On January 6, 2021, the U.S. Department of Labor (DOL) finalized its highly anticipated independent contractor rule. The rule delivers on the DOL’s promise to simplify, clarify and harmonize the factors for determining when a worker is an independent contractor versus an employee under the Fair Labor Standards Act (FLSA). It is meant to be the sole and authoritative interpretation for this analysis. Although the rule is slated to take effect March 8, 2021, the new administration is expected to review this along with other rules adopted during the last few months by the outgoing administration.1
Overview of the New Rule
After the DOL considered nearly 1,800 comments, the final rule largely tracks what the agency originally proposed, with a few significant clarifications. The rule focuses on the concept of economic dependence as the touchstone of the economic reality test.
The rule clarifies the relevant factors the DOL will use to determine whether workers are in business for themselves (independent contractors) or economically dependent on a putative employer for work (employees). The rule emphasizes that the proper analysis is whether a worker is dependent on a purported employer for work as opposed to whether a worker is dependent on the income received.
The most significant changes from the original proposal responded to comments—including those by Littler’s Workplace Policy Institute, whose comments on behalf of industry the DOL thoughtfully considered and cited extensively—requesting additional examples. The DOL added 29 CFR § 795.115, which shows how the new rule applies to six additional examples.
Until now, the DOL and most courts considered seven economic reality factors when analyzing a work relationship using the economic reality test.2 The rule replaces the seven factors with two core factors: (1) the nature and degree of control over the work; and (2) the worker’s opportunity for profit or loss.
A hallmark of the new rule is that the two core factors are the primary and most important factors deserving the most weight. Three additional non-exhaustive guidepost factors can be considered, however, if the core factors are not determinative or point in different directions:
- The amount of specialized training or skill required for the work that the potential employer does not provide;
- The degree of permanence of the working relationship, focusing on the continuity and duration of the relationship and weighing toward independent contractor status if the relationship is definite in duration or sporadic; and
- Whether the work performed is “part of an integrated unit of production.”
The DOL clarified in the final rule that this list is not exhaustive and any factors that are probative can be considered.3 The non-core guidepost factors need not be considered if the two core factors support a conclusion as to the worker’s classification, as the combined weight of all three guideposts are not likely to ever outweigh the combined weight of the core factors. Here is how the seven prior factors fit into the new test:
Image courtesy of Littler.
The Core Factors
The first core factor weighs toward independent contractor status to the extent the worker, as opposed to the potential employer, exercises substantial control over key aspects of the work. The DOL declined to make requested changes that would (1) look at the control exercised by both the worker and the potential employer; (2) provide examples of the sorts of control that would be relevant to the economic dependence inquiry; and (3) provide examples of control that would not demonstrate an employment relationship.
In response to comments, the final rule expressly provides that where a worker has the ability to accept other work but chooses not to take it, and works for only one provider of opportunities, that does not establish employee status because the worker retains control over this aspect of their work.
The final rule retains the DOL’s position that requiring a worker to comply with specific legal obligations, safety and health standards, to carry insurance, meet contractual obligations or quality control standards or other terms common among businesses, as opposed to employment relationships, is not indicative of an employment relationship, as these requirements apply equally often to employees as independent contractors. Similarly, the rule provides that requiring contractors to comply with the law, follow safe practices or perform timely quality work does not indicate employment status. Significantly, the DOL declined to permit businesses to offer benefits similar to those offered employees presumably even under a statute like California’s Proposition 22. The DOL said a business can compensate workers with benefits that provide the worker their own benefit plan in lieu of cash, but making a contractor part of an employer’s benefit plan is still likely to demonstrate an employment relationship.
Notably, the final rule focuses on actual control rather than “what may be contractually or theoretically possible” for a purported employer to do. Currently, plaintiffs challenging contractor status try to focus on rights a potential employer could exercise (i.e., retained control) as opposed to actual practice, as this rule now provides. Eliminating arguments about what an employer might be able to do, despite never having actually or even imagined doing it, should reduce litigation costs by narrowing the inquiry and overall litigation.
The second core factor includes consideration of the worker’s investment within the traditional opportunity for profit or loss factor. The rule provides that the proper analysis is whether the worker has an opportunity for profit or loss based on: (1) the exercise of personal initiative, including managerial skill or business acumen; and/or (2) the management of investments in, or capital expenditure on, for example, helpers, equipment or material.
Here, the DOL abandons the notion that investments made by an independent contractor must be similar in amount to those made by the company engaging them. The “side-by-side comparison method,” the DOL states, “merely highlights the obvious and unhelpful fact that individual workers—whether employees or independent contractors—likely have fewer resources than businesses that, for example, maintain corporate offices.”
The DOL points out that changes from an industrial to knowledge-based economy diminish the relevance of this comparison focusing exclusively on physical capital, since human capital can be more important in a knowledge-based occupation. The new rule recognizes that today individuals may earn high incomes while utilizing someone else’s business model from home or in a car with a cell phone and a computer. This change, once effective, will significantly diminish this factor that has spurred much litigation.
The rule as originally proposed stated that this factor weighs toward employment status if the individual is unable to affect earnings or able to do so only by working more hours or more efficiently. One comment from Littler’s WPI expressed concern that the rule should acknowledge that those who use initiative to increase profits can be contractors rather than employees. The DOL agreed to change the language to clarify that this test applies only to those earning on a piece-rate basis, who increase their pay by working faster. The clarification ensures that the use of initiative will indicate independent contractor status.
If the guideposts are consulted, the rule attempts to explain how each should be analyzed to avoid overlap with other factors. The rule expressly acknowledges that these provisions make each guidepost less dispositive of the ultimate classification result.
The assessment of skills required for a job will now focus on who provides the training for the worker to obtain the skill. This factor will no longer include (1) initiative or the related issues of judgment and foresight as they are addressed in both of the core factors; or (2) exclusivity of the relationship as that is addressed under the first core factor of control. The DOL clarified in response to comments that because of the overlap with control, this factor’s relevance is diminished to “near irrelevance.”
Permanence will focus on whether the parties’ intent as to whether the relationship is by design definite in duration or sporadic, regardless of length, or is by design indefinite or continuous. Exclusivity is not part of the “permanent” factor but rather should be analyzed as part of the control factor. For example, the preamble and one of the new examples provides that a seasonal worker whose work begins and ends with the season and returns season after season is an employee, not a contractor working for a limited duration or engaged in a sporadic relationship.
The rule changes the “integral” factor to “integrated” to avoid focus on the worker’s importance to a business, which “has questionable probative value regarding the issue of economic dependence, and may even be counterproductive in some cases,” especially given the “increasing difficulty of defining important or core functions” of a company.
As expected, stakeholders expressed the most concern or confusion over this factor. The DOL did not change it, but attempted to clarify when a worker is integrated into a unit of production that indicates employee status versus being part of a separable unit of production, indicating independent contractor status. The DOL reiterated that the centrality or importance of a worker’s job is not probative of their integration into a unit of production. The rule explains:
[t]his factor weighs in favor of employee status where a worker is a component of a potential employer’s integrated production process, whether for goods or services. The overall production process need not be a physical assembly line, but it must be an integrated process that requires the coordinated function of interdependent subparts working towards a specific unified purpose.
Additionally, the rule cites the 2019 opinion letter that provided that a gig economy company’s “primary purpose” is a referral system and not a provider of services to end-market consumers. The DOL explained that the gig company’s “business operations effectively terminate at the point of connecting service providers to consumers and do not extend to the service provider’s actual provision of services.” So long as the “assembly line” ends at the time the service provider and consumer are connected, there would be no integration making the individual an employee of the gig company.
Two of the six examples added to the rule focus on this factor. The example compares a part-time newspaper editor who works from home but interacts with employees to assign, review, determine layout, and sometimes write articles, which are the same job functions performed by full-time employee editors with a freelance writer who submits an article every two to three weeks, which the paper can accept or reject. Not surprisingly, the DOL concludes that the editor’s interaction and multiple duties make her an integrated part of the unit of production, whereas the individual who has nothing to do with the paper other than submitting an occasional article is an independent contractor.
This final rule is extremely popular with industry and the vast majority of individuals working as independent contractors who submitted comments to the Department of Labor. In a stakeholder call, Wage & Hour Administrator Cheryl Stanton touted that the 230 non-Uber independent contractors who submitted comments supported the rule by a margin of 20 to 1 and felt the rule was “right on track.”4 The “key word in Independent Contractor is Independent” she noted from one comment. Many commented that this rule provides “clarity and was simple to understand” and is better suited for the modern workforce than alternatives like the restrictive ABC test adopted by some states. Stanton also said the rule supports the many women with childcare responsibilities who could not work a traditional job but have provided for their families by choosing flexible opportunities as independent contractors.
The DOL’s rule “respects the time-honored American tradition of being our own boss,” said both Stanton and Secretary of Labor Eugene Scalia. The modern economy, and particularly the rise of the gig economy, have drastically increased the number of opportunities for workers to experience the flexibility and other rewards of being their own boss including control over when, how, and for whom they work. “Some of the best work our country is producing” is for independent contractors, said Stanton. According to Secretary Scalia, unlike California’s AB 5 and other states’ ABC tests that “redraw boundaries to reclassify many more workers as employees,” the DOL’s rule “preserves independent contractor status under the FLSA, so that the many Americans who prefer being in business for themselves can continue to do so.”
Despite the rule’s popularity, President-elect Biden has vowed to delay, or if possible derail, the rule. It is not yet clear what steps a new Department of Labor or Congress may take to effectuate that goal, but litigation is likely.
- Dane Steffenson, Special Counsel, Atlanta, GA
- Tammy D. McCutchen, Principal, Washington, DC
- James A. Paretti, Jr., Shareholder, Washington, DC
- Michael J. Lotito, Shareholder, San Francisco, CA & Washington, DC
Compliments of Littler Mendelson P.C. – a member of the EACCNY.