The Second Circuit’s New 6-Factor Test for Analyzing Joint Employer Liability Under the FLSA and Its Potential Impact on Legitimate Outsourcing Agreements

By Carla R. Walworth and Neil B. Stekloff

Introduction

In Zheng v. Liberty Apparel Co., 2003 WL 23028312 (2d Cir. Dec. 30, 2003), the Second Circuit Court of Appeals created a new six factor test for assessing when businesses are liable as "joint employers" for Fair Labor Standards Act ("FLSA") violations committed by their subcontractors. Zheng is particularly noteworthy in that the Court expressly recognized that literal application of its newly-formulated, six factor test might suggest joint employer liability under many legitimate outsourcing and subcontracting relationships. Although the Zheng Court went out of its way to say that this was not its intention, and that "normal" outsourcing agreements would not give rise to joint employer liability under the FLSA, its new test seemingly opens the door wide for aggrieved employees to argue that any legitimate outsourcing relationship is a "mere subterfuge" to avoid FLSA obligations and, therefore, creates joint employer liability.

The Zheng Plaintiffs were 26 garment factory workers, responsible for sewing labels and buttons, and for cuffing, hemming, and hanging the garments. They were directly employed by six contractors (the "Contractors") who, in turn, were hired by Defendant Liberty Apparel ("Liberty") to physically assemble the garments after Liberty designed the garments and cut the fabric to customer specifications.

Plaintiffs brought suit against both the Contractors and Liberty, alleging they were not paid either minimum wage or overtime, as required by the FLSA and New York Labor Law (the "NYLL"). By the time Plaintiffs sued, however, the Contractors were nowhere to be found – making the central issue in the case whether Liberty could be considered Plaintiffs’ joint employer.

Liberty did not hire or fire the Zheng Plaintiffs, nor did Liberty determine their rate or method of payment. That was done by the Contractors, who also set Plaintiffs’ work schedules. Liberty monitored assembly of their garments by visiting the Contractors’ factory and performing "quality control" with respect to the finished garments – although the parties disputed the nature and extent of that monitoring. The parties also disputed how much of Plaintiffs’ work was actually done for Liberty. Plaintiffs asserted that 70-75% of their assembly work was done for Liberty, whereas Liberty claimed that the Contractors were only responsible for approximately 10-15% of Liberty’s assembly jobs.

Applying a four-factor test first articulated by the Second Circuit in 1984 in Carter v. Dutchess Community College, 735 F.2d 8 (2d Cir. 1984), and reaffirmed as recently as 1999 in Herman v. RSR Security Serv., 172 F.3d 132 (2d Cir. 1999), the District Court entered summary judgment for Liberty on the grounds that Liberty could not be considered Plaintiffs’ "employer" under the FLSA given that Liberty could not and did not: (1) hire and fire Plaintiffs; (2) supervise and control Plaintiffs’ work schedules; (3) determine Plaintiffs’ rate and method of pay; and (4) maintain employment records with respect to Plaintiffs. The District Court thereafter declined to exercise supplemental jurisdiction over Plaintiffs’ NYLL claims, dismissing all claims against Liberty.

The Second Circuit reversed the summary judgment for Liberty and remanded for consideration of a new set of factors. It held that the District Court erred in relying exclusively on the Carter/Herman factors in determining whether Liberty could be considered Plaintiffs’ joint employer, observing that both Carter and Herman were cases where the Court did find a joint employer relationship based on the joint employer’s ability to hire and fire, control work schedule, and payment. This, according to the Court, was sufficient to find a joint employer relationship in those particular cases – but not necessary, as it remains possible to be a joint employer under the FLSA even if the Carter/ Herman factors weigh against such a finding.

As support for this proposition, the Court relied on the United States Supreme Court’s decision in Rutherford Food Corp v. McComb, 331 U.S. 722 (1947). In Rutherford, the Supreme Court held that a slaughterhouse was the joint employer of workers who de-boned meat on its premises because it had de facto control over their work, notwithstanding that the workers were actually hired (and fired), paid, and supervised by a "boning supervisor" with whom the slaughterhouse had subcontracted. Rutherford thus is a case where a business was held liable as a joint employer even though it did not hire and fire employees, set their hours, or pay them directly – which, according to the Second Circuit, necessarily precludes exclusive reliance on the Carter/Herman factors. This obviously begs the question of what additional factors the Court should consider in its analysis beyond Carter/ Herman.

After examining Rutherford, together with Carter, Herman, and other cases, the Second Circuit articulated six factors for assessing joint employer liability under the FLSA. By the Court’s express admission, many of the factors are sufficiently unclear that they require a detailed explanation with illustrations. And, to make matters even more confusing, the Court added the following two caveats: (1) even these factors are non-exhaustive, as a district court is "free to consider any other factors it deems relevant"; and (2) the factors are not in a particular order signifying any relative importance. The factors are, in the Court’s own words, "nonexclusive and overlapping":

1. Whether a Putative Joint Employer’s Premises and Equipment Are Used By Plaintiffs. This is one of the few factors that does not require prolonged discussion. A shared use of premises and equipment makes it more likely that a putative joint employer has "functional control" over the Plaintiffs’ work, although this is not dispositive by any stretch.
2. Whether The Putative Joint Employees Are Part of a Business Organization That Shifts (or Could Shift) As a Unit From One Putative Joint Employer to Another. In the Court’s view, a subcontractor that seeks business from a variety of clients is "less likely to be part of a subterfuge arrangement than a subcontractor that serves a single client." Translation: the Court is more likely to find joint employment if the Plaintiffs (the putative joint employees) and the subcontractor (Plaintiffs’ "direct employer") work only for one client. This is especially so if the subcontractor completely lacks the resources to seek work from multiple clients at the same time. A joint employer finding is less likely if the subcontractor legitimately works for a number of different clients simultaneously – or at least has the resources to do so.
3. The Extent To Which Plaintiffs Perform a "Discrete Line-Job" That Is Integral to the Putative Joint Employer’s Process of Production. This is the least concrete of the new Zheng factors. The Court essentially created an analytical spectrum, on one end of which is the type of "piecework" performed in Rutherford requiring minimal training and which is an essential step in the client’s production process. This signifies "control" and weighs in favor of joint employment. At the other end of the spectrum is work that is "not part of an integrated production unit, that is not performed on a predictable schedule, and that requires specialized skills or expensive technology" – which is less indicative of "control" and weighs against joint employment.

   The Court stated that "industry custom and historical practice" should be considered when placing a specific subcontracting arrangement on this spectrum. Functions that are commonly subcontracted or outsourced are "unlikely to be a mere subterfuge to avoid complying with labor laws," in the Court’s view – unless, of course, the common outsourcing of those functions ultimately developed "in response to and as a means to avoid applicable labor laws," in which case the Court might find a joint employer relationship after all.

4. Whether Responsibility Under the Contracts Could Pass From One Subcontractor to Another Without Material Changes. Notwithstanding the awkward language, this factor essentially boils down to the following question: what happens to Plaintiffs if the outsourcing relationship between the subcontractor and the putative joint employer terminates? Put differently, do Plaintiffs stay with the client, as in Rutherford, thereafter becoming "employees" of the next subcontractor hired? Or do Plaintiffs leave with the subcontractor, such that the client must hire a new subcontractor with its own employees? If the former is the case, joint employment is more likely; if the latter is the case, joint employment is less likely.
5. The Degree to Which The Putative Joint Employer Supervises Plaintiffs. While extensive supervision generally weighs in favor of a joint employer finding, the Court noted that supervision on matters such as "contractual warranties of quality and time of delivery" has no bearing on the analysis because the client must have some way of ensuring that the outsourced work is done correctly. The key inquiry is whether the client actually controls the "terms and conditions" of Plaintiffs’ employment, e.g., work schedules and payment rates and methods.
6. Whether the Plaintiffs Work Exclusively or Predominantly for the Putative Joint Employer. A joint employment relationship is more likely when the Plaintiffs work exclusively or predominantly for the one client at issue, as that client may "de facto become responsible" for setting schedules and rates of pay. The Court also attempted to clarify how this factor is slightly different from the second factor above: the second factor looks at whether the subcontractor has the resources to work for multiple clients simultaneously, whereas the sixth factor looks at the degree to which the subcontractor works for the one client at issue. For example, if a subcontractor worked exclusively for two or three different clients but lacked the resources to work for any others, the second factor would weigh in favor of a joint employment relationship but the sixth factor would not. In contrast, if the subcontractor worked exclusively for one client but had the resources to seek out additional clients at any time, the sixth factor would weigh in favor of a joint employment relationship but the second factor would not.

Perhaps most striking about Zheng is the degree to which the Court went out of its way to explain, repeatedly, that it did not intend to bring "normal, strategically-oriented contracting schemes within the ambit of the FLSA." The Court specifically noted that it is "mindful of the substantial and valuable place that outsourcing, along with the subcontracting relationships that follow from outsourcing, have come to occupy in the American economy." Rather, the aim of the Zheng test is to impose joint employer liability on those arrangements which are nothing more than "a mere subterfuge to avoid complying with labor laws," while at the same time respecting legitimate outsourcing and subcontracting arrangements.

The Court’s anticipation that Zheng may be used to assert joint employer liability under a broad range of outsourcing relationships is not entirely unfounded, as even the most legitimate outsourcing relationships may "fail" multiple Zheng factors. Take, for example, a commonly-outsourced function: office services, such as mailroom operation and copying and facsimile services. In this context, the outsourced employees at issue will necessarily work on the client’s premises, likely using the client’s equipment – meaning that the first Zheng factor would suggest joint employment. And to the extent that the subcontractor does not have either a broad client base or the means to solicit one, the second and possibly sixth Zheng factors may suggest joint employment. Because office services jobs generally do not require "specialized skills or expensive technology," the third Zheng factor could also arguably suggest joint employment. So, too, could the fifth and sixth Zheng factors, as the client would certainly monitor not only the quality of the mailroom and copy services but also possibly working hours, essentially giving the client de facto control over work schedules and perhaps pay. As the foregoing example illustrates, Zheng could easily be used as a weapon by employees seeking to impose joint employer liability under the FLSA pursuant to standard outsourcing agreements, notwithstanding the Court’s assurances that the test is not intended to cover such "legitimate" arrangements.

In light of Zheng, a business seeking to minimize the risk that it is held jointly liable for FLSA violations committed by subcontractors with whom it has entered into outsourcing agreements should consider the following provisions, among possible others, with respect to those agreements:

• Outsourced work should be done offpremises to the greatest extent possible, understanding that in many contexts, such as office or cafeteria services, this is not possible;

• The subcontractor should own and maintain the equipment needed to perform the outsourced services to the greatest extent possible;

• The subcontractor should be a sufficiently large and profitable company in its own right such that it is simultaneously engaged in similar outsourcing relationships with other clients – or, at the very least, has the resources to do so;

• The outsourced function should be one that is commonly outsourced in the relevant industry. Novel outsourcing arrangements require extra scrutiny after Zheng;

• The employees should expressly "belong to" the subcontractor in the outsourcing agreement and move with the subcontractor when the agreement terminates;

• The subcontractor should be responsible for setting work schedules, rates and methods of pay, and disciplining the employees if necessary – ideally through on-site supervisors. "Quality control" should be vested in the subcontractor’s supervisors to the greatest extent possible, although the client retains the right of ensuring contract performance; and

• The outsourcing agreement should conform to any applicable state law requirements. California, for example, has recently enacted legislation containing specific requirements for outsourcing agreements in certain contexts, including the outsourcing of janitorial and security services. See Cal. Lab. Code § 2810.

After Zheng, the foregoing suggestions are somewhat likely to reduce the possibility of a joint employer finding under the FLSA. Consequently, it would be prudent for businesses to review all current and prospective subcontractor outsourcing agreements in light of the Zheng factors – especially considering the recent explosion of FLSA collective action lawsuits. Of course, given the acknowledged lack of clarity in the Zheng factors, there is one more important consideration:

• The subcontractor should have a record of complying with the FLSA and state labor laws in all jurisdictions in which it performs under outsourcing agreements.

After all, the safest way to avoid joint employer liability under the FLSA is to ensure that the subcontractor does not commit FLSA violations in the first place.