Threatening Behavior — A Mental Health Disability? Quirky Question # 132
Quirky Question # 132:
One of our employees has been very belligerent of late. He has made comments to co-workers that were intimidating and frightening. Some of his co-workers have considered them to be threats of violence and have reported them to our HR group.
HR investigated, corroborated the accuracy of the allegations, and confronted the employee. He basically admitted making the statements, but attributes his behavior to some unspecified mental health disability. We plan to terminate his employment. Is this plan prudent?
Roy’s Analysis:
Your question is very interesting, implicating a number of fundamental aspects of the Americans With Disabilities Act (ADA) and the parallel state anti-discrimination statutes. Further, your question contains within it several issues that warrant your consideration. First, is your employee a “disabled” employee under the ADA? Second, what types of disability claims could be asserted by the employee if your company carries out its plan to terminate his employment? And third, what defenses would your company have to any such claims? Let’s examine each of those issues sequentially.
As noted above, the first question is perhaps the most fundamental – is your employee a “disabled” employee under the ADA? The ADA prohibits discrimination against a “qualified individual with a disability.” In turn, an individual has a “disability” under the ADA if one of three conditions are met: a) he has a physical or mental impairment that substantially limits one or more major life activities; b) he has a “record of” such an impairment; or c) he is “regarded as” having such an impairment.
Here, your employee might have a cognizable disability and might be able to structure his claims based on either on the assertion that he “has a mental impairment” or that he is “regarded as” having a mental impairment. Perhaps your employee is suffering from a mental or emotional disorder (e.g., severe depression or paranoia) that is affecting the way he interacts with his co-workers and is contributing to his threatening behavior. Even if your employee is not suffering from a physical or mental impairment, he nevertheless could assert that he is perceived as (or “regarded as”) someone with a disability. As you described in your question, co-workers complained that his behavior has been “belligerent,” “intimidating,” and “frightening,” and your HR group investigated the situation and corroborated the underlying facts. Arguably, then, he is regarded as an employee who has, charitably described, a “difficult personality.” Again, whether that problem is linked to a cognizable psychological problem can’t be ascertained from your question.
A corollary inquiry when evaluating whether your employee is disabled is – what “major life activity” is substantially limited by the impairment? Somewhat surprisingly, some plaintiffs have made the argument that their inability to interact appropriately with others is itself a “major life activity” under the ADA. Who knew? Other plaintiffs advance a somewhat broader concept that has gained traction in the courts, which is that the disability (be it physical or mental) affects the major life activities of “working or learning.” Regardless of the theory advanced with respect to the “major life function” involved, many courts analyzing these issues have skipped over this issue to assess other critical aspects of a disability claim.
The second basic question referenced above is what types of claims could your employee bring pursuant to the ADA. Essentially, there are three. Your employee could claim disparate treatment. He could contend that you failed to accommodate his disability. Or, depending on what he communicated and when he communicated it, he could claim retaliation. Let me touch briefly on each.
As to the disparate treatment claim, as I have stated in other Blog posts, the key to these types of claims is the concept of differential treatment. This leads to the question of whether you have had any other employees who have engaged in threatening or intimidating behavior and how your company responded in those situations. If you have addressed these kinds of situations in a consistent and balanced manner, adopting a response appropriate to the perceived risk, your company should not have to worry unduly about a disparate treatment claim. Keep in mind too that courts have emphasized that for employees to succeed on disparate treatment claims in disciplinary contexts, the other individuals against whom the comparison is being made must be comparable in “all material respects” (e.g., same type of job, same supervisor, comparable experience, comparable qualifications, same conduct, etc.). Needless to point out, these variables make it difficult for a plaintiff to pursue successfully a disparate treatment claim when it comes to an employer’s disciplinary response to unacceptable conduct.
Another common claim under the ADA is a failure to accommodate claim. It is not clear from your question whether this employee requested any type of accommodation or made any comments that put your company on notice that it needed to engage in the interactive process associated with disability claims. A separate question is whether any accommodation would even be possible, given the nature of the conduct involved here. This will depend on the nature of the job involved, the degree of interaction with co-workers and the public, and other factors bearing upon whether your company could do anything to mitigate the consequences of the intimidating behaviors.
The third type of claim is a potential retaliation claim. Here, I’ll simply reiterate my standard advice to my clients – do NOT convert a weak underlying claim of employment discrimination into a compelling retaliation claim. Time and time again, employers confronting weak and easily defensible discrimination claims take actions that are retaliatory. Then, even if the underlying discrimination claim is dismissed, the retaliation claim will likely survive.
Assuming that your employee institutes litigation and pursues a disability discrimination claim, your company should have a strong defense to the claim based on the employee’s conduct. If your company carries forward with the discharge it is planning as a result of the reasons you described above, your soon-to-be-ex-employee will have to demonstrate that these reasons are a pretext or cover-up for discrimination. This will be a tough hurdle for your former employee. Remember, to show pretext, a plaintiff “must show more than [defendant’s] decision was mistaken, ill considered or foolish, and as long as [the employer] honestly believes those reasons, pretext has not been shown.” See Hague v. Thompson Distributing Co., 436 F.3d 816, 823 (7th Cir. 2006).
Another interesting defense in the context of your question is the concept that under the ADA, an individual is not a qualified individual with a disability if he is a direct threat to himself or others. You may recall that there were a number of these kinds of cases, which arose in the early stages of the AIDS crisis. At that time, there were fewer effective medical treatments for individuals who were HIV positive and there was a high level of public anxiety about what initially was a nearly always a fatal disease. Therefore, cases involving HIV carriers worked their way through the legal system, often examining whether the job performed by the HIV infected employee created a risk for the employee himself/herself or others.
This same analytical framework has applicability to your situation, or any context where an employer is concerned by the risk of workplace violence. If your company can demonstrate (and you have the burden of persuasion on this point) that your employee poses a direct threat to himself or others, he ceases to be a qualified individual with a disability.
Yet a third compelling defense in a context like this is grounded on the distinction between a mental health disability and the behaviors linked to that disability. Think of this issue, for example, in the area of alcohol or drug dependency. Although an employer may have an obligation to accommodate an employee with alcoholism who is receiving treatment, an employer does not have to tolerate an employee who shows up at work under the influence of drugs or alcohol. Analogizing to the fact pattern you described, even assuming that: a) your employee had a cognizable mental health disability; b) that substantially impaired a major life activity; and c) requested an accommodation; your company still would not be obligated to tolerate the behavioral manifestations of his disability in the workplace.
In short, even if you discharged this employee and he sued your company for disability discrimination, it would appear that you would have several persuasive defenses. Of course, your company would not need to advance those defenses if the court concluded that your employee was not disabled under the ADA.
An interesting case that implicates many of the issues addressed above is Bodenstad v. County of Cook, et al., No.08-1450 (7th Cir. June 22, 2009). In Bodenstad, a physician/anesthesiologist at Cook County Hospital claimed that he was fired in violation of the ADA. After approximately nine years of employment with the hospital, Bodenstad was diagnosed with a cancerous lesion on his mouth. When discussing his own health and his fears about his cancer metastasizing, he told a friend that if his health deteriorated, he was going to kill his supervisor and several other physicians. His friend was sufficiently concerned about these comments that she shared them with the Chicago police and the FBI. The police felt that the threats were credible.
The hospital’s initial response was to suspend Bodenstad, with pay, pending a psychiatric evaluation. Although Bodenstad first refused to submit to an examination, he later agreed to obtain treatment at the Professional Renewal Center (PRC), where he completed a five-day multi-disciplinary assessment. The PRC assessment was that Bodenstad suffered from paranoid and narcissistic personality features and “occupational and interpersonal stressors.” Bodenstad agreed to be treated at the PRC for three additional months, at the end of which Bodenstad was directed to continue to treat with a psychiatrist, a directive he disregarded. Not long thereafter, the hospital conducted a hearing involving Bodenstad’s behavior, after which the hospital decided to terminate his employment. After being fired, Bodenstad sued.
The federal district court granted the defendants’ motion for summary judgment and the case was appealed to the Seventh Circuit. The appellate court affirmed the decision. Even assuming that “interacting with others” constituted a “major life activity” and that Bodenstad was “substantially limited” in this activity, the Court of Appeals still found that Bodenstad could not establish a viable ADA claim. Essentially, the appellate court concluded that the hospital’s reasons for discharging the physician were legitimate and that Bodenstad could not demonstrate that the reasons articulated by the defendant for its decision were pretextual. As the court emphasized, “summary judgment was . . . appropriate because Cook County presented undisputed evidence that it fired Bodenstad for threatening his co-workers.” The court also pointed out that “there is no legal obligation to ‘accommodate’ conduct, as opposed to a disability.” The appellate court noted, “The law is well settled that the ADA is not violated when an employer discharges an individual based upon the employee’s misconduct, even if the misconduct is related to a disability.”
Finally, in the area of employment law, employers often are forced to evaluate competing risks. Here, the competing risks are litigation by a belligerent, intimidating, threatening employee who is terrifying his co-workers, or litigation by a co-worker injured by that person, or worse yet, by the co-worker’s estate in the event of his or her death. Which lawsuit would your company rather defend? As I’ve stressed in other Blog posts involving risks of workplace violence, employers cannot be responsible for risks of which they were unaware, but known risks cannot be ignored. Assuming that your investigation corroborated the basic underlying facts and your best judgment is that your employee poses a risk of violence to his co-workers, I think your path is clear.
Arbitration Waiver, Quirky Question # 131
Quirky Question # 131:
We have employment agreements with our employees that contain mandatory arbitration provisions. Recently, one of our senior executives departed and joined a competitor. This arguably violated his non-competition agreement, though that involves issues unrelated to my present inquiry.
We filed a lawsuit against our executive alleging breach of contract and other wrongful conduct. At the same time we filed our Complaint, we filed a Motion for Preliminary Injunction and a Motion to Compel Arbitration. We decided not to pursue the Motion to Compel Arbitration, electing instead to see what kind of result we could first obtain from the federal court on our preliminary injunction motion. Our thinking was that if we could get a positive outcome from the federal judge on the injunction motion, we could keep the case in federal court and disregard the arbitration forum. Unfortunately, the federal judge ruled against us on our motion for injunctive relief, so our former employee continues to compete with us.
We now are trying to schedule our motion to compel arbitration. Our ex-employee’s attorney, however, claims that we “waived” our right to pursue our claims in arbitration. How can that be? We filed our Motion to Compel Arbitration at the beginning of the case, some four months ago, so our ex-employee was on notice all along regarding our desire to arbitrate. Moreover, shouldn’t the arbitrator decide the issue of whether we “waived” our right to pursue arbitration?
Roy’s Analysis:
You ask whether your company’s conduct could be construed as a waiver of your company’s right to arbitrate. Let’s start with the basics. To establish an enforceable arbitration agreement, three conditions must be satisfied: a) a written agreement to arbitrate must exist; b) the dispute must fall within the scope of the arbitration agreement; and c) the party seeking arbitration must not have waived its right to arbitrate.
You stated that your company uses employment agreements that contain arbitration provisions, so the first requirement is satisfied. Presumably, your former employee’s competition with your company falls within the scope of your arbitration provision. So, the enforceability of the arbitration agreement will turn on whether your organization has waived its right to arbitrate.
Your last question was: “Who decides the issue of waiver – the court or the arbitrator?” This seemingly straightforward question is not quite as easy as one might assume, since the decision-maker on “waiver” is dependent on the type of waiver that is alleged. When waiver claims are based on the argument that critical evidence has been lost due to the delay of the other party, the arbitrator decides the issue. This type of waiver is referred to as “laches” or “estoppel” waiver. (See, e.g., Parler vs. KFC Corp., 529 F. Supp. 2d 1009, 1012 (D. Minn. 2009)).
When the waiver argument is based on actions involving the initial pursuit of claims in court, however, a judge, not an arbitrator, decides whether waiver has occurred. As the District Court recently summarized in the Parler decision, “courts generally decide whether a party has waived its right to arbitrate by ‘actively participat[ing] in a lawsuit or tak[ing] other actions inconsistent with the right to arbitration.’” Id. (internal citations omitted). In short, for the type of waiver involved in the fact pattern you described, the court, not the arbitrator, decides the waiver issue.
Courts focus on three questions when assessing this type of waiver: 1) did the party seeking arbitration know of an existing right to arbitrate; 2) did the party act inconsistently with that right; and 3) did those inconsistent actions prejudice the other party? That is the analytical framework that should be applied to your fact situation.
As you note, your company included an arbitration obligation. Moreover, your firm clearly was aware of that provision (you pointed out that you filed a Motion to Compel Arbitration at the same time you filed the Complaint). So the first question clearly would be answered in the affirmative.
The second inquiry – whether your company acted inconsistently with your right to arbitrate – will be the legal battleground on this issue. As the courts have pointed out, this type of waiver is evaluated from the “totality of the circumstances” and must be assessed “in context.” There are no per se rules dictating the way this issue is assessed. So, courts have the opportunity to look at any and all factors they consider relevant to the waiver issue.
Further, courts have recognized that a party to an arbitration agreement “acts inconsistently” with its right to arbitrate when it: delays assertion of its right to arbitrate; actually participates in a lawsuit; substantially invokes the litigation machinery; or takes other actions inconsistent with the right to arbitrate. These are the standards that will be applied to your company’s conduct.
In support of your argument that your company has not waived its arbitration rights, you will be able to point out that you filed your Motion to Compel Arbitration simultaneously with your filing of your Complaint. Arguably, that action put your employee on notice of your intent to arbitrate.
The other facts you describe, however, are more problematic for you. You note, for example, that you filed your Motion to Compel Arbitration. But, apparently, you did not serve your arbitration motion on the opposing party, the action that starts the clock running on when the opposing side must respond to a pending motion. Even worse, your company took no steps to pursue its Motion to Compel Arbitration. Juxtapose that decision with your effort to pursue your Motion for a Preliminary Injunction. In the period since the filing of your Complaint, you have been able to schedule, brief and argue your Preliminary Injunction Motion. Presumably, you could have done the same with Motion to Compel Arbitration had you been serious about pursuing that motion.
You also state, “We decided not to pursue the Motion to Compel Arbitration, electing instead to see what kind of result we could first obtain from the federal court on our preliminary injunction motion. Our thinking was that if we could get a positive outcome from the federal judge on the injunction motion, we could keep the case in federal court and disregard the arbitration forum.”
In sum, as you acknowledge, you made a conscious decision not to pursue arbitration initially, hoping first to obtain a favorable ruling from the federal court on your preliminary injunction motion. You also point out that had your company been able to obtain a positive outcome from the federal court on your injunction motion, you would have elected to forego arbitration altogether.
These facts are particularly problematic for you. As a number of courts have noted, filing a case in federal court and “seeking arbitration only after the litigation goes badly is acting inconsistently with the right to arbitrate.” See, e.g., Parler, 529 F. Supp. 2nd at 1015. As the Eighth Circuit emphasized in a recent decision, the defendant “wanted to see how the case was going to go in federal district court before deciding whether it would be better off there or in arbitration. [Defendant] wanted to play ‘heads I win, tails you lose’ [which] is the worst possible reason for failing to move for arbitration sooner than it did.” Hooper v. Advance America Cash Advance Centers of Missouri, Inc., No. 08-3252 (December 16, 2009).
The bottom line is that your company seemingly engaged in the very conduct that a number of courts have decried, first testing the waters in a judicial forum and only after suffering a setback, attempting to pursue the claim in arbitration. Whether your company’s efforts to pursue your federal court action constituted a waiver of your right to pursue claims in arbitration will be for the court to decide but, as discussed above, some of the facts you revealed are problematic.
Now, some readers may be wondering whether I’ve missed an important point, specifically, the idea that your federal court lawsuit was only a Motion for a Preliminary Injunction, arguably intended to preserve the status quo pending a merits resolution of the underlying dispute. With regard to this issue, I’d make several quick observations. First, whether a company has the right to pursue an injunction motion in court (state or federal) in advance of an arbitration may depend, at least in part, on how the arbitration provision in the employment agreement is drafted. Some arbitration provisions specifically state that a company may pursue an injunction in court without prejudice to the right to later pursue arbitration. Other arbitration provisions do not. As to the latter group of contracts, the federal circuits are divided on whether a company may first seek an injunction in court. Second, note that a company could pursue an injunction in an arbitral forum. Third, as noted above, the time lag between the employee’s departure and the filing of the Complaint and injunction motion may bear upon the court’s analysis. How did the status quo change since the employee’s departure?
Finally, the third part of the waiver analysis is whether the opposing party would be prejudiced by requiring arbitration. Here, too, there is a split among the circuit courts, with some minimizing the significance of this variable. But, for those courts that do examine this issue, they look at the consequences for the adverse party, focusing on: a) how much has the party expended on the litigation in the period preceding the motion to compel arbitration; b) how much of the work already conducted would have to be repeated in the arbitration; and c) what costs would be associated with repeating some or all of the work in the arbitral forum. Some courts also factor in the investment by the judiciary in the pre-arbitration period, with some sensitivity to the issue of wasting not just parties’, but judicial, resources as well.
As stated by the Eighth Circuit just one month ago in the Hooper case, a party must do “all it could reasonably have been expected to do to make the earliest feasible determination of whether to proceed in arbitration.” It does not appear to me that your company did so, a fact that enhances your opponent’s waiver argument.
Classification of Independent Contractors, Quirky Question # 130
[Readers: Quirky Question # 130 was posed to my colleague, Jessie Collings. Jessie's analysis is set forth below. If you have any questions about this analysis, please do not hesitate to contact Jessie. She can be reached at collings.jessie@dorsey.com or at 612.492.6128. Additional information about Jessie is available at http://www.dorsey.com/collings_jessie/. Regards, Roy]
Quirky Question # 130:
We’ve heard that classification of workers as “independent contractors” instead of “employees” has been coming under increased scrutiny by courts and regulators. Since our company works with a number of independent contractors, we wonder if we should be concerned. Do you have any guidance?
Jessie‘s Analysis:
The short answer is: yes, the issue is getting increased attention, and there indeed may be cause for concern.
In truth, whether workers are appropriately classified as “independent contractors,” or should, instead, have been deemed “employees” by the companies for whom they work is an issue that has been the subject of considerable litigation for years. But in this economic climate, “misclassification” of workers has become a hot button issue, in large part because federal and state governments stand to lose considerable income via mandatory tax withholdings where workers are inappropriately classified as independent contractors. In fact, Senator John Kerry of Massachusetts introduced legislation in mid-December 2009 that would amend the Internal Revenue Code in an effort to reduce the “misclassification” of workers for federal tax purposes. Similar legislation was introduced in July 2009 by Senator Jim McDermott of Washington. In August 2009 the United States Government Accountability Office (“GAO”) issued a report on misclassification of workers, in which the GAO offered a number of suggestions for reducing the incidence of “misclassification” of workers.
What is the difference between an “independent contractor” and an “employee”?
Although courts and federal and state agencies approach the question of whether a worker is an “independent contractor” or an “employee” somewhat differently depending upon the applicable law at issue, the crux of the inquiry is generally the same: how much control does the purported “employer” have over the worker in question? The more “control” an entity exerts over the worker, the more likely the worker will be deemed an “employee” under the relevant law. In assessing whether an entity has sufficient “control” over an individual to render that individual an “employee” under the applicable law, courts and agencies employ slightly varied, multi-factored, fact-specific inquiries.
A. Determination of Worker Status Under Federal Income Tax Principles
Under federal income tax principles, a worker constitutes an “employee” when the party for whom services are performed has “the right to control and direct” the worker “not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.” Rev. Rul. 87-41, 1987-1 C.B. 269 (quoting language from Treas. Reg. §§ 31.3121(d)-1(c); 31.3306(i)-1, and 31.3401(c)-1). For purposes of this test, the employer need not “actually direct or control the manner in which the services are performed,” provided that the employer “has the right to do so.” Id. If a worker constitutes an employee under the test, the description or designation of the relationship by the parties as anything other than that of employer and employee is immaterial. Id.
In 1987, the Internal Revenue Service (“IRS”) issued Revenue Ruling 87-41, which identified 20 factors that help to indicate whether “sufficient control is present to establish an employer employee relationship.” It cautioned that the 20 factors were not equally-weighted criteria to be assessed in a quantitative manner, but offered little guidance in applying the factors. Subsequently, however, the IRS released training materials for its examiners that helpfully organize and condense the factors from Revenue Ruling 87-41. See Internal Revenue Service, Independent Contractor or Employee? Training Materials, Training 3320-102 (Oct. 1996) (“IRS Memo”). The IRS Memo incorporated the latest court decisions and authorities in arranging the factors and discussing the weight and significance of each factor. Based on the IRS Memo, the determination of employee status turns on three main considerations: behavioral control, economic control and the relationship of the parties.
1. Behavioral Control Factors (indicating Employee status). Behavioral control of how the work is performed is the central element of the employee status test.
· Instructions on when, where and how to perform the work.
· Training with respect to the methods or procedures of the work.
2. Financial Control Factors (indicating Independent Contract status). Control over the means and details of the business aspects of how the worker performs services can be as important as express control over work processes.
· Significant Investment.
· Business/Travel Expenses.
· Services Available to Market.
· Method of Reimbursement.
· Realization of Profit or Loss.
3. Relationship of the Parties. The following factors indicate the intent of the parties regarding control of the worker, which is less important than the behavioral control and economic control factors, but can be important in close situations.
· Intent of the Parties Shown in Written Contract, Tax Reporting, Employee Benefits.
· Discharge/Termination Rights.
· Permanency of the Relationship.
· Regular Business Activity.
B. Determination of Worker Status Under Certain Case Law.
A number of federal civil rights statutes, such as Title VII of the Civil Rights Act of 1964, as amended (“Title VII”), the Age Discrimination in Employment Act (“ADEA”), the Americans with Disabilities Act (“ADA”), and the Fair Labor Standards Act (“FLSA”) protect only employees. To determine whether an individual is an employee protected by such anti-discrimination laws, some courts have looked to the IRS’s 20-Factor Test set forth above. Other courts have applied the common-law agency test set forth by the United States Supreme Court in Nationwide Mutual Insurance Company v. Darden, 503 U.S. 318, 112 S. Ct. 1344 (1992). See, e.g., Wortham v. American Family Ins., 385 F.3d 1139, 1140-41 (8th Cir. 2004) (applying the Darden test); Weary v. Cochran, 377 F.3d 522, 525 (6th Cir. 2004) (same); Barnhart v. N.Y. Life Ins. Co., 141 F.3d 1310, 1313 (9th Cir. 1998) (same). In Darden, the Supreme Court was examining certain individuals’ claims that they were employees protected by Employee Retirement in Security Act (“ERISA”). The Court held that, absent a more specific definition, the term “employee” in federal employment statutes should be defined in accordance with the common law “right to control” test. As such, in Darden the Supreme Court considered the following twelve factors to determine whether an individual qualifies as a common law employee:
(1) The alleged employer’s right to control manner and means by which the individual’s work is accomplished;
(2) The skill required to perform the individual’s duties;
(3) The source of tools and instrumentalities needed to perform the duties;
(4) The location where work is performed;
(5) The duration of relationship of parties – a shorter relationship indicating lack of an employer/employee relationship;
(6) The alleged employer’s right (or lack thereof) to assign additional projects;
(7) The individual’s discretion over when and how long to work;
(8) The method of payment;
(9) The individual’s role in hiring and paying assistants;
(10) Whether the work is part of alleged employer’s regular business;
(11) Whether “employee benefits” are provided; and
(12) The tax treatment of the individual.
Darden, 503 U.S. 318, 323-24, 112 S. Ct. 1344. As with the IRS’s 20 Factor Test, described above, the crux of the question is whether the purported employer exerts sufficient control over the manner and means by which the alleged employee performs his or her duties for the Company; the more control exerted, the more likely it is that a court will find the existence of an employer/employee relationship.
Another, similar test used by courts to determine whether an individual is an employee subject to the protections of various employment laws, is the “common law hybrid employment test,” which combines the economic realities of the working situation and the common law agency test set forth in Darden. See, e.g., Wilde v. County of Kandioohi, 15 F.3d 103, 105 (8th Cir. 1994); Cobb v. Sun Papers, 673 F.2d 337, 339 (11th Cir.), cert. denied, 459 U.S. 874 (1982). In these cases, courts again consider, and place a good deal of importance upon, the extent of the employer’s right to control the means and manner of the worker’s performance. However, the courts also place emphasis on the economic realities of the situation, and consider other factors such as: (1) whether the alleged employer or the worker furnishes equipment used and place of work; (2) length of time during which the individual has worked; (3) the method of payment; and (4) whether the work is an integral part of the alleged employer’s business. See, e.g., Lopez v. Johnson, 333 F.3d 959 (9th Cir. 2003); Trainor v. Apollo Metal Specialities, Inc., 318 F.3d 976 (10th Cir. 2002).
What are the risks if my workers are deemed to have been “misclassified” as independent contractors?
To put this issue in its proper perspective, set forth below are some examples of the negative consequences that may result in the event that a company’s “independent contractors” are deemed “employees” by a court or agency.
Federal Tax Consequences: If an employer has misclassified employees as independent contractors, it can be held liable for the total amount of employment taxes that should have been withheld from wages paid to the workers. This includes the total amount of federal income tax that should have been withheld (and state income tax, if applicable) and both the employer and employee shares of FICA (which are equal to 15.3% of wages up to the FICA wage base, which is currently $106,800). An employer can be relieved of liability for federal income tax withholding to the extent that it can show that the worker actually reported the income and paid the income tax attributable to it.
At present, there is some comfort on this last point – but that comfort may be short-lived. Under Section 530 of the Revenue Act of 1978, employers who misclassify employees as independent contractors may be relieved of liability (and may continue for future periods to treat such workers as independent contractors without liability) if they meet certain requirements. The basic requirements for Section 530 relief are: (1) the employer must have filed all federal tax returns on a basis consistent with the treatment of the worker as not being an employee (normally, this means that the employer must have filed Forms 1099), (2) the employer must have treated individuals in substantially similar positions to that of the worker as independent contractors, and (3) the employer must have a “reasonable basis” for having treated the worker as other than an employee. “Reasonable basis” is defined as including (but not limited to) one of the following: (1) legal authority such as a judicial precedent, a published tax ruling, or a private letter ruling addressed to the employer; (2) a past audit by the Internal Revenue Service in which no assessment was made attributable to the treatment (for employment tax purposes) of individuals holding positions substantially similar to the position held by the workers in question; (3) a long-standing recognized practice of a significant segment of the industry in which the worker is engaged. The employer is also free to try to establish another “reasonable basis” for its classification. Section 530 relief does not apply in the case of a worker who provides services as “an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work.”
However, one of the proposals identified by the GAO for a means to address “misclassification” of workers as independent contractors is to revise Section 530 to permit fewer positions to qualify for the exception, and Senator Kerry of Massachusetts introduced a Bill in December of last year that would do just that. The proposed legislation, entitled “The Taxpayer Responsibility, Accountability, and Consistency Act of 2009” (S 2882.IS), revises Section 530 such that the definition of “reasonable basis” is more limited, and as such, the “530 safe harbor” would be available in fewer circumstances. Time will tell the fate of the proposed legislation.
Vulnerability to Discrimination and Related Claims Under Various Employment Statutes: As explained above, many federal civil rights statutes, such as Title VII, the ADEA the ADA, and the FMLA apply only to employees. Thus, if an individual who is not an employee brings a cause of action against an employer under any one of these statutes, that cause of action can be addressed by a motion to dismiss or motion for summary judgment based upon an argument that he or she is not an “employee,” and therefore, is not subject to the protections of the relevant statute. If, on the other hand, the individual is an employee (or even has a good argument that he or she is an employee), the company will be forced to delve much further into the underlying facts surrounding the individual’s claim. It is worth noting that some state analogues to the federal antidiscrimination statutes have a looser definition of “employee,” such that companies may be seen as the employer just because it pays the individual for providing services.
Vulnerability to Claims of Violation of the FLSA: Likewise, the FLSA protects only employees. If individuals are held to be the company’s employees under the FLSA, they will be able to maintain claims against the company for violation of the FLSA for, for example, failure to pay requisite overtime or meet standard minimum wage requirements. In addition, the GAO has proposed that a separate provision be added to the FLSA, making the misclassification of workers its own, separate violation of the Act.
Possibility that Individuals will be Held to be Entitled to Benefits: If an individual is held to be an employee, he or she may be entitled to benefits conferred by the company upon its employees. For example, if the company has any incentive compensation plans that apply to particular “employees,” an independent contractor held to be a “common law employee” may be able to argue that he or she is entitled to the benefits conferred under that incentive compensation plan, depending upon the language of the plan at issue.
What do I do now?
Given the current legislative and economic climate, now is a perfect time to re-examine the status of those workers your company has classified as “independent contractors.” The factors used by the IRS as well as the common law tests employed by courts, described above, should help guide your analysis. Pay particular attention to the requirements you impose upon your independent contractors and delve deeply to assess whether those requirements are necessary and appropriate.
California Wage and Hour Issues, Quirky Question # 128
[Readers: Our "First Wednesday" of the month provides us another West Coast Quirky Question. This inquiry was posed to my colleague, Joel O'Malley, who works out of our Minneapolis office but who is licensed in both Minnesota and California. If you have any questions about Joel's analysis, don't hesitate to contact him at 612.492.6727, or via email at O'Malley.Joel@dorsey.com. Additional information regarding Joel is available at: http://www.dorsey.com/omalley_joel/. Regards, Roy]
Quirky Question # 128:
I work for a California employer with nonexempt retail employees who earn commissions on their sales. We have been sued for failing to provide our employees with meal and rest breaks. I understand the company may be liable to each employee for one hour of pay when a break was not provided. The class action complaint against us, however, alleges the one hour of pay is based on each employee’s rate after incorporating his/her earned commissions, and that for days in which a missed meal and rest break occurred, the employee is owed two hours of pay. Is that correct?
Joel’s Analysis:
California wage and hour litigation is a growth industry right now. Like you, employers are more frequently becoming defendants in class actions alleging violations of California’s complicated and restrictive wage and hour laws. Notwithstanding the volume of litigation, however, many fundamental questions about how California’s Labor Code applies remain unanswered. You present two such questions. While California courts have largely yet to provide direct answers to your questions, an analysis of the Labor Code and the relevant cases that do exist provides a good indication of where courts might come down.
Let’s first tackle the question about double recovery for meal and rest period violations. The complaint against you alleges your employees are entitled to one hour of wages for each meal period violation and, in addition, one hour of wages for each rest break violation, even when those violations occur on the same day. There does not appear to be any direct support under California state law for this request. To the contrary, the statutory language and assumptions made by the courts appears to support an argument that only one hour of pay is due for each day, regardless the violations.
The controlling statute regarding the provision of meal and rest periods in California provides, in relevant part:
If an employer fails to provide an employee a meal period or rest period in accordance with an applicable order of the Industrial Welfare Commission, the employer shall pay the employee one additional hour of pay at the employee’s regular rate of compensation for each work day that the meal or rest period is not provided.
Cal. Labor Code § 226.7(b) (emphasis added). The statute suggests the one hour of additional wages is calculated not by counting the number of meal period violations and number of rest period violations; rather, it is calculated by counting the number of work days on which some violation occurs. Thus, under the terms of the statute, multiple violations in a single day (e.g., being denied both a morning and afternoon rest period, or both a rest period and a meal period) arguably should result in only one additional hour of compensation for the employee.
California courts, however, have not expressly endorsed this conclusion. But, the California Supreme Court appears to accept this analysis. In Murphy v. Kenneth Cole Prods., Inc., 40 Cal. 4th 1094, 1112 (2007), the court determined that the one hour of pay provided in § 226.7(b) constituted a wage, not a penalty, for purposes of determining the applicable statute of limitations. As part of its discussion, the court summarized the defendant’s argument that the additional hour of pay was a penalty “because it is imposed without reference to actual damage, since an hour of pay is owed whether the employee has missed an unpaid 30-minute meal period, two paid 10-minute rest periods, or some combination thereof.” Id. at 1112. The Murphy court did not question the foundation for the defendant’s argument; rather, it held the statute establishes a set amount of compensation because damages are obscure and difficult to prove. Id. at 1113-14.
The California Supreme Court recently reaffirmed this assumption. In Arias v. Superior Court, 46 Cal. 4th 969, 987 (2009), the court cited Murphy for the proposition that the remedy for a § 226.7 violation is “one additional hour of pay.” Federal courts also appear to be in agreement. See Thomas v. Home Depot USA Inc., 527 F. Supp. 2d 1003, 1008 (N.D. Cal. 2007) (stating that Labor Code § 226.7 “provides for an additional hour of pay for each day that an employer fails to provide an employee a meal or rest period”); Corder v. Houston’s Rests., Inc., 424 F. Supp. 2d 1205, 1207 (C.D. Cal. 2006) (stating that “the plain wording of [§ 226.7] is clear that an employer is liable per work day, rather than per break not provided”).
There is some contrary authority, though upon close analysis, it does not appear sound. In a federal decision from the Central District of California, Marlo v. United Parcel Service, Inc., 2009 WL 1258491, at *6-7 (C.D. Cal. May 5, 2009), the court held that one hour of pay was due both for rest break and meal break violations, even when those violations occurred on the same work day. The court’s sole reason for its holding was that liability per work day rather that per violation would create the incentive for employers to require an employee who has missed a ten-minute morning rest break to also miss the lunch period. The court then went on to hold that, under its interpretation, “if more than one rest period violation occurs in a single work day but no meal period violations occur, [an employee] may only recover one additional hour of pay for all of the rest period violations combined; likewise, if more than one meal period violation occurs in a single work day but no rest period violations occur on that day, [an employee] may only recover one additional hour of pay for all of the meal period violations combined.” Id. at *7.
Strangely, this holding is directly contrary to the rationale the court used to justify its per violation rather that per work day interpretation. That is, if an employer would be encouraged to require an employee who has missed a ten-minute morning rest break also to miss the lunch period, the employer would have just as much incentive to force that employee to miss subsequent rest periods. But under the court’s rule, two missed rest periods results in one additional hour of pay. Based on this analytical flaw, I would argue a plaintiff’s attorney would have a difficult time relying on Marlo over the other authorities cited above to request multiple hours of wages for days on which meal and rest periods were not provided.
So, let’s assume one additional hour of pay is owed for each work day a violation occurs. Your next question, to which we now turn, asks what rate of pay applies to this additional hour of pay. The complaint against you claims the hour of pay must include not only the employee’s straight time hourly compensation, but also a pro-rated amount accounting for the employee’s other earnings during the relevant pay period, including commissions, bonuses, and spiffs. The claim essentially is that the additional hour of pay should be based on the employee’s “regular rate of pay,” the rate used for calculation of overtime compensation. Like your other question, there is little direct authority on point. I believe, however, a good argument can be made that the straight time rate, not the regular rate, should be used.
Again, the meal and rest period statute provides, in relevant part:
If an employer fails to provide an employee a meal period or rest period in accordance with an applicable order of the Industrial Welfare Commission, the employer shall pay the employee one additional hour of pay at the employee’s regular rate of compensation for each work day that the meal or rest period is not provided.
Cal. Labor Code § 226.7(b) (emphasis added).
The statute does not define “regular rate of compensation.” Plaintiff appears to believe the “regular rate of pay” definition used for purposes of calculating overtime premium pay, see Labor Code § 510(a), which may include certain bonuses or commissions, also applies to the “regular rate of compensation” used to determine meal and rest break violation compensation. I do not believe this is supportable.
Although “regular rate of pay” is not defined in the Labor Code, it is a defined term by adoption of the Federal “regular rate” definition found at 29 U.S.C. § 207(e). See DLSE Enforcement Manual § 49.1.2. The California Legislature chose not to use that same term for purposes of meal and rest break violations. One must assume the Legislature chooses the words in its enactments with purpose, and the fact “regular rate of compensation” is different than the defined term “regular rate of pay” must mean something.
The difference between the phrases flows from the different purposes of overtime premium pay, on one hand, and compensation due for meal or rest break violations, on the other. For the former, the money is designed to pay an employee for time spent working longer than a statutory maximum; the premium pay is based directly on the money the employee actually earned during the actual work time. See Murphy, 40 Cal. 4th 1109 (overtime’s “central purpose is to compensate employees for their time”). For the latter, however, the award is designed to compensate an employee for time the employee had a right not to work. See id. at 1103-04. Because it is meant to compensate non-working time, the compensation is not tied to any tangible money the employee actually earned during that time – because there is no corresponding time worked.
I admit this is a technical distinction, but one I think is valid. Thus, I would argue that any violations for meal or rest breaks should be compensated based on the employee’s straight time rate of compensation, not to include additional forms of pay that may be earned during actual work time, such as the commissions your retail employees may earn.
In the end, what your questions seem to highlight is the need for defense counsel to craft thoughtful arguments in what remains a heavily litigated, though as yet unsettled, area of law.
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