The Problem With Misclassifying Independent Contractors
As the economy improves, there has been an increased focus on the problem of independent contractor misclassification in the service sector (the part of the economy in which employees provide services and information, in contrast to producing manufactured goods, mining, or farming). Since August 2009, employment by staffing agencies has grown 41 percent, compared with just 6 percent for total employment. Jobs with staffing agencies account for 11 percent of the jobs gained since February 2010, when U.S. employment hit its low point. Subcontracted, outsourced, franchised, and other non-standard employment structures are prevalent in many of the service-sector industries experiencing the greatest growth, such as food preparation and service, healthcare, administrative services, cleaning, and transportation.
Silicon Valley Shares Some of the Blame
Silicon Valley has contributed to the swelling of the 1099 economy, with new startups employing the “digital middleman” model pioneered by companies like Uber and Airbnb springing up every day. These companies connect service-sector workers to people in need of services—from laundry (Washio) to package delivery (Shyp) to cleaning (Homejoy) to home-delivered meals (SpoonRocket). A recent study estimated that in 2013, venture capitalists invested $1.6 billion in tech startups providing services on demand. In the San Francisco Bay Area, it has become increasingly common to hear someone, when describing a new company say, “You know, it’s like Uber for ____.”
See also: Age Bias in Silicon Valley
One indication of the prevalence of classifying employees as independent contractors is the emergence of a new vocabulary: independent contractors are increasingly referred to as “1099ers” after the tax form on which they report their earnings (Form 1099-MISC, as opposed to Form W-2, on which employment earnings are reported), and the designation of an employee as an independent contractor is referred to as “1099ing” as in, “I was 1099’d.”
The growth of the 1099 economy has been accompanied by a surge in new lawsuits alleging that employers have misclassified service-sector employees, including a well-publicized lawsuit in which Uber drivers claim that the company purposefully misclassifies them.
How do you determine whether an employee has been misclassified as an independent contractor?
Under California law, all workers are presumed to be employees. An employer cannot change the legal status of an employee by requiring the employee to sign an independent contractor agreement or giving the employee a Form 1099 instead of a W-2.
In determining whether an employee has been misclassified, lawyers, judges, and government agencies closely examine the facts of the employment relationship and apply the law to the facts. In California, the rule of thumb for determining whether a 1099er is actually an employee is the “control test”: if the hiring entity has the right to control the manner and means by which tasks are performed and has the right to discharge the worker at will, then the worker likely is an employee. That said, the determination whether a worker may be classified as an independent contractor depends upon a number of factors, which are discussed in greater depth in our previous post: When is an Independent Contractor Actually an Employee?
Why does it matter whether an employee is classified as an independent contractor?
Whether a person hired as an independent contractor is properly classified as an employee matters for many reasons:
- Employees can hold their employers accountable for violations of wage and hour laws, such as those requiring employers to pay their employees for all hours worked, pay additional compensation for overtime, provide meal and rest breaks, and reimburse employees for work-related expenses.
- Employees are protected from discrimination and retaliation by their employers.
- Employees are entitled to family medical leave.
- Employees have the right to bargain collectively with their employers to improve their working conditions.
- Employees can go to the California Department of Labor Standards Enforcement (“DLSE”) to settle disputes with their employers, but independent contractors must file a lawsuit seeking to enforce their rights under their contracts.
- Employers are required to pay into social security, Medicare, and unemployment insurance on behalf of their employees, and deduct payroll taxes.
- Employers may exclude independent contractors from participation in employee benefit plans, such as group medical and pension plans, and from the computation of the number of employees for the purposes of the Affordable Care Act.
- Employers are required to maintain workers’ compensation insurance to cover their employees, and are liable for their employees’ work-related injuries.
- Employers who misclassify employees as independent contractors face stiff penalties from the LWDA and the IRS, and often are liable to the misclassified employees for unpaid overtime and unreimbursed expenses, among other things.
What does a typical California independent contractor agreement look like?
In the service sector, a typical independent contractor agreement will, at minimum, lay out the nature of the services to be performed under the agreement, the relationship between the parties to the agreement, and the terms of compensation. The agreement may also:
- Provide for reimbursement of certain expenses incurred by the contractor in performing services pursuant to the contract
- Specify that the contractor is not an employee of the company
- Specify that the contractor is not entitled to the benefits of employment, such as unemployment compensation, disability insurance, health insurance, worker’s compensation insurance, and paid vacation and sick leave
- Contain warranties related to the contractor’s skill and ability to perform the work
- Contain warranties related to any personnel the contractor will use to carry out services pursuant to the contract
- Specify that the contractor is free to perform the same or similar products and services to other clients, so long as doing so does not interfere with the contractor’s ability to fulfill the contractor’s obligations under the agreement
- Specify that the contractor may schedule his or her own time and provide the services at his or her own pace, subject to any deadlines specified in the agreement
- Contain provisions restricting the disclosure of confidential or proprietary information or materials the contractor may have access to while performing the services under the contract
It is important to keep in mind that signing a written independent contractor agreement does not make a person an independent contractor under the law. Instead, government agencies (such as the DLSE) and the courts will look at the interactions between the parties and the nature of the work performed to determine whether the relationship between the parties is actually an employer-employee relationship. If an independent contractor agreement contains provisions specifying the way in which the “contractor” is to perform the work under the contract and the means by which the contractor is to perform the work, the contract may itself be evidence of an employer-employee relationship.
Which types of service sector employees are frequently misclassified as independent contractors?
Recently filed cases suggest that independent contractor misclassification is prevalent across the service sector. A few examples follow.
Delivery, Taxi, and Livery Drivers
Many of the highest-profile cases involving independent contractor misclassification have been brought by drivers—both those who transport things and those who transport people. Drivers often are required to supply, maintain, and insure their own vehicles, incurring significant expenses.
- In their lawsuit against Uber, drivers allege that the company violated the law by requiring them to sign independent contractor driver agreements in order to avoid reimbursing their expenses and providing benefits, and by depriving drivers of the full value of their tips.
- Recently, in Alexander v. FedEx, the Ninth Circuit Court of Appeals held that drivers who delivered packages to customers were properly classified as employees, since they had to wear company uniforms, drive company-approved vehicles, groom themselves according to company appearance standards, and deliver specific packages to specific locations at specific times.
- Ayala v. Antelope Valley Newspapers, which recently was addressed by the California Supreme Court, involves a group of newspaper delivery persons who allege that the newspaper misclassified them as independent contractors.
Nurses, Caregivers, and Home Health Aids
The healthcare industry is also a target for independent contractor misclassification claims. Nurses, nursing home workers, home health aides, and other workers in the home health care industry are frequently paid for only a portion of the time they spend working, and then may suffer the added indignity of having to pay for supplies and travel expenses out of their own pocket. As a result, some of these workers wind up making less than the minimum wage.
- The Department of Labor is prosecuting a case against Nightingale Home Support & Care Inc. The lawsuit, which resulted from an investigation conducted by the department’s Wage and Hour Division, alleges that the company misclassified in-home supportive services and nursing care providers as independent contractors and willfully failed to pay them for all hours worked.
- A federal judge ordered a spa owner to pay back wages and damages to massage therapists at Redmond Herbal Spas, finding they had been misclassified as independent contractors. The company typically paid the therapists on a commission-only basis, resulting in violations of minimum wage and overtime laws.
Cleaning and Housekeeping Services
Janitors, housekeepers, and cleaning staff, many of whom are recent immigrants, are particularly vulnerable to misclassification. Given the already-low wages in this industry, misclassification frequently results in minimum wage violations.
- A court ordered an Illinois-based cleaning service, Super Maid LLC, to pay back wages and other damages because it had misclassified its cleaning staff as independent contractors. The company’s claim that the maids were independent contractors was proven false by actions the company took, including requiring maids to sign noncompete agreements and not allowing them to clean homes other than those assigned by Super Maid. The company intimidated and threatened workers with disciplinary actions and loss of pay for exceeding time limits for cleaning, and in many instances paid them less than the minimum wage for the hours they worked.
- The Department of Labor has sued a company that manages hotels for misclassifying housekeepers, attendants, and laundry staff it hired through a staffing agency as independent contractors. The housekeepers were paid by the room, and often were not paid minimum wage for the hours they worked.
- Last year, a $10 million settlement was reached in a class action lawsuit against CleanNet USA Inc., which allegedly misclassified custodians performing janitorial work as independent contractor “franchisees.” The lawsuit claimed that CleanNet induced class members to purchase cleaning franchises and required them to purchase general liability and workers’ compensation insurance for the benefit of CleanNet.
Misclassified topless dancers, strippers, and other workers in the adult entertainment industry not only are denied the protections of employment laws (including laws governing discrimination and harassment), but also frequently are forced to pay a fee or a percentage of their tips for opportunity to work at a club. As a result of misclassification, many of these workers are owed very large sums in unpaid wages and unreimbursed business expenses.
- Last year strippers employed by the Spearmint Rhino chain of clubs won an unprecedented $13 million settlement, the result of a class action suit filed in a federal court in California, Trauth v. Spearmint Rhino Companies Worldwide, Inc. The court ordered Spearmint Rhino to stop charging dancers “stage fees” for the right to work and to grant all dancers in their clubs employee status, ending the illegal practice of classifying dancers as independent contractors while also placing workplace demands on them that far exceed that legal status.
- In Stevenson v. Great American Dream, a Georgia court held that adult entertainers were misclassified as independent contractors when their employer set the standards for appropriate dress, dictated how they were to conduct themselves onstage and in the VIP room.
The above cases are just a few examples. Misclassification happens across the service sector, and beyond. To give just a few examples, cases have been brought on behalf of individuals working as directory assistance providers, customer service representatives, landscapers, restaurant workers, hairstylists, manicurists, consultants, painters, internet/phone/cable installers, security guards, electricians, emergency medical technicians, city workers, tutors, insurance agents, auto care workers, credit union workers, childcare providers, inspectors, and salespersons, as well as occupations outside the service sector, such as roughnecks (oil rig workers) and construction workers.
Because the inquiry whether a person is properly classified as an independent contractor is fact-specific, individuals who believe that they may have been misclassified as independent contractors should contact an attorney who specializes in employment law for help and advice. In light of the potential liability and tax consequences, companies, too, should review their independent contractor agreements with the help of an employment attorney.