This article is reprinted with permission of The Metropolitan Corporate Counsel magazine.
Recent studies show that there are currently 8.5 million independent contractors, representing 6.7 percent of the workforce. Thirty percent of all companies in the United States use independent contractors to fulfill some of their work requirements. 1/ For simple economic reasons, the use of independent contractors is likely to continue to expand. Employers are not obligated to withhold taxes or contribute payroll taxes for independent contractors. And, perhaps more important, employers do not have to provide increasingly expensive employee benefits for independent contractors.
In order to enjoy the economic advantages afforded by the use of independent contractors, however, companies must strive to establish appropriate and defensible non-employee relationships with such workers. Courts have consistently held that a worker is not an independent contractor merely because he or she is designated as such in a contract between the two parties. Instead, courts examine numerous factors in order to make the determination of whether a worker is an independent contractor or an employee. To further complicate issues, the various statutory schemes at play employ different tests in the determination of employee/independent contractor status.
Because the issue of proper classification is inherently complex and factual, companies often face significant challenges in successfully establishing with any degree of certainty that a given worker is truly an independent contractor and not an employee of the company. The risks of improperly classifying workers are substantial. Reclassification of workers under tax, employee benefit, labor and employment laws can have potentially devastating financial consequences for a business. The Microsoft case is a prime example. In Vizcaino v. Microsoft,2/ the court held that Microsoft Corporation misclassified over 5,000 workers. Consequently, those workers were entitled to damages including company stock and 401(k) retirement plan contributions.
Independent Contractor Status Under The National Labor Relations Act
In the labor context, the classification of workers has become a very contentious issue as unions and other workers' rights groups have vigorously opposed the proliferation of the independent contractor workforce. The National Labor Relations Act (NLRA) is the primary federal statute protecting employees' rights to organize and to bargain collectively with their employers. But the NLRA, like most employment and labor laws, does not cover independent contractors. As a result, many employers are classifying workers as independent contractors to avoid unionization.
Traditionally, the National Labor Relations Board and federal courts have applied the common law of agency to determine whether a worker is an employee versus an independent contractor. They have considered ten factors: (1) the extent of control which, by agreement, the employer may exercise over the details of the work; (2) whether or not the worker is engaged in a distinct occupation or business; (3) whether work of that occupation is usually performed under an employer's supervision; (4) the skill required in the particular occupation; (5) whether the employer or the worker supplies the instrumentalities, tools, and the place of work for the person doing work; (6) the length of time for which the person is employed; (7) the method of payment, whether by time or by job; (8) whether or not the work is part of the regular business of the employer; (9) whether or not the parties believe they are creating an employment relationship; and (10) whether the principal is or is not in business. Until recently, the focus of this inquiry has been on the employer's right to control the means and manner in which work was performed - the so-called Right to Control test. The Board found that a worker was an independent contractor only if the individual retained substantial control over the services he or she provided, and bore proprietary risks associated with running an independent business.
Two recent Board decisions, however, indicate a departure from this traditional view. Relying on Supreme Court precedent, the Board in Roadway Package System, Inc. and Wholesale and Retail Food, Distribution, Teamsters Local 63 3/ and Dial-A-Mattress Operating Corporation and Local 363, Industrial and Allied Trade Workers, International Brotherhood of Teamsters, AFL-CIO 1/ expressly rejected the Right to Control test and held that all of the factors indicating an agency relationship should be equally considered in determining employee status. Looking at the individual facts of each case, the Board concluded that the truck driver owner 4/operators working for Dial-A-Mattress were independent contractors, while owner/operators working for Roadway were not. Roadway operates a nationwide package pickup and delivery system of over 5,000 drivers working out of over 300 terminals.
The issue in the case was whether a class of drivers at Roadway's Ontario, California and Pomona, California terminals were independent contractors. The drivers made package deliveries in a primary service area and could not refuse to pick up or deliver in that area. While on their routes, the drivers had to use a scanner to feed tracking data about their work into an onboard computer that electronically transmitted the information to Roadway's central computer. Roadway could, however, transfer overflow work from one driver's primary service area to other drivers to pick up and deliver as part of Roadway's "flex program". Examining the terminal operations, the Board concluded that the drivers did not operate their own businesses, but were an integral and essential part of Roadway's business; their work did not require any prior training or experience, but they received training from Roadway instead; they did business under Roadway's name; they had no substantial proprietary interest beyond ownership f their trucks; and they had no significant entrepreneurial opportunity for gain or loss. All of these facts indicated that the Roadway drivers were employees who could be organized by the union.
On the other hand, the Board held that drivers for Dial-A- Mattress, a national mattress discounter, demonstrated the requisite entrepreneurial characteristics to be considered independent contractors. The Board emphasized that the Dial-A-Mattress drivers had formed their own trucking companies; had their own company uniforms; hired their own helpers; used their trucks to make deliveries for companies other than Dial-A-Mattress; and that they could submit contract proposals or try to negotiate special pay deals for their individual companies.5/
Forming An Independent Contractor Relationship
Based on the opposite results in the Roadway and Dial-A-Mattress cases, it is clear that the Board will strictly scrutinize the details of challenged independent contractor arrangements. It is also apparent that because the Board's inquiry is so fact specific, it is becoming increasingly difficult for employers to predict whether they have established a legitimate independent contractor relationship with a worker. Seemingly minor, superficial factors often have the cumulative effect of swaying the Board's determination one way or the other. There are some steps that companies can take to properly classify their workforce, however:
1.Examine operations to determine where you may have vulnerabilities and educate company personnel as to the legal and economic implications of worker classification.
2.Choose the right independent contractor. It is best to choose an independent contractor with specific skills and experience, who has an established business, is incorporated, has partners and/or associates, has capital/equipment, has a business premises, holds him or herself out to the public as an independent business person, and has other customers, preferably at the same time. Preferably, the company should not have to train the worker.
3.Enter into a written agreement with the independent contractor before any work is begun. The agreement should be carefully drafted and make specific reference to the factors that are used to determine employee/independent contractor status. For example, the agreement should contain, where possible, the following provisions:
- (a)Refer clearly to the worker as an independent contractor.
- (b)Set forth the results the worker is expected to obtain. Leave how the results will be obtained to the discretion of the worker.
- (c)Do not specify the method or order of services. Where certain control elements exist in a relationship due to a government regulatory requirement, the fact that such element is mandated by the government, and not the service recipient, should be made apparent in the agreement.
- (d)Provide for payment by the piece or job, rather than by the hour or week.
- (e)State that the worker is ineligible for any benefits that are or may be provided to the company's employees.
- (f)Limit the term of the agreement and specify a termination date. Leave the timing of the worker's services to the worker's discretion; do not specify hours to be worked.
4.Avoid the use of both independent contractors and employees to perform substantially similar tasks.
Independent contracting arrangements can benefit both the service recipients and the service providers. On the one hand, contractors have greater flexibility, can control their own hours, are not subject to the direct control of one employer and often obtain tax benefits. Businesses, on the other hand, are able to cut labor and benefits costs and better respond to changing economic conditions. The risk associated with using independent contractors is, of course, that an employer will label its workers independent contractors when, in fact, a court or governmental agency will consider them employees. But a business that carefully considers and implements its independent contractor relationships may avoid the numerous potential legal pitfalls and still reap the substantial benefits afforded by non-employee staffing.
1/Michelle M. Lasswell, Workers' Compensation: Determining the Status of a Worker as an Employee or an Independent Contractor, 43 Drake L. Rev. 419 (1994) (citing a June 1991 study conducted for the U.S. Small Business Administration).
2/120 F.3d 1006 (9th Cir. 1997).
3/ 326 NLRB No. 72 (1998).
4/326 NLRB No. 75 (1998).
5/Despite the conclusion reached by the majority of the Board, the Board Chairman, William B. Gould, wrote a dissenting opinion citing what he viewed as strong evidence that the Dial-A-Mattress drivers were employees. The Chairman cited Dial-A-Mattress's control over the assignment of geographic areas in which the drivers made deliveries; control over the schedule for loading and unloading trucks; and discipline of drivers for breach of the company's policies. In Gould's opinion, the majority elevated form over substance and failed to consider the "powerful incentives" that some employers have "to evade the strictures of employment laws like the National Labor Relations Act."
This article is published to inform clients and friends of Morgan Lewis and should not be construed as providing advice on any specific matter.