worker is economically dependent on, and thus an employee of, a putative employer.

The DOL’s proposal — which would be codified at 29 C.F.R. §§ 795.100 through .195 —  first would elevate two “core factors” from the economic realities test above all others:

  • The nature and degree of an individual’s control over the work; and
  • The individual’s opportunity for profit or loss.

If both factors point toward the same classification, whether employee or independent contractor, “there is substantial likelihood that is the individual’s accurate classification.” If they point in opposite directions, then the three “other factors” likely will tip the balance. These are:

  • The amount of skill required for the work;
  • The degree of permanence of the working relationship between the individual and the potential employer; and
  • Whether the work is part of an integrated unit of production.

The proposal contains certain specific guidance to assist companies in determining whether they can engage in certain workplace practices to enhance the safety of all employees and invitees while holding workers to certain final results in requirements in terms of quality and timeliness of provided services. It makes clear that “[r]equiring an individual to comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses” does not render a worker more or less likely to be an employee. Such guidance likely will help franchisors in particular, who maintain that some level of control is inherent in a true franchise relationship and actually is required under the Federal Trade Commission’s Franchise Rule, 16 C.F.R. § 436.1, et seq. and Federal Trademark Law, 15 U.S.C. § 1127. It also provides that the opportunity for profit or loss isn’t limited to a worker’s capital investment and can include the exercise of initiative, such as managerial skill or business acumen or judgment, another hallmark of a business-format franchise relationship. It dispels the notion that a “long-term” worker is more likely to be an employee by stating that such a factor weighs in favor of employee status “to the extent the work relationship is instead by design indefinite in duration or continuous.”

Perhaps most significantly, and in contrast to interpretations of the ABC test under California and some other state’s wage-hour laws, the proposal substantially would reduce reliance on the extent to which a worker’s services are “integral” to, or an essential part of, the putative employer’s business. In a section helpful to companies that provide a platform or marketplace for customers to be matched with workers who desire to provide services, the DOL persuasively explains in the preamble to its proposal why such a formulation is inappropriate in determining whether a worker is economically dependent on, and thus an employee of, a company. In its place, the DOL proposes to inquire whether a worker’s activities are “a component of the potential employer’s integrated production process for a good or service,” further explaining that a worker is more likely to be a contractor when the work is “segregable from the potential employer’s production process.” Indeed, in the preamble explaining the proposal, the DOL noted that, under this test, “discrete, segregable services for individual customers is not part of an integrated unit of production” and provided an example of workers who provide services to a virtual marketplace company’s individual customers. The proposal further stresses that this factor should not be confused with “the concept of the importance or centrality of the individual’s work to the potential employer’s business.”

Finally, in a subsection that may assist employers in defeating or limiting collective action certification, the DOL’s proposal stresses that “the actual practice of the parties involved is more important than what may be contractually or theoretically possible.” Thus, a worker’s theoretical ability to negotiate prices or work for a competing business doesn’t move the needle much toward contractor status if those don’t happen. On the other hand, the mere contractual authority to supervise or discipline a worker is of little relevance in deeming a worker an employee if that authority isn’t exercised.

The Limits of the DOL’s Proposal

The DOL’s proposal is far from a cure all for companies seeking absolute clarity on a worker’s status under the FLSA. Under the proopsal, the definition of employee becomes more clear, but it remains fairly broad and will continue to be applied based on the particular facts of any case.  And there are some instances where a company may have more difficulty in classifying a worker as a contractor where that worker does not have an opportunity for profit or loss.

If finalized, the proposal must be kept in perspective. Unlike some other recent DOL rules, such as on the minimum salary for the white-collar exemptions, this DOL rule is an interpretive guidance. Courts have the final say on who is an employee and who is an contractor, and they must give a DOL interpretation such as this one Skidmore deference, which is based on how persuasive each judge finds this guidance.

Further, to the extent that this proposal is applied by courts, it is applicable only under the FLSA. Differing definitions of “employee” will continue to exist under other federal employment statutes. More significantly, several state overtime and other wage-hour laws, some of which use the ABC test to determine employee vs. contractor status, are unaffected by the DOL’s proposal.

What Happens Next

Whether the rule becomes finalized and effective remains to be seen. The DOL announced a 30-day comment period that will commence upon formal publication of the proposal, which likely occur on Friday. Once comments are submitted, the DOL must consider them and then prepare a final rule. It is not clear whether that can be accomplished before Inauguration Day and whether a different administration would continue to pursue this proposal. It also is possible that the rule could be subject to rejection under the Congressional Review Act, a possibility if the Senate majority changes parties and the administration changes. It also is possible that a coalition of state attorneys general will seek an injunction against the rule, similar to the one recently granted by a federal district judge against a recent DOL interpretation on the definition of joint employer.