Department of Labor Issues Final Rule on Independent Contractor Definition under the Fair Labor Standards Act

Seyfarth Synopsis:  Today the U.S. Department of Labor issued its final rule, attempting to define employee versus independent contractor status under the Fair Labor Standards Act (FLSA) (the “Final Rule”).  The Final Rule jettisons an earlier attempt under the prior Administration to modernize and simplify how to determine who is an employee and who is a contractor by focusing on two core factors. The Final Rule instead purports to return to an ambiguous totality-of-the-circumstances approach, while also placing a thumb on the scale in favor of more workers being deemed employees under the FLSA.

Background

The FLSA defines “employee” in an unhelpful, circular fashion. Section 3(e) of the FLSA defines the term “employee” as “any individual employed by an employer.” Section 3(d), in turn, defines “employer” to “include[e] any person acting directly or indirectly in the interest of an employer in relation to an employee.” 

In the absence of a concrete statutory definition of “employee,” and to distinguish between employees (who are covered by the FLSA) from independent contractors (who are not), court decisions predominately coalesce around some form of an “economic realities test,” in which courts balance several factors to determine if a worker is so dependent on the business to which they render services that they must be deemed an employee.  But application of the economic realities test has led to divergent outcomes based on similar facts. As summarized by Judge Easterbrook of the Court of Appeals for the Seventh Circuit, the economic realities test “is unsatisfactory both because it offers little guidance for future cases and because any balancing test begs questions about which aspects of ‘economic reality’ matter and why.”  Sec’y of Labor v. Lauritzen, 835 F.2d 1529, 1539 (7th Cir. 1988) (Easterbrook, J. concurring). 

In January 2021, the DOL issued an interpretation delineating how to define an employee versus a contractor under the FLSA (the “2021 Rule”).  In doing so, the DOL proposed to simplify the multi-factor test by setting forth two core factors to consider: (1) the nature and degree of the worker’s control of the work, and (2) the worker’s opportunity to earn a profit or loss. The proposal further provided that, if both factors point toward the same classification—whether employee or contractor—then the worker is likely to be classified as such. If, however, those factors point in opposite directions, then three other factors should be considered: (1) the amount of skill required for the work; (2) the degree of permanence of the working relationship between the individual and the company, and (3) whether the work is part of an integrated unit of production. The 2021 Rule was a welcome development for the business community.

Following the change in administration, however, the DOL delayed the effective date of that rule and then (unsuccessfully) attempted to withdraw it in May 2021. 

The DOL’s New Interpretation

As we discussed here, on October 11, 2022, the DOL issued a notice of proposed rulemaking (“NPRM”) proposing to rescind the 2021 Rule and replace it with a multifactor, totality-of-the-circumstances analysis to determine whether a worker is an employee or an independent contractor under the FLSA. And as we discussed here, here, and here, the NPRM proposed an analysis which skewed the inquiry in favor of employee status. The Final Rule largely adopts the NPRM, with a few exceptions, as noted below.

(1)        Totality-of-the-circumstances test. As with the NPRM, the Final Rule adopts a totality-of-circumstances test, eschewing the more targeted and focused inquiry under the 2021 Rule. Under this analysis, “no one factor or subset of factors is necessarily dispositive, and the weight to give each factor may depend on the facts and circumstances of the particular relationship.”  Absent from the Final Rule is any indication on how courts should weigh each factor, depending the particular facts and circumstances, or even the facts within each factor. Indeed, the DOL expressly declined to create an analytical framework that would provide businesses and workers “a scorecard or a checklist.” The Final Rule also appears to permit consideration of multiple facts across different factors, but provides no guidance on how that should occur, so that those individual facts will not be afforded outsized weight in the final analysis.

(2)        The worker’s opportunity for profit or loss depending on managerial skill. “This factor considers whether the worker has opportunities for profit or loss based on managerial (including initiative or business acumen or judgment) that affect the worker’s economic success or failure in performing the work.” The Final Rule helpfully clarifies that it is a worker’s “opportunities” for profit and loss, instead of whether the worker actually takes advantage of that opportunity, that is the touchstone under this prong. Under the NPRM, a worker’s unilateral choice to forego an entrepreneurial activity would have made employee status more likely. Under the Final Rule, however, it is the fact that the worker has the choice at all—and thus the ability to exercise his business judgment—that is indicative of independent contractor status. The Final Rule also added the language “including initiative or business acumen or judgment,” which was absent from the NPRM. This is a welcome addition because the NPRM focused merely on “managerial skill,” which narrowed the types of evidence indicative of independent contractor status.

(3)        Investments made by the worker and the employer. The Final Rule adopts the NPRM’s formulation that an investment borne by the worker must be capital or entrepreneurial in nature to indicate independent contractor status, and that investments should be assessed separately from the opportunities-for-profit-or-loss factor (unlike in the 2021 Rule). The Final Rule also adopts the NPRM’s approach that a worker’s investment “should be considered on a relative basis with the potential employer’s investments in its overall business.” However, the Final Rule clarifies that the comparison should be primarily qualitative, rather than quantitative—i.e., on whether the worker is making similar types of investments, not on the amount or size of the investments (which will almost always be greater for the alleged employer). Further, although the NPRM originally suggested that any cost borne by a worker to perform a job could not be evidence of capital or entrepreneurial investment, the Final Rule acknowledges that investments in tools and equipment may occur for many reasons beyond performance of a particular job, including the performance of more types of work, the reduction of costs, or the extension of market reach, and thus could be evidence of independent contractor status in certain circumstances.

(4)        Degree of permanence of the work relationship. The Final Rule states that the permanency factor “weighs in favor of the worker being an employee when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers.” The NPRM originally provided that, where a lack of permanence is due to “operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ,” that lack of permanence would not necessarily be evidence of independent contractor status. The Final Rule was adjusted to acknowledge that if the lack of permanence was both related to operational characteristics and the worker’s exercise of independent business initiative, it may be evidence of independent contractor status. The Final Rule, however, provides no clear guidance as to what qualifies as the worker exercising his business initiative in this context. The Department’s commentary also newly recognizes that the permanence factor cannot be reduced to mere considerations of length, and instead, can only be fully analyzed against the backdrop of a full understanding of the relationship between the worker and business (such as intermittent freelancing).

(5)        Nature and degree of the business’s control over the worker. The Final Rule largely adopts the NPRM with respect to the control factor. Facts relevant to control would include whether the employer sets the worker’s schedule, supervises the performance of the work, sets the price or rate for service, or explicitly limits the worker’s ability to work for others. One important change from the NPRM is that the Final Rule clarifies that “actions taken by the potential employer for the sole purpose of complying with a specific, applicable Federal, State, Trial, or local law or regulation are not indicative of control.”  In contrast, “actions taken by the potential employer that go beyond compliance . . . and instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control.”  The DOL seems to be saying that strict compliance with health and safety standards imposed by law are not indicative of employee status, but if an employer goes beyond those standards (e.g., creates a safer work environment than strictly required) this “may” be indicative of employee status. This creates a potentially harmful disincentive: businesses that go beyond minimum safety standards risk having their independent contractors deemed employees. Equally problematic, the Rule provides no clarification of the meaning behind its “sole purpose” language. For example, a business may believe that imposition of a legally required standard has secondary value (indeed, most laws exist for some beneficial purpose beyond the mere fact of compliance). But it is unclear under the Final Rule’s articulation whether such a secondary consideration, even if it would have had no impact on the business’s act of complying with the law, could impact the analysis of this factor.

Separately, the NPRM originally provided that any means of technological “supervision” would be relevant evidence of control. The Final Rule, however, acknowledges that is not always the case, and provides that technological supervision is only evidence of control if used to “supervise the performance of the work.” That is, under the Final Rule, merely collecting data generated from the actions of a worker (e.g., that an item was delivered) is not necessarily evidence of control. However, if that data is paired with additional supervisory action, such as directing or correcting the worker’s conduct, it may be evidence of employer-like control under the Final Rule.

(6)        Extent to which the work performed is an integral part of the employer’s business. The DOL’s framing of this factor may be particularly problematic. The Final Rule states that “this factor does not depend on whether any individual worker in particular is an integral part of the business, but rather whether the function they perform is an integral part” and that when the work a worker performs is “critical, necessary, or central to the employer’s principal business,” then this factor weighs in favor of employer status. It begs the question of how to determine an employer’s “principal business” or what is “critical, necessary, or central to it,” though the DOL’s commentary to its proposal provides possible guidance. The Final Rule fails to offer any convincing explanation for its departure from the “integrated unit of production” standard used in the 2021 Rule and first articulated by the Supreme Court in Rutherford Food Corp. v. McComb, 331 U.S. 772 (1947), which largely rests on the DOL’s belief that using Rutherford’s actual language would be “overly rigid.”

(7)        Whether the worker uses specialized skills in performing the work. Under the Final Rule, like under the NPRM, if a worker “uses specialized skills and . . . those skills contribute to business-like initiative,” then the worker is more likely a contractor. In its commentary, however, the DOL proposes to define those skills narrowly. The DOL commentary also proposes that, even when a worker possesses specialized skills, that fact is irrelevant unless the work requires those skills.

Under the proposed rule, no one factor would be dispositive or entitled to predetermined weight. While on the one hand this may seem to lead to greater flexibility, it blurs lines, leads to inconsistent results, and provides businesses and workers little of the clarity that rulemaking on worker status was supposed to provide.

What’s Next and What Will It Mean

With the Department of Labor’s retreat from the 2021 Rule only a short time after it went into effect, businesses and workers alike are faced with yet another potential analytical test against which they must measure their work relationships. Although the Final Rule attempts to tilt the scale towards employee status in the average case, substantial questions remain about the ultimate impact of the Final Rule, including whether it will be afforded any deference from courts, whether it will survive an inevitable legal challenge, and whether (like the 2021 Rule) it will be in jeopardy in any administration change. In the meantime, businesses should review their independent contractor relationships in light of the Final Rule.

 

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