In an important decision for businesses who utilize independent contractors, a U.S. District Court for the Eastern District of Texas has reinstated a January 2021 Department of Labor (“Department”) rule that makes it easier for companies to classify workers as independent contractors under the Fair Labor Standards Act (FLSA) (the “Contractor Rule”). The court’s ruling is widely considered a victory for businesses and independent contractors as the Contractor Rule emphasizes an “economic reality” test as the basis for determining whether a worker is an employee or an independent contractor under the FLSA.

Background

The FLSA is a federal law which establishes a minimum wage for all hours worked and overtime pay for covered, non-exempt workers who work in excess of 40 hours per week. As it is written, the FLSA does not distinguish between an employee and an independent contractor.

In January 2021, the Department promulgated the Contractor Rule in furtherance of providing clarity and guidance to this determination. The Contractor Rule was originally scheduled to go into effect on March 8, 2021 but was delayed pending the nomination and appointment of a new Department Secretary. In May 2021, prior to the new scheduled effective date, the Department withdrew the Contractor Rule and a coalition of unions challenged the withdrawal by filing suit against the Department in the U.S. District Court for the Eastern District of Texas.

The Core Factors of the Contractor Rule

Historically, courts and the Department have relied on a list of non-exclusive factors to guide the analysis as to whether a worker was an employee or an independent contractor under the FLSA. Rather than afford equal weight to these factors, the Contractor Rule focused the inquiry on two core considerations:

• “the nature and the degree of the individual’s control over the work;” and
• (ii) “the individual’s opportunity for profit or loss.”

If it is clear from these factors that the working relationship is one of “economic dependence,” then the working relationship is that of an employer and employee. Conversely, if the factors indicate that the relationship is not one of economic dependence, then the worker is considered an independent contractor. If, and only if, the analysis is inconclusive, then the Contractor Rule provides for the consideration of three additional factors: the amount of specialized training or skill required for the work, the degree of permanence of the relationship between the parties, and whether the work is part of an integrated unit of production.

What Does this Mean for Your Organization?

There are several important takeaways from the federal court’s decision to reinstate the Contractor Rule:

1. Although federal courts will now likely rely upon the Contractor Rule when seeking to determine whether a worker is an employee or an independent contractor under the FLSA, it is highly probable that the Department will either appeal the district court’s decision or propose a new test for determining the classification of a worker under the FLSA.
2. As the Contractor Rule only applies to an analysis under the FLSA, different agencies use different tests to determine what constitutes an “employee.” Most notably, the Internal Revenue Service has its own oft-cited means of classifying workers.
3. Increasingly, there are several states that, through their legislative process, have adopted what is commonly referred to as the “ABC test” to classify workers for various state purposes. The ABC test, which is far more restrictive than the Contractor Rule or the economic reality test, considers a worker an employee unless three criteria are satisfied: (i) the worker is free from the employer’s control or direction in performing the work; (ii) the work takes place outside the usual course of the business of the company and off the site of the business; and (iii) the worker is customarily engaged in an independent trade, occupation, profession, or business.[1]
4. Employers should consult with legal counsel to ensure they are properly and accurately classifying their workers as the failure to do so can be severe. The penalties for worker misclassification – even if inadvertent – could include fines (from the Department of Labor, Internal Revenue Service, or a state agency), back payments, criminal penalties and punitive damages. Under the FLSA, corporate officers and supervisors may be held personally liable for misclassifying employees.