What you need to know about the US Department of Labor’s Final Rule to clarify Independent Contractor Status under the Fair Labor Standards Act AND your Global Workforce Strategy

SUMMARY

1. Distinction between employee and independent contractor: Current legal situation
2. The Final rule on the independent contractor question
3. Delimitation between employee and independent contractor stays fraught with risks
4. How can you do to ensure that your business partner is an independent contractor, also in a global context?

I. Distinction between employee and independent contractor: Current legal situation

The Department of Labor’s (DOL) Wage and Hour Division issued a final rule revising its interpretation of independent contractor status under the Fair Labor Standards Act of 1938 (FLSA) on Jan. 6. This is supposed to “promote certainty for stakeholders, reduce litigation and encourage innovation in the economy.”

Court decisions as to who is an independent contractor under the FLSA have been inconsistent. The newly refined economic reality test could reduce worker misclassification. As this is a new federal rule that is due to become effective March 8, you will generally be affected if you have employees or work with independent contractors in the US.

According to the FLSA, among other things, employees are to be paid at least the federal minimum wage and overtime pay for every hour worked over 40 in a workweek (29 U.S.C. 206(a), 207(a) (minimum wage and overtime pay requirements). Also, employers have to keep certain records in regard to their employees (29 U.S.C. 211(c) (record keeping requirements). 

The Supreme Court has made it clear that only the “total situation controls” for the classification of a worker (Rutherford Food Corp. v. McComb, 331 U.S. 722 (1947); Bartels v. Birmingham, 332 U.S. 126 (1947). How to determine this has been a question of assessing many characteristics. Consequently, federal courts of appeals have also uniformly held, that independent contractors are not “employees” for purposes of the FLSA (Saleem v. Corporate Transportation Group, Ltd., No. 15-88 (2d Cir. 2017).

In the end, entrepreneurs are forced to apply many factors in a variety of ways with an uncertain outcome of an inquiry if contested in court. Willful violations of the FLSA may result in criminal prosecution and fines up to $10,000 while a second conviction may even result in imprisonment.

II. The Final rule on the independent contractor question

The final rule explains that independent contractors are workers who, as a matter of economic reality, are in business for themselves as opposed to being economically dependent on the potential employer for work. Basically, an independent contractor has a business of his own whereas as an employee does not. It defines “independent contractors” under the FLSA, but only employees are covered by the law.

The Final Rule includes five distinct factors/clarifications, instead of the five or more overlapping factors used by most courts. The two “core factors” that have the most weight are (“probative of the question of economic dependence or lack thereof than other factors, and thus typically carry greater weight in the analysis than any others.”)

• The nature and degree of the worker’s control over the work.
• The worker’s opportunity for profit or loss based on initiative and investment.

Additional guideposts – first and foremost intended to help, when the two core factors do not point to the same classification – in the analysis are:

• The amount of skill required for the work.
• The degree of permanence of the parties’ work relationship
• An analysis of whether the work is part of an integrated unit of production.

Also, the actual practice of the worker/employee-employer relationship is more relevant than what may be contractually or theoretically feasible. Last but not least, six fact-specific examples applying the factors, but no industry-specific examples to the final rule, are provided.

The standard adopted does not supersede state law or apply to other federal laws beyond the FLSA. Therefore, employers must consider state law variances, including states that stand by a more demanding standard (for example, California / Dynamex Operations W. v. Superior Court, 4 Cal. 5th 903 (2018).

III. Delimitation between employee and independent contractor stays fraught with risks

The final rule is a step in the right direct. It could simplify compliance for businesses and help to identify who is covered by the FLSA as an employee. Nevertheless, it will often remain difficult to differentiate independent contractors from employees, as the five characteristics still give room to different opinions. Especially the tight cases can be regarded from different angles in practice. Even worse, the new rule’s future is uncertain. The Biden administration may delay or block it, also issuing a completely different rule is possible. Legally challenged, the Biden DOL may not defend the final rule. In this scenario, we will be back to square one. If it comes into effect eventually, the lack of industry-specific examples to the final rule is a problem.

IV. How can you do to ensure that your business partner is an independent contractor, also in a global context?

If your business strategy is built on work relations with independent contractors in the US, you should monitor further developments when determining whether a worker is rightly classified. Properly structuring those work relationships is very important. Even if the new rule is rescinded, the five factors might be considered for your classification documentation in the future.

In practice, we often see global business strategies built on predominantly working with independent contractors not being harmonized. That is the legal substantiation of work relations with independent contractors in the US differs from that one in China or Germany, for example. To some extent, this is unavoidable as every jurisdiction has to be addressed specifically. On the other side, businesses with a global approach should try not to give fundamentally different legal assessments on the very same core business strategy.

Authorities communicate among each other more and more. A coordinated, global legal substantiation could help to reduce the risk of legal disputes. Especially in jurisdictions with even higher protection standards for employees, the misclassification of independent contractors could lead to immense costs when social security contributions have to be repaid for many years back. For instance, in China and Germany, wrongly classified contracts with independent contractors could not be terminated without due reason, as employees enjoy special protection against dismissal.

Do you need more information on this subject, feel free to contact us at any time!