Lessons from the School of Hard Knocks
Misclassification of Independent Contractors Has Serious Consequences
If you own or operate a small to mid-sized business, you have probably considered whether or not to hire an employee or retain an independent contractor to engage in your business model. You are not alone. In 1984, an estimated 3.4 million American workers (approximately 3% of the total workforce) were classified as independent contractors; by 2014, that number had exploded to an estimated 15 million workers (or approximately 10% of the workforce).
What explains this extreme transformation of the American workplace over the preceding 30 years? In a phrase, “cost/benefit analysis”. If the benefits of an aggressive classification of a worker as an independent contractor rather than as an employee outweigh the potential costs of that classification being found to be wrong, taking the risk made economic sense.
On the benefits side, reliance on independent contractors rather than employees enabled business owners to avoid obligations under a host of state and federal laws, including legal requirements which apply only to employees, not to independent contractors, such as federal and state employment taxes and withholding obligations, federal and state wage and hour laws, employee benefit laws, federal and state discrimination laws, federal and state medical and family leave laws, and many others.
On the potential cost side of the ledger, for the most part, neither state nor federal regulators showed much proclivity to challenge any but the most egregious misclassifications. The result should not surprise anyone: a 400% growth in the number of independent contractors over the past 30 years. Studies from the U.S. Department of Labor indicated that as many as 30% of such "independent contractors" have in fact been misclassified.
But to quote Bob Dylan, “The times they are a’changin’.”
Over the past few years, the losses to state and federal treasuries and the impact of misclassification on the financial health of American workers has awoken the dozing regulatory giant. The U.S. Department of Labor has initiated and prevailed in a host of enforcement actions against both small and large employers, many of which resulted in million dollar judgments and settlements. Many states, in particular California, have stepped up their enforcement actions, frequently obtaining million dollar awards and penalties. The IRS and state tax agencies have also stepped up efforts to close this "leak" of tax revenue - although the IRS in particular is hampered by the decades old Safe Harbor Provision in this regard.
In addition, more and more workers who have been classified by their employers as independent contractors have sought damages and penalties under federal and state wage and hour statutes. Class actions in state and federal court involving newspaper carriers for the Sacramento Bee, installers for a home improvement retailer, exotic dancers, cleaning services, workforce management/staffing companies, drivers for a car service company and airport shuttle companies, and cable installation companies are only a few recent examples of expensive verdicts and/or settlements based on misclassification.
So, before you choose to classify someone who works for you as either an independent contractor or an employee, I invite you to sit in the classroom of another business who faced the same choice and continues to deal with the expensive consequences of its decision: FedEx Corporation.
The Expensive Lesson of FedEx
As everyone knows, FedEx's business model is to deliver packages to its customers on time and every time. Thus, the central feature of FedEx's reason for existence as a business enterprise is the delivery of packages. To accomplish this purpose, between 2000 and 2007, FedEx entered into contracts with approximately 2,300 drivers to deliver those packages to its customers in California for which the drivers would be paid. The operating agreement between FedEx and its drivers (“Operating Agreement") expressly characterizes the drivers as independent contractors. Nevertheless, in order to work for FedEx, the drivers were required to wear FedEx uniforms, drive FedEx-approved vehicles, and meet FedEx's appearance standards. Also, FedEx required the drivers to pick up and deliver packages within their service areas every day that FedEx is open for business in within a specific window will time negotiated between FedEx and its customers and structured its drivers’ workloads to ensure that they work between 9 1/2 and 11 hours every working day. Drivers were prohibited from carrying passengers not authorized by FedEx.
In December 2005, Plaintiffs, on behalf of the 2,300 FedEx full time drivers who delivered packages for FedEx between 2000 and 2007, brought a legal action against FedEx for violation of California's wage and hour laws in California Superior Court. At the center of the dispute lay the critical question of whether the drivers were employees or independent contractors. After FedEx removed the action to the Northern District of California this case was combined with approximately 40 other cases filed against FedEx between 2003 and 2009 in proceedings in Indiana.
Plaintiffs then asked the District Court in Indiana to determine that, as a matter of law, they were FedEx employees. At the same time, FedEx asked the court to determine that the drivers were independent contractors. The District Court agreed with FedEx and held that the drivers were independent contractors, not employees. The drivers appealed to the Ninth Circuit, who issued its ruling in Alexander v. FedEx Ground, 765 F.3d 981 (2014)
The Ninth Circuit, as did the lower court, applied the multi-factor test set forth in the California Supreme Court’s 1989 decision in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 342 (1989). Under Borello, California adopted the common law “right-to-control” test under which “The principal test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.” Borello, 48 Cal.3d at 350. In addition, under Borello, additional factors are considered “secondary indicia” of an employment relationship, including whether the one performing services is engaged in a distinct occupation or business; the method of payment, whether by the time or by the job; and whether or not the work is a part of the regular business of the principal. Borello, 48 Cal.3d at 351.
As an initial assertion, the Ninth Circuit points to Borello’s unambiguous assertion that “[t]he label placed by the parties on their relationship is not dispositive.” Borello, 48 Cal.3d at 349. FedEx's reliance upon the Operating Agreement’s express description of the relationship as one involving independent contractors, therefore, was determined to be misplaced. What matters is what the contract actually allows or requires. In particular, “If the employer has the authority to exercise . . . control, whether or not that right is exercised with respect to all details, an employer-employee relationship exists.” Empire Star Mines Co. v. Cal. Emp’t Comm’n, 28 Cal.2d 33, 37 (1946)
The Ninth Circuit found that the fundamental factor of the right to control the manner the drivers perform their work for FedEx “strongly favors” finding drivers to be employees.
The Operating Agreement and FedEx’s policies and procedures unambiguously allowed FedEx to exercise a great deal of control over the manner in which its drivers do their jobs. This most important factor, therefore, strongly favored the drivers' position.
First, FedEx could and did control the appearance of its drivers and their vehicles. FedEx controlled its drivers’ clothing from their hats down to their shoes and socks. FedEx required drivers to paint their vehicles a specific shade of white, mark them with the distinctive FedEx logo, and to keep their vehicles “clean and presentable [and] free of body damage and extraneous markings.” These requirements went well beyond those imposed by federal regulations. See 49 C.F.R. § 390.21. FedEx dictated the vehicles’ dimensions, including the dimensions of their “package shelves” and the materials from which the shelves are made.
Second, FedEx could and did control the times its drivers could work. Although the Operating Agreement did not allow FedEx to set specific working hours down to the minute, the Operating Agreement clearly demonstrated that FedEx held a significant amount of control over the drivers’ hours. FedEx structured its drivers’ workloads in such a manner to force them to work 9.5 to 11 hours every working day.
Third, FedEx could and did control aspects of how and when the drivers delivered their packages. It assigned each driver a specific service area, while FedEx retained the right to, "in its sole discretion, reconfigure.” FedEX told the drivers what packages they must deliver and when.
Viewing the evidence in the light most favorable to FedEx, the Ninth Circuit determined that the Operating Agreement granted FedEx the broad right to control the manner in which its drivers performed their work. As a result, the most important factor of the right-to-control test came down heavily on the side of the drivers' employee status. Because the remaining factors failed to support either employee status or independent contractor status to any significant degree, the Ninth Circuit held that the plaintiffs and the class they represented were employees as a matter of law under California’s right-to-control test.
After the Ninth Circuit ruled against FedEx, FedEx settled the class action for $228 million, which the Court approved in late 2015. An expensive lesson and one to which any business owner who pays workers to perform jobs for the company should pay close attention. So what are those lessons to help you and your business?
Lessons that will be on the test
Ignorance is NOT Bliss!!
If you are a business owner who relies on others performing work for you and decided that you could save money on the bottom line by classifying them as independent contractors, you may be tempted to let sleeping dogs lie. Don’t. Just because no one has challenged your classification yet, doesn’t mean they won’t in the future. Take the time to see how your relationships with those working for you stacks up against the applicable legal standards. As a friend of mine is constantly reminding me, you don’t know what you don’t know. And if you don’t know whether or not a simple solution could save you from severe consequences, that ignorance could be deadly.
A Written Contractual Provision is a Life Line Tied to an Illusion.
If the old Chinese proverb that insanity is doing the same thing over and over while expecting different results is true, many businesses are being run by people who are touched with insanity. Many business continue to rely on agreements that label themselves as Independent Contractor Agreements with provisions according to which, both the business and the workers admit and acknowledge that the worker is not an employee, but an independent contractor.
“But, we have a written signed agreement!!” Thus goes the refrain.
But this argument failed yesterday. It fails today. And it will fail tomorrow. The law does not care what label the parties place on the relationship, but rather about how the relationship works in reality. If you think that you are safe because you have a contract that establishes your worker is an independent contractor - don’t. It doesn’t. Really.
If It Looks Like a Duck, Walks Like a Duck and Quacks Like a Duck, ….
The key issue highlighted by the FedEx decision is whether an employer controls the manner and means by which the desired results are achieved. When a worker is required to wear a company uniform, fit a company appearance profile, drive a truck painted a specific color with specific logos attached and that contains specifically defined shelving, the distinction between an employee and independent contractor blurs. If it looks like an employee, walks like an employee, and talks like an employee, it is probably an employee.
Allow Yourself the Luxury of a Practice Test
If the correct classification of one of your workers as an employee or independent contractor depends on a test - and it does, no one can deny that knowing what the test will be is a critical step in passing that test. Unlike that Western Civilizations test you hated in high school, the test for Correct Classification of Workers allows - and even encourages - those who will be graded to alter the answers to fit the questions before the test even begins. By knowing the test questions ahead of time, a business owner can either adjust the working relationship to ensure that any classification of a worker as an independent contractor is consistent with the actual relationship between the business and the worker or come to grips with the conclusion that the law as it stands is inconsistent with the owner’s desire to use the independent contractor classification. Consult with a trained professional to review your policies and procedures and take a “practice test”. And remember that assorted tests are used for different situations.
If you want to learn more about reducing your risks of enduring the consequences of misclassifying employees as independent contractors, sign up for a complimentary white paper or updates on my upcoming seminar by clicking on the respective buttons below.
As with any legal issue that impacts your business, you should consult directly with a competent attorney to help address your particular situation.