Gig-Worker Model Upends Employee Classification Debate

The gap between federal direction and state law grows

Roy Maurer By Roy Maurer May 23, 2019
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​Classifying workers—as independent contractors or employees—was already a contentious issue in the workplace before the rise of the freelance, or gig, economy and recent developments have only muddied the waters more.

A new federal opinion letter made it easier for employers to classify a worker as an independent contractor, while a court ruling handed down days later in California doubled down on the state's more-restrictive standard, making it harder for companies to classify workers as independent contractors.

"There's an ongoing conflict in how to classify workers under federal and state law," said Mark Terman, a partner at Drinker Biddle and Reath in Los Angeles and national vice chair of the firm's labor and employment practice group. "Some state laws more closely follow federal law and are more willing to allow independent contractor classification. Many states, like California, continue to be hostile to independent contractor classification and I wouldn't expect them to follow or adopt the emerging federal trend on classification of gig-economy service providers as independent contractors."

The distinction matters: Employees are entitled to minimum wage, overtime pay and other protections that are not afforded to independent contractors, who may work for themselves or for several employers.

"Misclassification [occurs] when a business engages an individual as an independent contractor when the individual should be classified as an employee," said Sheryl Jaffee Halpern, an attorney in the Chicago office of Much Shelist and chair of the firm's labor and employment group. "The challenge for businesses is that various courts and government agencies apply different tests to determine whether an individual is a contractor." 

Halpern said that the risks of misclassifying workers as independent contractors include violation of wage and hour laws; unpaid income tax withholdings and Social Security, Medicare, and unemployment insurance contributions; and gaps in workers' compensation insurance coverage.

[SHRM members-only toolkit Employing Independent Contractors]

DOL Suggests Gig Workers Are Independent Contractors

The U.S. Department of Labor (DOL) issued an opinion letter Apr. 29 saying the gig workers who use an unnamed "virtual marketplace" platform to connect with consumers are independent contractors rather than employees of the platform provider. The virtual-marketplace company provides a referral service.

"Employers, however, should not assume they are home free in light of the DOL letter," Halpern said. "The DOL repeatedly mentioned that its opinion was based on the particular facts and circumstances before it. In other words, the opinion should not be construed to be binding, generally, but rather is applicable only to the business that requested the DOL's opinion."

The agency's guidance reversed a narrower 2015 interpretation from the Obama administration and offers a range of factors for companies to choose from, making it much easier to reach an independent contractor classification.

"This is consistent with what I see as a trend at the federal level to recognize the realities of gig companies providing the platform for service providers and not employing the service providers," Terman said. "The National Labor Relations Board made a similar ruling May 14 that classified service providers as independent contractors unable to unionize under the National Labor Relations Act."

The DOL opinion letter can be used by companies as a "persuasive authority for classification purposes" and in litigation, he said. But it's not binding and has no effect on state laws with stricter standards.

California Law Differs

California is the most prominent of those states with a higher bar and particularly important in the gig work context, because many of the largest gig platform companies, such as Uber Technologies and Lyft, are based there.

"The most onerous [worker classification] test is the one made famous in April 2018 in the California Supreme Court's decision in Dynamex Operations West, Inc. vs. Superior Court of Los Angeles," Halpern said. She explained the court's application of the "ABC" test, which presumes a worker to be an employee unless the employer proves each of the following:

  • A. The worker is free from the employer's control and direction in connection with the performance of the work, both under the contract for the performance of the work and in actual reality.
  • B. The worker performs work that is outside the usual course of the hiring entity's business.
  • C. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

"Each of these requirements must be satisfied in order to rebut the presumption that a worker is an employee, as opposed to misclassified as an independent contractor," she said. "Notably, this is even more stringent than the test utilized by the IRS, where control is the most important factor."

The "B" factor of the test is the most difficult for many companies to overcome, Terman said. He gave the example of a company without an IT department outsourcing that function to a third-party provider—those workers would likely be independent contractors assuming the employer is not in the IT business. "But if the employer is in the IT business and hires someone or a company that provides IT services, a contractor classification will be difficult under Dynamex," he said.

"Dynamex has been a tough pill to swallow for many companies, particularly those who have relied on independent contractor classification for flexibility and cost."

On May 2, the U.S. Court of Appeals for the Ninth Circuit strengthened the Dynamex decision when it decided that the ABC worker classification should apply retroactively.

"The retroactivity decision is not binding in California state courts, but it's just a matter of time before the issue is addressed in state appellate courts and the state's supreme court," Terman said.

Complying with State and Federal Classification Regulations

Most states still operate under the federal Fair Labor Standards Act, but as a general rule, the law of the state where the companies' services are performed will govern employee status, Terman said. Companies will have to re-evaluate their business models and account for "applicable state law first, since state law will likely be more onerous for compliance purposes, and then secondarily federal law," he added.

"At the outset of the relationship, businesses should assess very carefully—ideally in consultation with a competent labor and employment attorney—whether an individual is properly classified as an independent contractor or is actually an employee," Halpern said.

"Just because an individual wants to be a contractor, or just because the operative agreement between the parties says that the individual is a contractor, doesn't make it so."

She advised companies "dead set on engaging an individual as a contractor despite the risks" to consider requiring the contractor to form an LLC or a corporation. "The business should contract with and pay that LLC or corporation instead of the individual," she said. "While this approach is not 100 percent bullet-proof in every industry, it is far less likely to come under scrutiny."

That's because only individuals are eligible for unemployment insurance benefits, and only individuals are protected by federal and state wage and hour laws and regulations.

"Before classifying an individual as a contractor, a business should consider the factors considered by each government agency—not only the DOL, but also the IRS and the applicable state's unemployment agency—as well as court decisions in the venue where the worker is located," Halpern said.

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