“Long Term” Independent Contractors, Quirky Question # 86

Quirky Question # 86:

We run an insurance company.  Some members of our workforce are employees; some are independent contractors.  Admittedly, some of our independent contractors have held this status for some time.

We don’t pay our independent contractors overtime for their efforts – we really don’t even know how many hours they put in.  I’ve heard some rumors that some of our independent contractors are unhappy about this arrangement and are talking about suing us for unpaid overtime.  Does this present any risks to us?

Dorsey’s Analysis:

Many years ago, I was at lunch with a client. We were generally discussing the client’s business and various challenges the client was confronting. Near the end of the lunch, the client observed, “We don’t pay our employees overtime. Is that a problem?” Not fully comprehending the comment that just had been made, I stated that the client did not need to pay its “exempt” employees overtime compensation, so it should not worry about that issue. The client corrected me and noted, “We don’t pay anyone overtime. We don’t believe that overtime is consistent with our company’s culture. We do, however, pay employees substantial bonuses based, in part, on how hard they work during the year.” I did my best not to choke on my food, to maintain my composure, and to calmly explain to the client that it did not have the right to opt out of a federal statute – the Fair Labor Standards Act (FLSA) – that had been in existence since the 1930s. Likewise, I advised the client that it was facing substantial exposure for unpaid overtime (OT) compensation, with the added risk that the base pay on which the OT compensation would be calculated likely would include the “bonuses” paid at year-end to compensate its “hard-working” employees.

As the phrase goes, “That was then, this is now.” The FLSA currently is the source of more employment litigation, and more potential exposure, than almost any other employment statute. Whereas a decade ago we were able to change the client’s policies, adopt a new compensation plan based on exempt and non-exempt employee status, and avoid litigation altogether, such an outcome would be extremely unlikely today. Plaintiffs’ counsel have figured out that the FLSA can work for them like a bank (without any toxic assets). Seven-, eight- and even nine-figure judgments and settlements are reported regularly based on a variety of claims ranging from misclassifying employees (exempt vs. non-exempt), failing to pay OT comp, failing to provide appropriate meal and rest breaks, failing to compensate employees for donning and doffing required safety gear, failing to compensate employees for travel time, etc.

So, in response to your question about whether you are confronting any risks, the answer is, “Most assuredly.” The key question implicit in the facts you describe is whether your “independent contractors” are truly “independent contractors” or whether they more realistically could (or should) be characterized as “employees.” This is the central issue on which your company’s potential liability is likely to turn. Unfortunately, there are no facts in your question that would enable me to offer many meaningful insights into your situation, other than your observation that many of your independent contractors have held that status for a protracted time period. Therefore, let me analyze your situation somewhat more generally.

The FLSA applies to employees. (Note, too, that many states have wage and hour statutes that also may present risks to your company; addressing those parallel state statutes is beyond the scope of my comments here.) The FLSA does not apply to independent contractors. Consequently, the determination of whether an individual working for your insurance company is an employee or an independent contract is the initial, fundamental inquiry.

The relatively recent case of Hopkins vs. Cornerstone America, et al., No. 07-10952 (5th Cir. October 13, 2008), is an illustrative example of how courts may evaluate this issue. In Hopkins, 14 former “sales leaders” sued their employer for unpaid overtime compensation under the FLSA. The defendant insurance companies (a group of inter-related entities) argued that these individuals all were independent contractors not entitled to the protections and benefits of the FLSA. The trial court perceived the situation rather differently, granting the plaintiff group summary judgment on the issue of whether they were employees. In other words, even assuming all of the facts (and inferences from those facts) were as the defendants alleged, defendants still lost on this issue. The Fifth Circuit granted the defendants’ request for interlocutory appeal. Because the appellate court was reviewing a summary judgment motion, it evaluated the issue de novo, that is, without giving any deference to the decision of the court below.

The Fifth Circuit reached the same conclusion as the trial court. Despite the company’s characterization of the 14 sales leaders as “independent contractors,” the court found that for FLSA purposes they were “employees.”

The appellate court began its analysis by citing to a 1992 Supreme Court decision, Nationwide Mutual Ins. v. Darden, which emphasized the FLSA “stretches the meaning of ‘employee’ to cover some parties who would not qualify as such under a strict application of traditional agency law principles.” The Fifth Circuit then applied the “economic realities test” – whether the worker is economically dependent on the alleged employer or is instead in business for himself — to determine whether these workers were independent contractors or employees.

Under the Fifth Circuit’s formulation of this test [other jurisdictions have somewhat different standards], the court is to evaluate five non-exhaustive factors: a) the degree of control exercised by the alleged employer; b) the extent of the relative investments of the worker and the alleged employer; c) the degree to which the worker’s opportunity for profit or loss is determined by the alleged employer; d) the skill and initiative required in performing the job; and e) the permanency of the relationship. As the court pointed out, no single factor is determinative.

Analyzing the relationship between the company and its 14 sales leaders on the basis of these criteria, the appellate court found that every factor supported the conclusion that these individuals were, in fact, employees, regardless of the label given them by defendants. For example, with respect to the issue of “control,” the court noted that the defendants had responsibility for hiring and firing all of the subordinate sales agents upon whom the sales leaders’ income was entirely dependent. The companies also handled the advertising and determined the prices of the insurance products. Perhaps even more significantly, the defendants prohibited the sales leaders from selling any other companies’ insurance products, controlled the number and sources of the sales leads, and determined the geographic territories in which the sales leaders could work.

With respect to the second criterion – investment – the court compared the resources invested by the companies with those invested by the sales leaders. The court of appeals found that the defendants’ investment vastly exceeded the individuals’ investment, a factor that supported the determination of “employee” status.

The appellate court then looked at the third factor – who determined the worker’s opportunity for profit and loss. Given that the companies dictated the geographic territories, assigned the sales leads, prevented the workers from selling any other companies’ insurance products, and hired and fired the subordinate agents upon whose production the sales leaders’ incomes depended, the court found this factor also supported the conclusion that these individuals were “employees.”

As to the skill sets possessed by the workers – the fourth factor – the Fifth Circuit found that the sales leaders did not have any particularly “unique” skills, instead possessing the skills common to any effective managers. Moreover, given the control exercised by the defendants, the sales leaders were precluded from exercising “true initiative” in their supposedly independent businesses. This variable also supported the determination that the sales leaders were employees.

Finally, the court looked at the “permanency” of the working relationships. Given that the sales leaders had been associated with the defendants for many years, the Court of Appeals also found that this factor supported the determination that the sales leaders were employees. The court was not persuaded by the defendants’ argument that the sales leaders were “at will” workers, free to terminate their association with defendants at any time for any reason. (Of course, although not referenced by the court, nearly all ‘employees’ are ‘at will’ as well.)

Based on its analysis of these five factors, as well as a few collateral considerations advanced by defendants, the Fifth Circuit found that the sales leaders were employees and were entitled to the protections of the FLSA. The case then was sent back to the District Court for further proceedings.

The Hopkins decision should provide you some insights into whether your company could convince a court that your independent contractors are, in fact, truly independent and not really employees. As suggested above, this determination could well have significant financial implications for your firm. Good luck.

Dorsey & Whitney

Dorsey & Whitney

Dorsey is a business law firm, applying a business perspective to clients' needs. We make it our first priority to know the context in which you do business - your market, your competitors, your industry.

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