On September 22, 2020, the U.S. Department of Labor announced a proposed rule concerning whether a worker is an employee under the FLSA or an independent contractor.
The Department of Labor has released a Notice of Proposed Rulemaking (NPRM) revising its interpretation of independent contractor status under the FLSA. The Department’s Wage and Hour Division (WHD) said it is planning to “finalize [the rule] before year-end.” The proposed rule is scheduled for official publication in the Federal Register September 25, 2020.
Key provisions. The Department proposes to:
Adopt an “economic reality” test to determine a worker’s status as an FLSA employee or an independent contractor. The test considers whether a worker is in business for themselves (independent contractor) or is economically dependent on a putative employer for work (employee);
Identify and explain two “core factors,” specifically: the nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss based on initiative and/or investment. These factors help determine if a worker is economically dependent on someone else’s business or is in business for themselves;
Identify three other factors that may serve as additional guideposts in the analysis, including: the amount of skill required for the work; the degree of permanence of the working relationship between the worker and the potential employer; and whether the work is part of an integrated unit of production; and
Advise that the actual practice is more relevant than what may be contractually or theoretically possible in determining whether a worker is an employee or an independent contractor.
“Suffer or permit” standard. The FLSA requires covered employers to pay their nonexempt employees at least the federal minimum wage for every hour worked and overtime pay for every hour worked over 40 in a workweek, and mandates that employers keep certain records regarding their employees. However, a worker who performs services for an individual or entity as an independent contractor is not an employee under the Act. Thus, the FLSA does not require an employing entity to pay an independent contractor either the minimum wage or overtime pay, nor does it require that person to keep records regarding that independent contractor. The FLSA also does not define the term “independent contractor.”
Courts and the DOL have long interpreted the “suffer or permit” standard in the definition of “employ” to require an evaluation of the extent of the worker’s economic dependence on the potential employer and have developed a multifactor test to analyze whether a worker is an employee or an independent contractor under the FLSA. The ultimate inquiry is whether, as a matter of economic reality, the worker is dependent on a particular individual, business, or organization for work (and is thus an employee) or is in business for him- or herself (and is thus an independent contractor).
Economic reality. According to the DOL, the underpinnings and the process for application of the economic reality test have lacked focus and have not always been sufficiently explained by courts or the Department, resulting in uncertainty among the regulated community. Thus, the Department believes that clear articulation will lead to increased precision and predictability in the economic reality test’s application, which will in turn benefit workers and businesses and encourage innovation and flexibility in the economy.
Accordingly, the NPRM proposes to introduce a new part to Title 29 of the Code of Federal Regulations setting forth the Department’s interpretation of the FLSA as relevant to whether workers are “employees” or are independent contractors under the Act. The proposed regulations explain 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. The proposed regulations also explain that the inquiry into economic dependence is conducted through application of several factors, with no one factor being dispositive, and that actual practices are entitled to greater weight than what may be contractually or theoretically possible.
Five-factor test. The Department proposes to sharpen this inquiry into five distinct factors, instead of the five or more overlapping factors used by most courts and the Department previously. Moreover, the Department proposes that two of those factors—the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss—should be more probative of the question of economic dependence or lack thereof, and thus these factors are afforded greater weight in the analysis than any others.
Replace previous interpretations. When finalized, this proposed rule would be the Department’s sole and authoritative interpretation of independent contractor status under the FLSA. As such, it would replace the Department’s previous interpretations of independent contractor status under the FLSA in certain contexts, including interpretations found at 29 CFR 780.330(b) (interpreting independent contractor status under the FLSA for tenants and sharecroppers) and 29 CFR 788.16(a) (interpreting independent contractor status under the FLSA for certain forestry and logging workers).
In Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 326 (1992), the Supreme Court held that the “suffer or permit” definition is broad on its face and is more inclusive than the common law standard for determining who is employed and thereby who is an employee. The Court stated in Darden that the scope of employment under the FLSA is broader than that under common law and is determined by the economic reality of the relationship at issue, relying on the “suffer or permit” standard that is unique to the FLSA.
However, according to the DOL, the Court has not mandated any specific set or formulation of economic reality factors for purposes of the FLSA, nor has it explicitly opined on any factor’s relative probative value to the inquiry.
Multifactor “economic reality” test. In the 1970s and 1980s, federal courts of appeals began to adopt a multifactor “economic reality” test. Drawing on the Supreme Court precedent, courts recognized that the heart of the inquiry is whether “as a matter of economic reality” the workers are “dependent upon the business to which they render service.” Some courts have clarified that this question of economic dependence may be boiled down to the question of “whether the individual is or is not, as a matter of economic fact, in business for himself.”
For example, in Real v. Driscoll Strawberry Assocs., Inc., 603 F.2d 748, 754 (9th Cir. 1979), the Ninth Circuit described its six-factor test as follows:
the degree of the alleged employer’s right to control the manner in which the work is to be performed;
the alleged employee’s opportunity for profit or loss depending on his managerial skill;
the alleged employee’s investment in equipment or materials required for his task, or his employment of helpers;
whether the service rendered requires a special skill;
the degree of permanency of the working relationship; and
whether the service rendered is an integral part of the alleged employer’s business.
Most courts of appeals articulate a similar test, but application between courts may vary significantly. The “skill required” factor is now articulated more expansively by some courts of appeals as including consideration of “initiative.” The “investment” factor has been modified by the Fifth Circuit to consider “the extent of the relative investments of the worker and the alleged employer.” Additionally, some courts of appeals have expanded the permanence factor to also consider the exclusivity of such relationships. Finally, the consideration of whether work is “part of an integrated unit of production,” is now typically articulated by many courts of appeal as whether the service rendered is “integral.” Courts of appeals applying the multifactor economic reality test draw from the totality of circumstances, with no single factor being determinative by itself.
Application of the economic reality test by WHD. Since at least 1954, WHD has applied a multifactor analysis when considering whether a worker is an employee under the FLSA or is instead an independent contractor. WHD also has issued numerous opinion letters addressing whether a worker is an employee under the FLSA or an independent contractor, generally relying on a multifactor analysis very similar to the six economic reality factors identified above. WHD has also promulgated regulations applying a multifactor analysis for independent contractor status under the FLSA in certain specific industries.
Title 29 amendments. The DOL proposes to amend Title 29 of the Code of Federal Regulations parts 780 and 788 and to add a new part 795, which will contain the Department’s general interpretations of the text governing individuals’ classification as employees or independent contractors under the FLSA.
In the context of the economic reality test, “economic dependence” is best understood in terms of what it is not. The phrase excludes individuals who, as a matter of economic reality, are in business for themselves. Such individuals work for themselves rather than at the sufferance or permission of a potential employer and thus are not dependent on that potential employer for work. Proposed § 795.105(b) recognizes the principle that, as a matter of economic reality, workers who are in business for themselves with respect to work being performed are independent contractors for that type of work.
Proposed application of economic reality factors. The first economic reality factor (proposed § 795.105(d)(1)(i)) is “the nature and degree of the individual’s control over the work.” This factor would weigh towards the individual being an independent contractor to the extent that the individual, as opposed to the potential employer, exercises substantial control over key aspects of the performance of the work. The control factor would weigh in favor of classification as an employee to the extent that a potential employer, as opposed to the individual, exercises substantial control over key aspects of the work.
The second economic reality factor (proposed § 795.105(d)(1)(ii)) is “the individual’s opportunity for profit or loss.” The Second Circuit also considers the individual’s opportunity for profit or loss based on investments. The Department believes the Second Circuit’s approach of combining the factors is preferable because it minimizes duplicative analysis of the same facts under different factors and aligns more closely with the Supreme Court’s original analysis in United States v. Silk, 331 U.S. 704 (1947).
“The amount of skill required for the work” is an economic reality factor under proposed § 795.105(d)(2)(i). The Department proposes to clarify that this factor should focus on the “amount of skill required,” as originally articulated by the Supreme Court in Silk. This factor would not include a consideration of “initiative” (or the related concepts of judgment and foresight) because facts related to initiative are considered as part of the control and opportunity for profit or loss factors.
“The degree of permanence of the working relationship between the individual and the potential employer” is an economic reality factor under proposed § 795.105(d)(2)(ii). Because the worker’s ability to work for others is already analyzed as part of the control factor, proposed § 795.105(d)(2)(ii) articulates the permanence factor without referencing the exclusivity of the relationship between the worker and potential employer.
Proposed § 795.105(d)(2)(iii) would clarify that the “integral part” factor should consider “whether the work is part of an integrated unit of production.” Concerned that focusing on the importance of work can sometimes send misleading signals regarding economic dependence, the Department determined that the inquiry under proposed § 795.105(d)(2)(iii) would examine whether the work was “part of the integrated unit of production,” with an emphasis that the factor is different from the concept of importance or centrality.
Two core factors. Proposed § 795.105(c) explains that the two core factors—i.e., control and opportunity for profit or loss—are each afforded more weight in the analysis of economic dependence than are any of the others. As a result of their greater weight, if both core factors point towards the same classification, their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposite classification.
In contrast to the two core factors, the other factors listed in § 795.105(d)(2) relating to skill, permanence, and integration are not always as probative to an inquiry into whether a worker is, as a matter of economic reality, in business for him- or herself or economically dependent on someone else for work. Rather, their relevance varies depending on the circumstances. Accordingly, the Department proposes to focus the economic reality test on the two core factors.
Actual practice. Proposed § 795.110 states that the actual practice of the parties involved—both of the worker (or workers) at issue and of the potential employer—is more relevant than what may be contractually or theoretically possible. The Department observed that the primacy of the parties’ actual practice applies to every potentially relevant factor, and it can weigh in favor of either an employee or independent contractor relationship.
Importantly, proposed § 795.110 does not suggest that what is contractually or theoretically possible in a work arrangement is irrelevant. Contractual and theoretical possibilities are also part of the economic reality of the parties’ relationship, and excluding them outright would not be consistent with the Supreme Court’s instruction in ” Rutherford Food Corp. v. McComb, 331 U.S. 722 (1947) to evaluate “the circumstances of the whole activity.”
Comment. In a news release, Secretary of Labor Eugene Scalia said that “once finalized, [the rule] will make it easier to identify employees covered by the Act, while respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.”
In additional comments, Wage and Hour Division Administrator Cheryl Stanton noted that “the Department believes that streamlining and clarifying the test to identify independent contractors will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.”
Commitment to final rule. Accompanying the DOL’s release of the NPRM, senior Department officials held a press conference and characterized issuance of the proposed rule as a “big moment,” notable because it is official rulemaking and 60 years have passed since the Supreme Court had spoken on the FLSA definition of employee. Now, the “economy has changed.”
When questioned about the short (30-day) comment period and the Department’s expressed commitment to issue the final rule by year-end, officials responded that the agency would undertake a “very thorough, very deliberate review.”
Pending publication. The proposed regulation is scheduled for publication in the Federal Register on September 25, 2020. The Notice of Proposed Rulemaking will be available for review and public comment for 30 days after it is published in the Federal Register.
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