Exposing Distributors to Increased Liability

Under proposed Labor Department rules, more workers are likely to be classified as employees, rather than independent contractors.

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Like other businesses, distributors often confront whether a “worker addition” can be classified as an independent contractor rather than an employee. Doing so keeps costs down, and reduces time spent and costs incurred dealing with personnel and payroll matters such as overtime pay, unemployment insurance, sick leave and other obligations that only apply to employees.

Ultimately, however, a worker’s classification status as an independent contractor or employee is not an employer “choice.” Rather, it is a function of the law and the rules promulgated by the U.S. Department of Labor (DOL), as well as individual state labor laws addressing the subject. Under a proposed rule the DOL recently published, more distribution workers are likely to be considered employees instead of independent contractors, no matter what label applies to them.

Published on October 13, 2022, the proposed rule would revise the DOL’s analysis for employee or independent contractor classification under the Fair Labor Standards Act (FLSA). State law, if not to the contrary, will follow. Specifically, the DOL is proposing to rescind a rule issued by the previous administration which identified five “economic reality factors” to be used in determining whether a worker was an independent contractor or employee. Under the prior rule, which is still controlling until the new proposed rule becomes final, two of the five factors — “the nature and degree of control over the work and the worker’s opportunity for profit or loss” were designated as “core factors” that carried more weight in the analysis.

“Economic Realities of the Working Relationship”

The rule issued by the previous administration was generally viewed as more employer-friendly in that it made it easier to classify a worker as an independent contractor. Under the new proposed rule, the pendulum would swing in the other direction. Such is no shock, as the employee v. independent contractor dispute has been in play for decades, whether under federal and state labor or employment laws, the tax code, or otherwise. If the proposed rule is in place, the “core factors” mentioned above would no longer be part of the analysis. Instead, the new rule uses a “totality-of-the-circumstances” approach and an “economic reality test” that looks at the economic reality of the worker’s activities and the nature of their working relationship with the employer.

The new proposed rule sets forth six factors to be used in determining whether the “economic realities of the working relationship” reveal a worker to be economically dependent on the employer – in which case they would be likely considered an employee – or whether the worker is in business for themselves such that they are an independent contractor:

  • “Opportunity for profit or loss depending on managerial skill”
  • “Investments by the worker and the employer”
  • “Degree of permanence of the work relationship”
  • “Nature and degree of control,” including “whether the employer uses technological means of supervision (such as by means of a device or electronically), reserves the right to supervise or discipline workers, or places demands on workers’ time that do not allow them to work for others or work when they choose”
  • The “extent to which the work performed is an integral part of the employer’s business”; and
  • The “skill and initiative” of the worker, meaning whether they use and brought specialized skills to the job or are “dependent on training from the employer to perform the work.”

It remains to be seen whether the final rule ultimately promulgated by the DOL will be the same or substantially similar to the proposed rule. Regardless, distributors and other businesses need to understand that just classifying a worker as an independent contractor does not necessarily make them one. Given how much employee misclassification hurts workers who inappropriately wind up being treated as contractors (and how much tax revenue is lost when businesses wrongfully classify such workers), it is no surprise that the federal government and individual states are cracking down on this classification practice.

When they do so, they crack down hard. The financial cost to the distributors and other businesses can be substantial, but it can also cost CEOs and other corporate decision-makers personally. Courts have held that corporate officers with significant ownership interests, day-to-day control of operations, and involvement in the supervision and payment of employees can be personally liable for FLSA violations, and many state employee classification laws provide for personal liability for officers or agents who knowingly misclassify employees.

If you have questions or concerns about employee classification, the old and/or new and other rules as to classification, including the new proposed DOL rule, please contact me at 312-840-7004 or [email protected].

Fred Mendelsohn is a partner at Burke, Warren, MacKay & Serritella PC in Chicago.

The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter. The author expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this article.

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