LawFlash

US Department of Labor Publishes Independent Contractor Proposed Rule

October 13, 2022

The US Department of Labor published a Proposed Rule on October 13 seeking to return to applying a test that would make it more difficult for certain workers to qualify as independent contractors.

The Proposed Rule revises the standard for determining when a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). The Department of Labor (DOL) will accept written comments regarding the Proposed Rule for 45 days from its publication date—i.e., until November 27, 2022. The DOL will then review the comments before issuing a Final Rule which may modify the Proposed Rule. The proposed changes will not go into effect prior to the Final Rule being published. It is not clear when the Final Rule will be published, but it is unlikely to occur this year.

The Proposed Rule would scrap a Trump-era independent contractor rule and apply a totality-of-the-circumstances economic realities test. The test’s ultimate inquiry is whether, as a matter of economic reality, the worker is economically dependent on the employer (and thus an employee), or in business for themself (and thus an independent contractor) by reference to a non-exhaustive list of factors. The proposed test would make it more difficult for certain workers to qualify as independent contractors.

TRUMP-ERA RULE WOULD BE REPLACED

In January 2021, DOL published a rule (2021 Rule) identifying five economic reality factors to be considered when determining whether a worker is properly classified as an independent contractor. The 2021 Rule identified two of the five—the nature and degree of control over the work, and the worker’s opportunity for profit or loss—as the “core factors” most probative of the nature of the relationship and stated that if those core factors suggest a certain classification, there is a substantial likelihood that the worker should be classified that way.

The 2021 Rule further stated that the other three factors—the amount of skill required for the work, the degree of permanence of the working relationship, and whether the work is part of an integrated unit of production—were “highly unlikely” to outweigh the probative value of the two core factors. The 2021 Rule also narrowed the relevant facts to consider in assessing the impact of other factors, including in connection with the control and opportunity for profit or loss inquiries.

The 2021 Rule was set to become effective on March 8, 2021. However, on March 4, 2021, the DOL published a rule delaying its effective date, and, on May 6, 2021, the DOL withdrew it in its entirely. In March 2022, a Texas federal district court vacated the delay and withdrawal, ruling that the 2021 Rule had become effective as of March 8, 2021. The new Proposed Rule would replace the 2021 Rule.

RETURN TO TOTALITY OF THE CIRCUMSTANCES TEST

In explaining the Proposed Rule, DOL expressed its belief that the 2021 Rule’s narrowing of the economic realities test to make it easier for workers to qualify as independent contractors did not comport with the FLSA’s text and purpose as interpreted by decades of case law. In issuing the Proposed Rule, the DOL seeks to return to the totality-of-the-circumstances approach to the economic realities test and offers detailed guidance as to how the underlying factors should be applied.

The six factors are: (1) the worker’s opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the employer; (3) the degree of permanence of the working relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral part of the alleged employer’s business; and (6) skill and initiative.

The Proposed Rule notes that additional context-specific factors may also be relevant.

The Worker’s Opportunity for Profit or Loss Depending on Managerial Skill

The first factor in the Proposed Rule is the worker’s opportunity for profit or loss depending on managerial skill. The Proposed Rule sets forth a non-exhaustive list of facts relevant to that inquiry: (1) whether the worker determines the charge or pay for the work provided (or can meaningfully negotiate it); (2) whether the worker accepts or declines jobs or chooses (or can meaningfully negotiate) the order and/or time in which the jobs are performed; (3) whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and (4) whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.

While the 2021 Rule considered the worker’s investment in assessing the opportunity for profit or loss, the Proposed Rule would consider that separately (as discussed below). The DOL also states that the fact that workers may earn more or less (and their earnings may decline) depending on how much they work is not the equivalent of experiencing a financial loss. Where a worker is paid by the job, the worker’s decision to work more jobs and the worker’s technical proficiency in completing each job are not, in the DOL’s view, the type of managerial skill that would indicate independent contractor status. Rather, the risk of loss must be based on the worker’s managerial decisions.

The Proposed Rule observes that workers who incur little or no costs or expenses, provide only their labor, and/or are paid an hourly or flat rate are unlikely to experience loss, and this factor may suggest employee status where those circumstances are present.

Investments by the Worker and the Employer

The second factor in the Proposed Rule is whether and the extent to which the worker makes investments in their business. The Proposed Rule specifies that in order to suggest independent contractor status, the worker’s investment must be capital or entrepreneurial in nature. For example, investments that would increase a worker’s ability to do different types of, or more, work, reduce costs, or extend market research, are entrepreneurial and suggest independent contractor status.

By contrast, the Proposed Rule specifies that costs borne by the worker simply to perform the job (for example, tools and equipment to perform a specific job or the use of a personal vehicle that the worker already owns to perform work) are not evidence of capital or entrepreneurial investments.

Finally, the Proposed Rule provides that the worker’s investments should be evaluated on a relative basis with the employer’s investments.

Degree of Permanence of the Work Relationship

The third factor is the degree of permanence of the work relationship. The Proposed Rule specifies that while an indefinite or continuous relationship is consistent with employee status, a worker’s lack of a permanent or indefinite relationship with an employer is not necessarily indicative of independent contractor status unless it results from the worker’s own independent business initiative.

In addition, the Proposed Rule recognizes that certain jobs, such as temporary, agricultural, or seasonal work, are inherently non-permanent, but workers in those jobs may still be economically dependent on the employer. One consideration under this factor is whether the work relationship is exclusive and the extent to which the worker works for others.

However, the Proposed Rule makes clear that an employee may be economically dependent on multiple employers, and the mere fact that a worker performs work for multiple companies is not determinative of independent contractor status.

Nature and Degree of Control

The fourth factor in the Proposed Rule is the nature and degree of control that the employer exercises over the worker. In contrast to the 2021 Rule, which designated this as a “core” factor, the Proposed Rule rejects the concept of placing heightened emphasis on this factor. The Proposed Rule describes setting a worker’s schedule, compelling attendance, or directing or supervising the work as examples of “direct” control, but notes that employers may also exercise control in other indirect ways, including by relying on technology to supervise a workforce, setting prices for services, or restricting a worker’s ability to work for others.

Significantly, while the 2021 Rule provided that requiring a worker to comply with specific legal or regulatory obligations, satisfy health and safety standards, carry insurance, and meet contractually agreed-upon deadlines or quality control standards does not constitute employer-type control, the Proposed Rule specifies that it may be appropriate to consider requirements that a worker comply with legal, safety, or quality control obligations as part of the control analysis.

The Proposed Rule suggests that whether required compliance with these obligations is indicative of control will depend, in part, on the circumstances: for example, a company requiring all individuals to wear hard hats at a construction site for safety reasons is “less probative” of control than the company requiring all workers to attend a weekly safety briefing at a particular time and place.

As to the means of “direct” control, the Proposed Rule notes that if a worker’s ability to pick one’s shift is offset by limited hours provided by the employer, the worker’s purported ability to set their own schedule provides only minimal evidence of independent contractor status. The same may be true if the employer exerts so much control over the amount or pace of work as to negate meaningful scheduling flexibility. Moreover, the power to decline work and maintain a flexible schedule is “not alone” persuasive evidence of independent contractor status where the employer can discipline a worker for turning down work.

The Proposed Rule also notes that where the nature of the employer’s business or the work to be performed makes direct supervision unnecessary, a lack of physical supervision in those circumstances does not compel a finding that the control factor weighs in favor of independent contractor status. In addition, remote supervision through technology—for example, monitoring systems that track a worker’s location and productivity—also constitute control.

The Proposed Rule would also reject the 2021 Rule’s provision that “unexercised powers, rights, and freedoms” are “less relevant” than those that are actually exercised. DOJ explained that while the 2021 Rule’s statement about the “right to control” being immaterial may be true in some cases, its blanket pronouncement on that point is incompatible with the proper totality-of-the-circumstances inquiry.

Extent to Which the Work Performed is an Integral Part of the Employer’s Business

The fifth factor in the Proposed Rule is the extent to which the work performed is an integral part of the employer’s business. The Proposed Rule calls for a “common-sense” approach to this factor that asks whether the employer could function without the service performed by the type of worker at issue (not the services of the individual worker).

Where an employer’s primary business is to make a product or provide a service, the workers who make the product or provide the service are integral. The focus of the inquiry is at the level of the work performed, not whether the individual worker possesses some unique qualities that render them indispensable as an individual.

Skill and Initiative

The sixth and final factor is the level of skill and initiative required to perform the work. This factor considers whether a worker uses specialized skills to perform the work. The Proposed Rule notes that where the work does not require previous experience, the worker is dependent on training from the employer to perform the work, or the work requires no training, the work likely does not require specialized skill and initiative.  

Additional Unspecified Factors

The Proposed Rule also notes that the six enumerated factors are intended to be non-exhaustive, though it declines to state any additional factors.

IMPACT ON STATE WAGE AND HOUR TESTS

The Proposed Rule would apply only to the FLSA. Therefore, it would have no impact on any state wage and hour laws that do not follow the FLSA for determining whether a worker should be classified as an employee or independent contractor. For example, California, Massachusetts, and several other states apply an “ABC Test,” (with some exceptions) under which a worker is considered an employee and not an independent contractor unless the hiring entity satisfies three conditions distinct from (but in some instances similar to) the factors in the Proposed Rule.

Accordingly, regardless of DOL’s guidance on who qualifies as an independent contractor, employers should always review whether and how different state laws may apply to their workforce.

PRACTICAL EFFECT AND EMPLOYER OUTLOOK

The Proposed Rule marks a significant departure from the 2021 Rule insofar as (1) the DOL seeks to move away from considering the exercise of control and the opportunity for profit and loss as the “core factors” in the economic realities analysis; (2) requiring compliance with legal or regulatory obligations could now be considered as part of the control factor; (3) evidence of work performed for multiple companies will not be viewed as dispositive of independent contractor status; and (4) only worker investments that are capital and entrepreneurial in nature will weigh in favor of an independent contractor finding. Those changes could have a significant impact on certain industries that rely on independent contractor business models.

The DOL’s proposed changes will not go into effect until it issues a Final Rule. Based on the comments it receives, the DOL may modify its position before publishing the Final Rule, which is likely to occur sometime in the first quarter of 2023.

Although the DOL will use the standard set forth in the Final Rule in its FLSA enforcement efforts, it is unclear how much deference courts will give to the new standard, particularly considering that the DOL’s view on what the proper standard is for determining independent contractor status keeps changing.

Regardless, the issue of whether a worker qualifies as an independent contractor will likely remain the subject of frequent litigation under the FLSA and applicable state wage and hour laws. Thus, employers should continue to review how their workers are classified and consider whether to comment on the Proposed Rule so that the DOL recognizes the practical effect that the Final Rule may have on certain industries.

NEXT STEPS

The Proposed Rule is designed to expand the FLSA’s coverage to additional workers who may be currently classified as independent contractors. Employers should consider the following actions:

  • Submitting comments to ensure that the regulatory record reflects the true effect of any proposed changes and to shape the Final Rule. Employers may do so individually or participate in association or coalition comments.
  • The publicity generated by the Proposed Rule may cause a number of workers to question whether they are properly classified as independent contractors. As such, although any final regulatory change is not imminent, companies should consider auditing their current independent contractor population to determine what changes will be made to staffing models and the classification of “close to the line” positions if and when the Proposed Rule becomes final. Those changes may include restructuring how certain workers are managed or reclassifying workers from independent contractor to employee. Reclassifying workers from independent contractor to employee, in turn, requires considering a broad range of issues, including communication strategy, manager and employee training, timekeeping policies and practices, scheduling, compensation structures, calculation of the overtime rate, and many other issues. Planning ahead is critical to managing the risks associated with reclassification.

HOW WE CAN HELP

Morgan Lewis lawyers are happy to work with you on providing comments to the DOL, as well as assisting in the next steps described in this LawFlash so you are well prepared when the DOL issues a Final Rule.

Contacts

Please contact the Morgan Lewis lawyers listed below if you have questions concerning the comment process or if you would like guidance on best practices to follow to when making classification decisions and to preserve independent contractor relationships.

Houston
Washington, DC