The “ride sharing” company Lyft is facing a class-action lawsuit by its drivers, who claim the company misclassified them as independent contractors when they should have been classified (and paid) as employees. Lyft thought it had reached a settlement with the drivers for over $12 Million, but the federal judge overseeing the case refused to approve the settlement, expressing concern that the settlement amount was too low. The parties have now resubmitted their proposal to the court–this time for $27 Million. But even that eye-popping amount is nothing compared to the $100 Million that Lyft’s competitor, Uber, recently offered to pay to settle its own misclassification case. (Uber’s offer was rejected by the judge in its case as well, and the case is still pending.) What can we learn from these start-ups’ recent troubles?
The dollar amounts involved in the Lyft and Uber cases may be unusual, but claims that a business has misclassified its employees as independent contractors are not. Many businesses, it seems, routinely mistake their employees for contractors – and end up paying the price for this mistake.
“Employee” or “Contractor”: The Choice Is Not Up To You.
Most businesses understand that—all things being equal—it is usually cheaper and easier to treat a worker as an independent contractor. So it makes economic sense that businesses want to classify as many workers as possible as contractors. Unfortunately, whether a worker is an employee or an independent contractor is a legal question, and the law does not leave the answer to the employer’s discretion. In short, simply calling your workers “contractors” does not make it so.
What Difference Does the Employee / Contractor Distinction Make?
Not only is the employee / contractor distinction not discretionary, it touches many fundamental aspects of the employment relationship, so it is critical that your organization get it right. Getting it wrong can affect:
- Payroll Taxes. Federal tax laws require employers to withhold incomes taxes, and to withhold and pay Social Security, Medicare, and other payroll taxes on wages paid to employees. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.
- Minimum Wage and Overtime. Under the federal Fair Labor Standards Act, employees are entitled to minimum wage and overtime benefits; contractors are not. The same is generally true in states that have their own minimum wage and overtime laws.
- Unemployment Benefits. Under both federal and Georgia law, employees are entitled to unemployment benefits, while contractors are not. These benefits are funded by a tax paid by employers on wages paid to employees, but not on payments to independent contractors.
- General Liability. A business will normally be liable for the negligence of its employees, but not its contractors. Similarly, your liability insurance will normally not cover you for damages caused by your contractors.
- Workers’ Compensation. Employees who are hurt on the job are entitled to workers’ compensation benefits. By the same token, the injured employee cannot sue her employer for negligence. The reverse is true for contractors: they do not receive workers’ compensation benefits, and their employers are not immune from suit. In turn, a business’s workers’ compensation insurance premiums are determined in part by the number of its workers that are classified as employees.
- Unionization and Collective Bargaining. Whether your workers are your employees will determine whether federal labor laws apply to your relationship.
- Application of Other Federal Employment Laws. Most federal employment laws, such as the Family and Medical Leave Act, only apply to businesses that have more than a given threshold of employees. Whether these laws apply to your business will depend in part on whether your workers are counted as employees or contractors.
What is the Test?
If the employer’s wishes don’t determine which workers are employees and which are contractors, what does? That depends on what aspect of the employment relationship is at issue. But generally, there are two tests a court will use to determine a worker’s status: the “right to control” test and the “economic dependence” test.
The “Right to Control” Test.
Under the law of most states, including Georgia, it is usually said that when the employer retains the power to control the “time, place, or manner” of the worker’s activities, the worker is an employee, not a contractor. Some examples of this control include setting work hours, assigning a place to do the work, and dictating how the work is performed. Note that under this test a worker is your employee if you have the right to control his work, even if you never actually exercise that right.
A common mistake is to assume that a part-time or seasonal worker is a contractor. Again, if you retain the right to control the work, your worker is mostly likely an employee–albeit a part-time or seasonal one.
The control test can have unexpected consequences. For example, the National Labor Relations Board recently ruled that workers hired by your sub-contractor can be considered your employees if the agreement with your sub gives you the right to exercise control over the workers (such as, for example, by giving you the right to specify work hours or locations for your sub’s workers, to remove your sub’s workers from the project, or to set other minimum qualifications or requirements for performing the work). As a result, the workers can be considered your employees (and subject you to federal collective-bargaining laws) even if that control was only exercised “indirectly” through your contract with the sub.
The “Economic Dependence” Test.
The control test is widespread, but it isn’t universal. Most significantly, the federal Fair Labor Standards Act, which creates minimum wage and overtime obligations, broadly defines an “employee” as “any individual employed by an employer”, and further defines “employ” as “to suffer or permit to work”. The United States Supreme Court has held that Congress intended this language to be construed more broadly, and to include more workers, than the right to control test. Working from the statute and the Supreme Court’s opinion, the federal Department of Labor, which enforces the Fair Labor Standards Act, has developed its own test: A worker is an employee if she is “economically dependent” on her employer.
But, you might reasonably ask, when is a worker “economically dependent” on her employer? To answer that question, we have to look at several factors, including:
- Do you control the time, place and manner of the worker’s efforts?
- Does the worker stand to profit if the venture is successful and, conversely, to lose money if it is a failure–or does he stand to make the same pay for the work done, regardless of the outcome?
- Does the worker buy his own equipment and materials, or do you provide them for him?
- Does the worker possess any special skills?
- Is your agreement with the worker long-term and relatively permanent?
- How central to your business is the service that the worker is providing?
None of these factors is controlling, however, and they must be considered in the overall context of the relationship. Unfortunately, there are very few bright lines to guide an anxious employer. In the end, though, we can be certain that current state and federal laws are intended to classify the vast majority of American workers as employees, not contractors.
So What Do We Do?
As Lyft’s and Uber’s experiences show, the consequences of misclassifying workers can be significant, maybe even catastrophic, to your business. Nevertheless, it is possible to structure these relationships so that your workers are legitimate independent contractors. But it is much safer—and far less costly in the long run—to take these steps at the outset of the relationship than it is to wait until after an investigator or a court has gotten involved.
Before you decide to classify a worker as a contractor, always consult your legal counsel. If you have questions regarding how to properly classify your workers, contact Ben Byrd at bbyrd@fh2.com or (770) 399-9500 for more guidance.
