Department Of Labor Proposes New Rule On Classifying Workers As Employees Or Independent Contractors

September 28, 2020
On September 22, 2020, the U.S. Department of Labor (the “Department”) announced a proposed rule setting forth a test to determine whether a worker should be classified as an employee or an independent contractor under the Fair Labor Standards Act (the “FLSA” or the “Act”).  The proposed rule can be found here.  Although the Department has issued guidance in the past on this subject, and has issued regulations addressing the meaning of independent contractor within specific industries, it has never promulgated a formal rule.  Consistent with the approach taken by numerous courts when considering a worker’s classification under the FLSA, the proposed rule would focus the inquiry on two “core factors”:  (i) “the nature and degree of the worker’s control over the work” and (ii) “the worker’s opportunity for profit or loss based on initiative and/or investment.”  According to the Department, if both of these core factors point to the same conclusion, “their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposition classification.”  “In other words, where the two core factors align, the bulk of the analysis is complete.” 

I. Background

The FLSA requires employers to pay nonexempt employees at least the federal minimum wage and provide overtime pay for each hour worked over 40 hours per week.  These requirements, however, do not apply to independent contracts.  Although the FLSA does not define “independent contractor,” it defines an “employee” as “any individual employed by an employer.”  29 U.S.C. § 203(e)(1).  The Act in turn defines “employer” as “any person acting directly or indirectly in the interest of an employer in relation to an employer,” id. § 203(d), and “employ” to “include[] to suffer or permit to work,” id. § 203(g).  Given that the FLSA’s definitions provide little guidance on whether a worker is an independent contractor or employee, courts have developed multi-factor tests designed to evaluate the “economic realities” of the worker’s relationship with the employer.

As we have previously discussed here, on July 15, 2015, during the Obama administration, the Department issued an Administrative Interpretation setting forth the Department’s position on when workers may be considered independent contractors instead of employees covered by the FLSA.  The guidance stated that “most workers are employees under the FLSA’s broad definition” of “to employ” and enunciated a rigorous test for when workers could be considered independent contractors, taking the position that the main focus of the economic realities test, irrespective of the particular factors used by various courts, should be whether the worker is economically dependent on the employer, in which case the worker should be considered an employee.  On June 7, 2017, under the Trump administration, the Department withdrew the Obama-era guidance in an announcement that can be found here.

II. The Proposed Rule

In its September 22, 2020 proposal, the Department stated that the “multifactor economic realities test” “as currently applied, has proven to be unclear and unwieldy” and therefore proposed “to promulgate a regulation that explains the contours of the economic reality test and clarifies and sharpens a test that has become less clear and consistent through decades of case-by-case administration in the courts of appeals.”  The Department also stated that the new rule, if finalized, would replace “previous industry-specific interpretations”[1] and constitute “the Department’s sole and authoritative interpretation of independent contractor status under the FLSA.” 

The proposed rule would reflect an “economic reality” test that “considers whether a worker is in business for him or herself (independent contractor) or is economically dependent on a putative employer for work (employee).”  According to the proposed rule, the “touchstone” of the test would be “economic dependence,” which “is best understood in terms of what it is not.”  Therefore, the Department proposes to “exclude[] individuals who, as a matter of economic reality, are in business for themselves” from the definition of employee, and explains that “the key question is whether workers are ‘more closely akin to wage earners,’ who depend on others to provide work opportunities, or ‘entrepreneurs,’ who create work opportunities for themselves.”

This “economic reality” test would consist of five factors, which are discussed in more detail below.  The first two factors are considered “core factors” that “help determine if a worker is economically dependent on someone else’s business or is in business for themselves.”  These factors are (i) “the nature and degree of the worker’s control over the work” and (ii) “the worker’s opportunity for profit or loss based on initiative and/or investment.”  The proposal states that these factors “are highly probative to the inquiry because the ability to control one’s work and to earn profits and risk losses strikes at the core of what it means to be an entrepreneurial independent contractor, as opposed to a ‘wage earner’ employee.” 

The remaining three factors are:  (i) “the amount of skill required for the work,” (ii) “the degree of permanence of the working relationship between the worker and the potential employer,” and (iii) “whether the work is part of an integrated unit of production.”  The proposal states that, although these three factors “are also probative depending on the circumstances,” they “should be evaluated in the context of the[] two core factors.”  The proposal adds that “if both proposed core factors point towards the same classification—whether employee or independent contractor—there is a substantial likelihood that the individual’s classification is accurate” because “it is highly unlikely for the other, less probative factors to outweigh the combined weight of the core factors.”

The proposed rule emphasizes that “the actual practice of the parties involved,” “both of the worker . . . and of the potential employer,” would be “more relevant than what may be contractually or theoretically possible.”  The proposal states 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,” though the proposed rule “does not suggest that what is contractually or theoretically possible in a work arrangement is irrelevant.”

III. The Five Factors

A. The nature and degree of the worker’s control over the work.

With respect to the first factor, “the nature and degree of the worker’s control over the work,” the proposal provides examples “of an individual’s substantial control,” including “setting his or her own work schedule, choosing assignments, working with little or no supervision, and being able to work for others, including a potential employer’s competitors.”  The proposal states that “an individual worker’s ‘substantial control of the key aspects’ of the work weighs in favor of independent contractor classification ‘even if the worker is not solely in control of the work,’” whereas 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 proposal also “clarifies that requiring an individual to comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses (as opposed to employment relationships) does not constitute control that makes the individual more or less likely to be an employee under the Act.”

B. The individual’s opportunity for profit or loss.

With respect to the second factor, “the individual’s opportunity for profit or loss,” the proposal states that “the worker’s meaningful capital investments may evince opportunity for profit or loss,” but “investment is not the only way to satisfy this factor because workers who ‘invest little’ may nonetheless have an opportunity for profit through the exercise of personal initiative.”  Therefore, this factor “would weigh towards the individual being classified as an independent contractor if he or she has an opportunity for profit or loss based on either or both:  (1) the exercise of personal initiative, including managerial skill or business acumen; and/or (2) the management of investments in, or capital expenditure on, for example, helpers, equipment, or material.”

C. Skill required by the individual.

With respect to the “skill required” factor, the Department “proposes to clarify that this factor should focus on the ‘amount of skill required,’” but should “not include a consideration of ‘initiative’” “or the related concepts of judgment and foresight,” as some courts and the Department have previously done, “because facts related to initiative are considered as part of the control and opportunity for profit or loss factors.”  This factor would “weigh[] in favor of the individual being an independent contractor to the extent the work at issue requires specialized training or skill that the potential employer does not provide,” and it would “weigh[] in favor of the individual being an employee to the extent the work at issue requires no specialized training or skill and/or the individual is dependent upon the potential employer to equip him or her with any skills or training necessary to perform the job.”

D. Investment by the individual in facilities for work.

With respect to the “degree of permanence” factor, the proposal “focus[es] . . . on the continuity and duration of the working relationship,” “without referencing the exclusivity of the relationship between the worker and potential employer,” which some courts have considered with respect to this factor, because “[t]he control factor already considers whether a worker has freedom to pursue external opportunities by working for others.”  Under the proposed rule, “[t]he permanence factor would weigh in favor of an individual being classified as an independent contractor where his or her working relationship with the potential employer is by design definite in duration or sporadic,” and it “would weigh in favor of classification as an employee where the individual and the potential employer have a working relationship that is by design indefinite in duration or continuous.”

E. Whether the work is part of an integrated unit of production.

With respect to the “integrated unit” factor, the proposal clarifies that it “should . . . consider ‘whether the work is part of an integrated unit of production,’” rather than considering “the extent to which services rendered are an integral part of the [potential employer’s] business,” as some courts and the Department have considered previously.  Under the proposed rule, “[t]his factor weighs in favor of employee status where a worker is a component of a potential employer’s integrated production process, whether for goods or services,” whereas “if the individual’s work is not integrated into the potential employer’s production process, the factor would favor classification as an independent contractor.”

The Department is only providing for a 30-day comment period on the proposed rule, which has drawn criticisms from Democrats.  Reportedly, a Department official told reporters that the Department plans to finalize the rule by year-end, before the end of President Trump’s first term.

[1]           The Department stated that its proposed rule would not replace the economic reality analysis “for determining independent contractor status under the Migrant and Seasonal Agricultural Worker Protection Act.”