Alert October 31, 2022

DOL Proposes Rule Regarding Independent Contractor Status

The Wage and Hour Division of the U.S. Department of Labor (“DOL”) recently published a proposed rule (the “Proposed Rule”) that would modify DOL’s regulations for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (“FLSA”), which, among other things, requires payment of minimum wages and overtime to covered employees.

The Proposed Rule would rescind a prior rule published in January 2021 (the “2021 Rule”) and replace it with a multi-factor “totality of the circumstances” analysis aimed at determining whether the worker is economically dependent on an employer or is in business for themself. Each of the six “economic reality” factors under the Proposed Rule would be given equal weight. That is a departure from the 2021 Rule, which placed greater weight on two “core factors,” i.e., the nature and degree of control over the work and the worker’s opportunity for profit or loss. DOL’s commentary accompanying the Proposed Rule states that it considered the 2021 Rule to have departed from case law interpreting the FLSA and that the six factor test “more fully reflects the case law and provides the flexibility needed for application to the entire economy.” Fundamentally, DOL intends the Proposed Rule to be a return to its policy in effect prior to the 2021 Rule, though there appear to be some meaningful differences described below.

The Proposed Rule is not yet final. Interested parties may submit comments to the Proposed Rule by December 13, 2022. The final rule that is ultimately adopted may be meaningfully different from the Proposed Rule.

The Proposed Rule’s Six-Factor “Economic Realities” Test

The Proposed Rule identifies six “economic reality” factors to guide the analysis of whether a worker is economically dependent on an employer or is in business for themself: (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral party of the employer’s business; and (6) skill and initiative. The Proposed Rule also states that “additional factors may be relevant” to the analysis. The “ultimate inquiry”, according to DOL, is “whether, as a matter of economic reality, the worker is economically dependent on the employer for work (and is thus an employee) or is in business for themself (and is thus an independent contractor).”

Key Takeaways

  • The assessment of the Proposed Rule’s factor concerning opportunity for profit or loss depending on managerial skill turns on whether the worker’s business acumen or judgment affects the worker’s economic success or failure. DOL notes that facts such as a worker’s ability to determine (or at least meaningfully negotiate) the charge or pay for work and whether to accept or reject jobs and/or choose the order in which they are performed, are relevant to assessing the degree to which the worker’s managerial skill impacts the worker’s economic success or failure. In one of several references to the “gig economy” in its discussion of the background of the Proposed Rule, DOL highlighted a case from the U.S. Court of Appeals for the Third Circuit involving Uber, in which the appeals court overturned the lower court’s independent contractor determination because Uber decided the fare, which drivers received a trip request, whether to refund or cancel a passenger’s fare, and the driver’s territory.
  • Under the Proposed Rule, the investment borne by the worker must be “capital or entrepreneurial” in nature to indicate independent contractor status. Such investments generally serve a business function, such as increasing the worker’s ability to do different types of work, reducing costs, and extending market reach. Costs borne by the worker to perform their job (e.g., tools/equipment to perform a specific job and the worker’s labor) are not evidence of capital or entrepreneurial investments and, according to DOL, actually indicate employee status under the Proposed Rule. DOL’s suggestion that a worker’s investment in their own tools or equipment is indicative of employee status appears to differ from one aspect of traditional independent contractor analysis, since reimbursement of a worker’s expenses (including those incurred in acquiring tools and equipment) has traditionally also been a factor in favor of employee status. In another reference to the gig economy, DOL noted that a worker’s investment in a personal vehicle is not viewed as an entrepreneurial investment.
  • DOL indicated that whether the business sets the worker’s schedule, supervises the performance of the work, disciplines the worker, controls pricing or rates for services, or explicitly limits the worker’s ability to work for others are all factors that are relevant to the employer’s control over the worker. Further, the Proposed Rule states that control implemented by the business with respect to compliance with legal obligations, safety standards, or contractual or customer service standards may be indicative of control. While training and monitoring programs may reflect an exertion of control over the worker, the Proposed Rule’s suggestion that merely obligating a contractor to comply with applicable legal, safety or similar requirements is indicative of employee status could prove problematic for businesses using contractors to provide services in regulated industries, like transportation, or that require their subcontractors to adhere to the specifications in a general contract.
  • According to the Proposed Rule, if a worker provides services that are integral to the business (i.e., if the work performed is “critical, necessary or central” to the principal business of the recipient of those services), then the worker is more likely to be an employee, whereas workers who perform more peripheral work are more likely to be independent contractors. While this is a factor in some other legal tests concerning independent contractor status, such as the test applied by the Internal Revenue Service, it does not appear to be directly relevant to whether a worker is economically dependent on the business. Nevertheless, DOL’s commentary accompanying the Proposed Rule states that “such workers are more likely to be economically dependent on the employer because their work depends on the existence of the employer’s principal business, rather than their having an independent business that would exist with or without the employer.” In light of this factor, companies may need to reassess the types of services for which they engage contractors, particularly if they relate to operations.

The Potential Effect of the Proposed Rule

Once it becomes effective, the Proposed Rule will not only govern DOL’s own enforcement activities, but it will also likely impact the way courts interpret the FLSA. Courts are generally required to give some degree of deference to an agency’s interpretation of a statute which it administers; the Supreme Court has previously held that DOL regulations interpreting the FLSA which were issued through notice and comment rulemaking were entitled to the highest level of deference. Nevertheless, while agencies are free to change their existing policies, they must offer good reasons for doing so, and opponents may challenge DOL’s explanation for the Proposed Rule and the extent to which courts must defer to it. 

Given the regulatory and enforcement activity in this area, businesses are advised to reassess their use of and relationships with independent contractors, particularly businesses that implemented meaningful changes to their practices in response to, or in reliance on, the 2021 Rule. The Proposed Rule should be less immediately concerning to companies that operate in states with stricter independent contractor tests (such as California and Massachusetts, which employ the strict “ABC test”), as their contractor relationships are already subject to more stringent requirements.

We’re Here to Help

The Proposed Rule is subject to change before it is promulgated as a regulation, since it is subject to the notice and comment process. If adopted, the Proposed Rule may well face legal challenges. Nevertheless, businesses will want to consider how the Proposed Rule could affect their workforce if it is adopted as a final rule in the same or close to the same form. We will continue to monitor developments and are ready to assist employers as they navigate this changing landscape.