Contractor Reality Check

Contractor Reality Check

Many employers in the insurance industry classify workers as independent contractors, rather than employees. But they often make this decision without first evaluating the legal test for contractor status. Employers often believe that if they simply agree to a contractor relationship, the law will honor that agreement. In fact, intent is only one of many factors that define contractor status.

The Fair Labor Standards Act (“FLSA”) regulates wage and hour matters, such as overtime and minimum wage, for employers throughout the country. The FLSA, however, applies only to employees. The Department of Labor (DOL) enforces the FLSA. DOL has adopted an “economic realities” test to determine contractor status. The test focuses on monetary risk. A worker that risks losing money on a job is typically a contractor. The money paid to a contractor is directly related to the end result. But a worker who receives the same amount regardless of result, or who receives payment based on time worked, is probably an employee.

DOL considers other factors relevant to the economic realities test: (1) whether the employer controls performance, including hiring, firing, and discipline; (2) whether wages are paid to the worker; (3) whether the worker invests in equipment; (4) the permanency of the relationship; (5) the skill required; and (6) whether the work is integral to the business. No one factor controls; all must be considered together.

In addition, DOL looks to whether the worker completes tax forms and is on payroll with deductions, whether the employer keeps books and records for the worker, whether the employer can approve employees of the worker, whether the worker has an economic interest in the work, and whether the worker must work at one location. The DOL does not consider relevant where the work is done, whether a formal work agreement exists, whether the worker is licensed, and whether the worker is paid a set wage as opposed to tips.

Moreover, in determining control, DOL looks at whether a contract indicates which party controls performance; whether the employer controls the worker’s business; whether the contract is for an indefinite or relatively long period; whether the employer can discharge the contractor’s employees; whether the employer can cancel the contract and if so, with how much notice; and whether the work is similar to that done by employees.

A recent federal case, Hopkins vs. Cornerstone America, involved overtime claims by insurance managers working in the sales and marketing division of a major health insurer. The company employed approximately 1,200 sales agents. Each agreed to work as a contractor on commission only. Some were promoted to “sales leader,” which was considered a management level position. Sales leaders trained, recruited, and managed teams of subordinate agents. Their primary income derived from their subordinates’ sales. No formal relationship existed between the sales leaders and their team members. Cornerstone controlled hiring, firing, assignment, and promotion of team members. The sales leaders had significant flexibility in setting their hours and their day-to-day affairs. They received no employment benefits, and Cornerstone did not withhold taxes from their pay.

Several former sales leaders sued Cornerstone, alleging unpaid overtime. After the District Court ruled for the plaintiffs, Cornerstone appealed. Applying the economic realities test, the Circuit Court found that Cornerstone controlled all meaningful economic aspects of the business, including hiring, firing, assignment, and promotion of team members. Cornerstone also controlled advertising for new recruits, and determined the type and price of insurance products sales leaders could sell.

Cornerstone controlled leads and determined geographic territories. Cornerstone’s investment – corporate offices, brochures, accounting, developing, and underwriting – outweighed the personal investment of the sales leaders. Moreover, sales leaders could not own other businesses. Thus, Cornerstone controlled the major factors determining profit or loss. Furthermore, no industry-specific skill set was required to perform as a sales leader. Finally, the work relationship was permanent – many sales leaders had worked exclusively for Cornerstone for years. Consequently, the plaintiffs were employees, not contractors.

Many employers have unpleasantly discovered, typically through a lawsuit or government audit, that the workers they felt confident were contractors were in fact employees. Penalties for failure to properly classify can be severe. They include penalties related to federal and state income tax withholding (these agencies have their own classification tests, further complicating the analysis), unemployment insurance contributions, workers’ compensation penalties, liability for minimum wages and overtime, and additional liabilities.

In addition, in difficult economic times, government agencies seeking additional revenue tend to be more aggressive in their efforts to find misclassified workers. The California Attorney General recently recovered millions of dollars from building contractors, transportation firms, and cleaning companies that had misclassified workers to evade workers’ compensation requirements. Industries in which classification decisions tend to be made in lockstep fashion are particularly appealing targets.
Consequently, at minimum, employers should (1) familiarize themselves with the legal requirements governing contractor/employee status; (2) conduct an audit of their practices to evaluate their level of compliance; (3) develop written policies on how to classify workers properly; (4) use job descriptions that identify whether a position is contractor or employee, including reasons supporting the classification decision; and (5) train managers so that practices are standardized throughout the company.

Finally, while this article has addressed certain legal requirements under federal law, the laws of each particular state must also be considered. For example, California has a specific test for contractor status that is similar, but not identical to, the FLSA test. Employers must comply with both their individual state’s wage hour laws and those of the FLSA.
The potential liabilities relating to improper contractor classification are significant. By taking a hard look at the realities of classification decisions at the inception of work relationships, however, employers can take a significant step toward ensuring compliance in their workforce.

[This article is not intended to be, and should not be relied upon as, legal advice. Consult a legal professional for advice in specific situations.]

About the Author: Spencer Hamer is Senior Counsel at Michelman & Robinson, LLP’s Los Angeles office and a member of the Firm’s Labor & Employment Department. You can reach him by calling 818.783.5530 or emailing him at shamer@mrllp.com.

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