Courts, legislators, and government agencies have striven for years to distinguish employees from independent contractors, and the question remains a lively one for attorneys. With roots in both statutory and common law, the distinction continues to evolve, as a recent decision from the Minnesota Court of Appeals illustrates.
The question of whether a worker is an employee or independent contractor may be one of the most fundamental issues in employment law. Coverage under a host of federal and state laws hinges upon the answer, with the costs and benefits—depending on your perspective—that go along with it. But despite the question’s apparent simplicity, employers and workers alike have found themselves out to sea due to the seemingly endless ways in which a working relationship can be structured. They have discovered, sometimes the hard way, that the question is not put to rest simply by agreeing on a particular title.1 And errors can be costly.2
Amid the persistent uncertainty, the Department of Labor and state governments have promised more vigorous enforcement of the laws prohibiting misclassification of workers as independent contractors. President Obama’s budget proposal for the 2011 fiscal year would provide the DOL with $25 million to employ 100 additional enforcement personnel, as well as to provide grants to the states as incentives to undertake their own enforcement. The size of this allotment is large, but it pales next to the approximately $7 billion over ten years that the Obama Administration has said the Treasury would receive through enhanced enforcement. State governments, for their part, have commissioned studies in an effort to narrow the “independent contractor” definition, and in some cases (including Minnesota) have enacted legislation that prohibits the misclassification of workers as independent contractors.3 These considerations point to the need for employers and workers, and their lawyers, to brush up on the law and to analyze their worker relationships with renewed vigor. A recent Minnesota Court of Appeals decision provides businesses in this state with helpful guidance for that analysis.
Employee or Independent Contractor
The cornerstone of the federal and state employment legislation has long been the perceived need to protect employees from the vagaries of the job market and the concept of “at-will employment.” Thus, the government has enacted laws setting wage and hour controls and establishing workplace health and safety protections. There are laws that compensate employees for on-the-job injuries and provide them with an income should their employment end involuntarily. Finally, there are laws against certain forms of discrimination, harassment and retaliation, designed to guarantee a minimum level of respect for every employee.
In contrast, independent contractors, historically having specialized skills and resources that allow them to “be their own bosses,” were thought to be economically independent from the companies and persons that hired them. They were considered masters in their own right.4
In recent years, however, the line between contractor and employee has been blurred because the elements of control and dependency that were so prevalent through the mid-20th century are now that much harder to detect. Savvy employers have generally succeeded in hiring workers as “independent contractors,” choosing to relinquish a certain amount of control over those workers in exchange for the corresponding reduced expense. Meanwhile, a greater number of workers, seeking the freedom to control how and when they work, are choosing self-employment as independent contractors.
More often than not, the business and the worker both prefer the independent contractor arrangement, but that mutual desire may not be enough to avoid an employment relationship in the eyes of a court or the government. The circular definitions in most workplace laws do not help, and sometimes compound, the problem.5
The FLSA’s Economic Realities Test
Perhaps the legal issues that have caused the most inquiries into the employer/contractor conundrum are wage and hour issues, usually arising under the Fair Labor Standards Act (FLSA). As with other workplace legislation, the FLSA only protects those workers who are “employees,” which are defined as “any individual employed by an employer.”6 Additionally, the act defines the term “employ” as “to suffer or permit to work.”7 That second definition is vital, because it affords the FLSA a more expansive coverage than any other federal workplace law.8 According to the Supreme Court in Nationwide Mutual Ins. Co. v. Darden, “the latter definition … stretches the meaning of “employee” to cover some parties who might not qualify as such under a strict application of traditional agency law principles.”9
Thus, courts analyzing the employment status of an individual in an FLSA action have created and utilized the “economic realities test.” The inquiry, derived from the factors found by the Supreme Court to be relevant in United States v. Silk,10 focuses on uncovering whether the putative independent contractor really is in business for him or herself. The test has evolved to encompass a survey of at least five factors:
- The degree of control exercised by the alleged employer.
- The extent of the relative investments of the putative employee and employer.
- The degree to which the alleged employee’s opportunity for profit or loss is determined by the employer.
- The skill and initiative required in performing the job.
- The permanency of the relationship.11
Several jurisdictions add a sixth factor to the inquiry: whether the service rendered by the individual is an integral part of the alleged employer’s business.12 Still, although these factors are commonplace, they set no rigid rules for assessing a working relationship under the act: the economic realities test must be “sufficiently comprehensive and flexible to give proper effect to the broad language of the FLSA.”13 Accordingly, courts are expected to ground their analysis in the reality of the individual’s economic dependence, “rather than technical concepts, determined by reference not to isolated factors but rather upon the circumstances of the whole activity.”14
The “Right to Control” Test
Outside the context of the FLSA, the common law of agency provides the backbone for a myriad of other tests of employment/contractor status. Long used in tort actions to determine employer liability for a worker’s indiscretions, the agency test was not utilized under federal workplace laws until the Supreme Court’s 1968 decision in NLRB v. United Insurance Co. of America.15 The Court, then interpreting the Taft-Hartley Act’s amendment to Section 2(3) of the National Labor Relations Act, which provides that the term “employee” shall not include “any individual having the status of independent contractor,” declared that “the obvious purpose of this amendment was to have the Board and the courts apply general agency principles to distinguish between employees and independent contractors.”16
Since then, the Court has reaffirmed its position in the contexts of the Copyright Act17 and ERISA.18 Justice Souter, writing for the Supreme Court in Nationwide Mutual Ins. Co. v. Darden, the ERISA case, reasoned that when Congress used the term “employee” without defining it, Congress intended to describe the conventional “master-servant” relationship under the common law agency doctrine.19 He went on to summarize the common law agency test as follows:
In determining whether a hired party is an employee under the general common law of agency, we consider the hiring party’s right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party’s discretion over when and how long to work; the method of payment; the hired party’s role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party.”20
The Supreme Court was also careful to point out that “since the common-law test contains no shorthand formula or magic phrase that can be applied to find the answer, all of the incidents of the relationship must be assessed and weighed with no one factor being decisive.”21 Nevertheless, all of the factors and incidents are to be analyzed in terms of a single over-arching concern: the degree of control the business exercises over the worker.
Variations on the “Control” Test
Following Darden, courts that had applied the economic realities and other tests to non-FLSA actions—actions involving statutes that did not include the FLSA’s unique “suffer and permit to work” language—discovered that continuing to apply those tests would cause many who were common law independent contractors to come under the coverage of other statutes, such as Title VII.22 As a consequence, what transpired was a gradual takeover of federal non-FLSA employment law by the common law right-to-control test.23
Not only the courts, but also federal administrative agencies were caught up in this trend as the right to control test informed the guidance offered by the agencies. Both the the Equal Employment Opportunity Commission (EEOC) and the Internal Revenue Service (IRS) have devised their own lists of factors elaborating on the basic common law test.
The EEOC’s Variation. The EEOC, which administers Title VII and other federal antidiscrimination laws that generally protect employees but not contractors, lists no fewer than 16 factors for distinguishing between an employee and an independent contractor:
- The employer has the right to control when, where, and how the worker performs the job.
- The work does not require a high level of skill or expertise.
- The employer furnishes the tools, materials, and equipment.
- The work is performed on the employer’s premises.
- There is a continuing relationship between the worker and the employer.
- The employer has the right to assign additional projects to the worker.
- The employer sets the hours of work and the duration of the job.
- The worker is paid by the hour, week, or month rather than the agreed cost of performing a particular job.
- The worker does not hire and pay assistants.
- The work performed by the worker is part of the regular business of the employer.
- The employer is in business.
- The worker is not engaged in his/her own distinct occupation or business.
- The employer provides the worker with benefits such as insurance, leave, or workers’ compensation.
- The worker is considered an employee of the employer for tax purposes (i.e., the employer withholds federal, state, and Social Security taxes).
- The employer can discharge the worker.
- The worker and the employer believe that they are creating an employer-employee relationship.24
As if 16 factors were not enough, the EEOC stresses that these factors are nonexhaustive and that other circumstances might affect a given assessment.25 Additionally, the status of employee could be established even if only some of the criteria are met.26
These factors have been endorsed by the United States Supreme Court for use in Title VII discrimination cases.27
The IRS Version. The IRS looks to the worker classification to determine whether the employer must withhold taxes from the worker’s salary, and make FICA or FUTA (unemployment) contributions on the worker’s behalf. After Darden, the IRS released an expansive 20-factor test to determine employee/contractor status under the Internal Revenue Code.28 Businesses long criticized this test as being overly confusing, and lobbied for clearer guidance.29 The IRS recently revamped its framework, with the key considerations divided among three major criteria:
- Behavioral control. These facts pertain to the business’s right to direct and control how the worker performs the task for which he is retained. The business does not actually have to direct and control the way work is done to make it the worker’s employer—it only need have the right to do so.
1. Instruction: Does the business give extensive instructions on how, when and where a worker performs his job? Does the business instruct the worker about what tools or equipment to use? Does the business determine what assistants to hire? Does the business dictate where to purchase supplies and services?
2. Training: Does the business train the worker about required procedures?
- Financial control. These facts demonstrate whether the business has a right to direct or control the business part of the work.
1. Significant investment: Does the worker have a significant investment in his work?
2. Expenses: Is the worker reimbursed for some or all business expenses?
3. Opportunity for profit or loss: Can the worker realize a profit or incur a loss from the work?
- Type of relationship. These facts pertain to how the business and the worker view their relationship. The terms of a written contract may be very significant if it is difficult to determine status based on the other factors.
1. Employee Benefits: Does the worker receive benefits such as pension, health insurance, or paid leave?
2. Written Contract: Is there a written contract regarding the worker’s status?30
The NLRB’s Modified Test. The employee/contractor distinction is also significant in the context of “traditional labor law,” for determining, among other things, which workers are eligible to form or join a union. In addressing the issue, the National Labor Relations Board (NLRB) also employs its own version of the common law test. The NLRB’s test, while regarding the employer’s right of control or lack thereof as a dominant factor, appears to place major emphasis on whether the alleged employee has entrepreneurial opportunities for gain or loss.31
In Corporate Express Delivery Sys. v. NLRB,32 the Court of Appeals for the District of Columbia upheld the Board’s modified analysis, agreeing with the Board’s finding that the truck drivers at issue were employees because, even though the drivers were owner-operators, they were not permitted to use their vehicles for other jobs or to employ others to do the company’s work. These facts demonstrated that the truck drivers lacked all entrepreneurial opportunity, a factor that the court explained “better captures the distinction between an employee and an independent contractor” than the employer’s control of the means and manner of the work.
The Test as Applied Under State Law
The common law test also lends itself to the assessment of whether a worker is an employee or independent contractor under state workplace laws. For example, the Minnesota Court of Appeals
recently clarified the distinction between independent contractor and employee in St. Croix Sensory, Inc. v. Department of Employment and Economic Development.33
St. Croix Sensory involved a sensory laboratory that specializes in odor testing of materials, products and air for private industry and governmental entities. The company hires assessors who perform independent odor evaluations and record their observations so that St. Croix Sensory can relay the test results to its customers. The assessors sign up for whichever tests they want to participate in, thereby setting their own schedules. They do the testing in whatever manner they choose, receive a lump sum for each assessment session rather than hourly pay, and are free to read the paper, play cards, knit, or just visit with the other assessors for about 50 minutes per hour during an assessment session. Despite these liberties, the state unemployment agency ruled that the assessors were employees, and ordered the company to pay unemployment taxes on wages paid to the assessors.
On appeal, the Minnesota Court of Appeals outlined the factors codified in Minn. R. 3315.0555 subds. 1 and 2—yet another variation on the common law “control” standard. Regarding the primary factor of control, the court held that St. Croix Sensory’s requiring the assessors to follow certain instructions “d[id] not negate the assessors’ overall right to control the method and manner of performance.” The court further explained that while St. Croix Sensory might retain control over the “end product,” i.e., the odor evaluations, the assessors controlled the manner in which they performed those evaluations. Finally, the court noted that to a large extent, St. Croix Sensory’s need to control the assessors’ end product was dictated by industry standards which, if not met, would render the assessors’ evaluations unusable to their customers. Such control, obviously, could not be “held against” the company.
The court also emphasized the fact that St. Croix Sensory could not discharge an assessor in mid-assessment without incurring liability, which again dictated under the state rules that the workers were independent contractors. The evidence showed that if St. Croix Sensory ever discharged an assessor, it would pay the assessor for the entire assessment session. The state had argued that such a liability is “very limited,” but as the court noted, the rules speak to liability, period, not to a certain minimum amount of liability.
Lessons for Minnesota Employers
While the St. Croix Sensory decision was very fact-specific, the case has important implications for Minnesota businesses. First, much of the state’s ultimately unsuccessful case was based on the wording of St. Croix Sensory’s contracts with its assessors. For example, the contracts stated that St. Croix Sensory had the right to stop an assessor’s work or prescribe alterations, even though St. Croix Sensory established that it never actually exercised such a right, and that contractual language constituted the state’s primary evidence of “control.” Thus, while businesses that utilize contractors are well-advised to use written contracts, they should review those contracts to ensure that they do not include language that indicates the company exerts control over the contractor.
Businesses utilizing contractors must be sure to avoid controlling the contractors’ methods of doing their work. While every business wants to ensure that its workers are doing the job right, businesses must afford their independent contractors a great deal of autonomy to avoid transforming them into employees. As the St. Croix Sensory decision makes clear, however, this does not mean that the company loses the right to control the ultimate “end-product” of the work or to ensure that the contractors comply with industry standards.
Finally, companies using contractors should avoid discharging the contractors without incurring liability. In other words, business should adopt a policy of paying contractors at least some fee even if they leave or are discharged before the job is done. While this policy can cost a business a small amount of money on the front end, the failure to pay a discharged contractor could ultimately cost a business much more money in the long run, by turning that contractor—and potentially every other similar contractor—into an employee.
1 See Speaks, Inc. v. Jensen, 309 Minn. 48, 51, 243 N.W.2d 142, 145 (1976) (“the nature of the relationship of the parties is to be determined from the consequences which the law attaches to their arrangements and conduct rather than the label they might place upon it”).
2 See, e.g., Vizcaino v. Microsoft Corporation, 120 F.3d 1006 (9th Cir. 1997) (en banc) cert. denied, 522 U.S. 1098 (1998); Vizcaino v. United States District Court, 173 F.3d 713 (9th Cir. 1999), amended by 184 F.3d 1070 (1999), cert. denied, 528 U.S. 1105 (2000). Microsoft classified a group of workers, labeled “freelancers,” as independent contractors. After an IRS audit that determined they were, in fact, employees, the workers filed a class-action lawsuit to seek participation in two of the company’s retirement plans. As a result, Microsoft was ordered to retroactively fund the workers’ benefits. Following several appeals, the parties ultimately settled out of court for $96.885 million, including $27.129 million in attorney fees and costs. Vizcaino v. Microsoft Corp., 142 F. Supp. 2d 1299 (W.D. Wash. 2001), aff’d, 290 F.3d 1043 (9th Cir. 2002).
3 See, e.g., Minn. Stat. §181.722; 820 ILCS 185.
4 See Matthew W. Finkin, “Employed or Self-Employed? The Role and Content of the Legal Distinction,” 21 Comp. Lab. L. & Pol’y J. 1 (1999). In a clever analysis, Prof. Finkin illustrates the different power dynamic that exists between contractors and employees by comparing communications between master painter Albrecht Durer and the merchant for whom he would soon paint, with those between Johann Sebastian Bach, an organist employed by the New Church in Arnstadt, and the council that oversaw the church’s affairs.
5 An example is the Employee Retirement Income Security Act (ERISA), which defines an employee as “any individual employed by an employer.” 29 U.S.C. 1002(6) (2009).
6 29 United States Code Service (USCS) §203(d).
7 29 USCS §203(g).
8 Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318, 325-326 (1992) (citing Rutherford Food Corp. v. McComb, 331 U.S. 722, 728 (1947)).
9 Id. at 326.
10 331 U.S. 704 (1947) (“the courts will find that degrees of control, opportunities for profit or loss, investment in facilities, permanency of relation and skill required in the claimed independent operation are important for decision”).
11 Brock v. Mr. W Fireworks, 814 .2d 1042 (5th Cir.), cert. denied, 484 U.S. 924 (1987).
12 See Brock v. Superior Care, 840 F.2d 1054 (2d Cir. 1988); Donovan v. DialAmerica Mktg., 757 F.2d 1376 (3d. Cir.), cert. denied, 474 U.S. 919 (1985); Secretary of Labor, U.S. Dept. of Labor v. Lauritzen, 835 F.2d 1529 (7th Cir. 1987); Donovan v. Sureway Cleaners, 656 F.2d 1368 (9th Cir. 1981); Dole v. Snell, 875 F.2d 802 (10th Cir. 1989).
13 Barfield v. N.Y. City Health & Hosps. Corp., 537 F.3d 132, 143 (2d Cir. 2008).
14 Id. at 141.
15 NLRB v. United Insurance Co. of America, 390 U.S. 254 (1968).
16 390 U.S. at 256.
17 Community for Creative Non-Violence v. Reid, 490 U.S. 730 (1989).
18 Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318 (1992).
19 503 U.S. at 322-323.
20 Id. at 323-324 (quoting Community for Creative Non-Violence v. Reid, supra, n.11, at 751-752).
21 Id. (quoting NLRB v. United Ins. Co. of America, supra, n. 9, at 258).
22 See Wilde v. County of Kandiyohi, 15 F.3d 103, 105-106 (8th Cir. 1994) (concluding that “application of the economic realities test results in Title VII coverage for some common-law independent contractors because they are vulnerable to discrimination arising in the course of their work. Because the economic realities test is based on the premise that the term should be construed in light of Title VII’s purpose and the construction is broader than at common law, Darden precludes the test’s application).
23 See, e.g., Loomis Cabinet Co. v. Occupational Safety & Health Review Comm’n, 20 F.3d 938, 941 (9th Cir. 1994) (noting the courts of appeals’ prior use of the economic realities test but subsequently applying Darden analysis to definition of “employee” in the Occupational Health and Safety Act).
24 Equal Employment Opportunity Commission, Compliance Manual Section 2: Threshold Issues (2000), available at http://www.eeoc.gov/policy/docs/threshold.html.
27 Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440, 449 (2003).
28 Rev. Rul. 87-41 (I.R.S. 1987).
29 See D. Stafford, “Contractors or Employees? The IRS Dividing Line’s Fuzzy,” Ventura County (Cal.) Star (09/13/09).
30 IRS Publication 1779 (Rev. 8-2008), available at http://www.irs.gov/pub/irs-pdf/p1779.pdf.31 See Roadway Package Systems, Inc. 326 NLRB 842, 851-52 (1998); see also Slay Transp., 331 NLRB 1992 (2000); see also Corporate Express Delivery Sys., infra n. 32.
32 Corporate Express Delivery Sys. v. NLRB, 292 F.3d 777, 780 (D.C. Cir. 2002).
33 That test is codified at Minn. R. 3315.0555 (2009).
The author gratefully acknowledges the assistance of Brian Cunningham, a law student at the University of St. Thomas, who will be joining Ford & Harrison as an associate in the fall of 2011.