United States: Misclassification Costs Will Mount For Unprepared Employers

The federal Fair Labor Standards Act ("FLSA") and its state law counterparts' minimum wage and overtime requirements do not apply to employers with respect to "independent contractors" or "1099 workers;" that is, those workers who provide services to an employer under a contract but are not "employed" by the employer. This can incentivize employers to misclassify employees as independent contractors because of the up-front cost savings.

However, federal and state governments have ramped-up enforcement and systematized information sharing between the federal and state levels and among states. Moreover, the various labor and employment agencies, including those charged with collecting payroll and unemployment taxes, providing workers' compensation, and enforcing wage and hour compliance, have prioritized the investigation of misclassification complaints and are imposing heavy penalties on violators. Finally, wage and hour misclassification, whether as 1099 workers or exempt employees, has become a favorite lawsuit of plaintiffs' attorneys.

Three recently resolved legal cases underscore the high risks associated with misclassifying 1099 workers as employees:

1) Hargrove v. Sleepy's, LLC (New Jersey Supreme Court, January 2015): Delivery truck drivers who had contracted with mattress retailer Sleepy's brought a class action lawsuit alleging that Sleepy's misclassified them as independent contractors. The Third Circuit Court of Appeals asked the New Jersey Supreme Court to determine the appropriate test for employment status. The state supreme court adopted the strict "ABC" test, variations of which are used by other states, which mandates that a worker is an employee unless the employer can show all of the following:

2) Uber Technologies, Inc. v. Berwyck (California Labor Commission, June 2015): Uber asserted that the driver was an independent contractor and therefore not entitled to wages or reimbursement for work-related expenses. The California Labor Commission found that the driver was in fact an Uber employee, noting that Uber obtained the customers and provided the drivers to the customers, vetted prospective drivers, controlled the tools the drivers used, paid their drivers a non-negotiable service fee, and, but for Uber's intellectual property, the driver would not have been able to perform the work. Uber has appealed the decision in California state court.

3) Alexander v. FedEx Ground Package Systems (Ninth Circuit Court of Appeals, August 2014): Delivery drivers for FedEx in California brought a class action lawsuit alleging that FedEx misclassified them as independent contractors. The court held that under California's multi-factor "right-to-control" test for determining employment status, the drivers were FedEx employees because FedEx had the right to control them. In June 2015, FedEx agreed to pay $228 million to resolve the lawsuit.

As we previously posted here, the federal Department of Labor ("DOL") recently published proposed updates to the FLSA overtime regulations governing "white collar" exemptions. Employer exposure for misclassifying employees as 1099 workers will only increase when the DOL publishes its final rule on the white collar overtime exemptions, as many more misclassified independent contractors will be entitled to unpaid overtime on top of back pay.

The interplay of enforcement agencies' current focus on the misclassification of employees as independent contractors and the Obama Administration's narrowing of overtime exemption eligibility will result in significant cost increases for even the most prepared employers. We recommend that you plan for these additional costs in current and future staffing budgets and minimize the risk of non-compliance through a proactive compliance effort.

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