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Whether people who work for a company are “employees” as opposed to “independent contractors” is a fundamental question for the application of a wide range of federal and state laws governing the workplace. These include both federal and state employment tax laws, unemployment compensation laws, workers’ compensation laws, laws regulating health insurance and retirement plans, and the laws governing payment of overtime premiums and minimum wage.
Case Study 1: Microsoft Corporation vs. the “Permatemps”
In response to economic realities, many employers seek alternatives to hiring full-time
“permanent” employees. Using “contingent” or “temporary” workers or “freelancers” or
“independent contractors” may work as a business strategy for avoiding costs, but the legal pitfalls are very real – just ask Microsoft.
During the 1980s and early 1990s, Microsoft Corporation attempted to save on costly benefits by using “freelancers” – ostensibly “independent contractors.” The “freelancers” had
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entered into special agreements with Microsoft which delineated them as independent contractors responsible for their own federal and state taxes, withholdings, social security, insurance and other benefits. Freelancers were not paid overtime, were paid through Microsoft’s accounts payable office rather than its payroll office, and could not participate in Microsoft’s benefits plans or employee stock purchase plans.
But the freelancers were fully integrated into Microsoft’s workforce. They often worked on teams along with regular Microsoft employees, shared the same supervisors, performed identical functions, and worked the same core hours. In addition, because Microsoft required that the “freelancers” work on site, they also received admittance card keys, office equipment and supplies from the company. The differences between the freelancers and “permanent” employees were mostly cosmetic – they had different colored badges and different email addresses.
Despite Microsoft’s efforts, following an investigation in 1989 and 1990, the Internal
Revenue Service determined that the “freelancers” were actually Microsoft’s “employees”.
Microsoft responded by either making some of the freelancers offers of regular, “permanent” employment, or by giving the option of continuing as employees of a temporary employment agency. Microsoft also sought to correct its past practice and began withholding and paying taxes on the “freelancers” as employees rather than independent contractors. The “permatemps,” as they came to be called, began seeking benefits under Microsoft’s 401(k) and stock option plans. When Microsoft refused, the “permatemps” sued in a class action.
In Vizcaino v. Microsoft Corporation , 120 F.3d 1006 (9th Cir. 1997), the Ninth Circuit held that the “freelancers” were in fact employees entitled to participate in various pension and welfare plans, including the company’s Savings Plus Plan and its Employee Stock Purchase
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Plan. The Ninth Circuit held Microsoft was responsible for providing past benefits arising out of the Savings Plus Plan and the Employee Stock Purchase Plan which had been previously denied.
In December 2000, rather than further appeal the case, Microsoft finally settled for a whopping
$97 million.
Legal Standards: “Right of Control”, “Economic Reality” & the IRS 20-Factor Test.
Courts and administrative agencies such as the Department of Labor, the Equal
Employment Opportunity Commission, and the National Labor Relations Board regularly grapple with the issue of whether a given worker is an “employee.” Two legal tests are generally applied: the common law “right of control” test and the “economic realities” test. The critical element of the “right of control test” is whether the employer controls or retains the right to control the means and manner of the work performed. In contrast, the “economic realities” test looks to whether the worker is really dependent upon the employer for his or her livelihood.
Depending upon which statute is involved, several courts and administrative bodies apply a
“hybrid” test and look for elements of both control and economic dependence.
One such hybrid test is used by the Internal Revenue Service. The IRS examines twenty factors in determining whether an individual is an employee or independent contractor. Such an individual would be an “employee,” under IRS rules, if:
 instructions are given to the worker
 training is provided to the worker
 the worker’s services are integrated in the business
 the worker’s services are rendered personally
 the worker is hired, supervised and paid by the company
 a continuing company-worker relationship exists
 the worker has set hours of work
 the worker’s full-time services are required
 work is done on the company’s premises
 there is an order or sequence set by the company for the worker
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 the worker is required to submit reports
 the worker is paid by the hour, week or month rather than by the task
 the worker is reimbursed for business and/or traveling expenses
 the employer furnishes the tools/materials
 no major investment is required by the worker
 the worker cannot realize profit
 the worker does not experience losses
 the worker is limited in making services available to the general public
 the company can discharge the worker
 the worker can terminate the employment
The IRS refers to these factors only as guidelines, and warns against excessive reliance upon them. No one factor or combination of factors is determinative. Rev. Rul. 87-41, 1987-1 C.B.
296.
Under the Fair Labor Standards Act , employers must pay non-exempt “employees” the minimum wage and overtime. The FLSA defines the term “employee” in the broadest (and somewhat circular) sense to mean “any individual employed by an employer.” 29 U.S.C.
§203(e)(1). Courts have consistently held under the Fair Labor Standards Act that employees who are “leased” (and therefore, technically hired, employed and paid by another entity) are employees of the leasing employer. See, e.g., Antenor v. D&S Forms , 3 WH Cases 2d (BNA)
677 (11 th Cir. 1996) (Grower was joint employer with labor contractor under FLSA and therefore, liable for any minimum wage and record keeping violations); Castillo v. Givens , 704
F. 2d 181 (5 th Cir.), cert. denied , 464 U.S. 850 (1983) (farm owner who leased workers from farm labor contractor held liable under FLSA for minimum wage and record keeping violations).
The Department of Labor Wage and Hour Division has also taken the position that a company using leased labor is jointly and severally liable with the supplier of leased employees for ensuring minimum wage, overtime, and record keeping requirements are fulfilled. Baystate Alt.
Staffing v. Herman , 5 WH Cases 2d (BNA) 65 (1 st Cir. 1998) (corporate staffing companies are
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employers of temporary workers they provide to client companies, notwithstanding simultaneous employer status of client companies).
Most courts ignore the traditional common-law, right-of-control test in determining whether an individual is an employee or an independent contractor, relying instead upon the
“economic reality test.” That is to say, is the alleged employee economically dependent upon the employer or business to which he renders services? If so, he or she is an employee. If not, he or she may be an independent contractor. See, e.g., Brock v. Mr. W Fireworks, Inc.
, 814 F.2d
1042, 1043, 1054 (5th Cir.), cert. denied , 484 U.S. 924 (1987); see also Henderson v. Inter-
Chem Coal Co., 41 F.3d 567 (10 th Cir. 1994) (“whether the individual is economically dependent on the business to which he renders service . . . or is, as a matter of economic fact, in business for himself”).
The “economic reality” test includes consideration of some factors that may not be readily apparent. For example, courts generally utilize five factors: 1) the degree of control exercised by the alleged employer; 2) the extent of the relative investments of the “employee” and the employer; 3) the degree to which the employee’s opportunities for profit and loss is determined by the alleged employer; 4) the skill and initiative required to perform the job; and 5) the permanency of the relationship. See, e.g., Brock , 814 F.2d at 1043. Courts may also examine whether the service is an integral part of the alleged employer’s business. See Real v.
Driscoll Strawberry Associates, Inc.
, 603 F.2d 748, 754 n.14 (9th Cir. 1979). Application of these factors must be determined on a case-by-case basis.
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Case Study 2: Delivery Drivers
In Herman v. Express Sixty-Minutes Delivery Service, Inc., 161 F.3d 299 (5th Cir. 1998), drivers for a courier business were required to attend an orientation session at which they had to sign an "Independent Contractor Agreement" providing that they will make deliveries for
Express using their own vehicles in exchange for receiving a commission for each delivery equal to a percentage of the customer's cost. The Fifth Circuit concluded that these drivers were independent contractors because three of the five traditional factors pointed toward independent contractor status. Primarily, the delivery service exercised minimal control over the drivers and drivers controlled the opportunity for profit or loss.
Degree of control.
Pursuant to their contracts, drivers agreed to make themselves available to work on-call for the company’s 24-hour delivery service. The company posted the on-call schedules at its offices and informed drivers that if unable to work, they were responsible for finding a replacement. A majority of the drivers who testified stated either that they were required to work on-call or that they had no input into when their on-call time was scheduled.
But under the terms of the contract, drivers had the right to accept or reject individual offers of delivery jobs, had no obligation to accept any specified number of jobs during any given period, and could decline offers without consequences. Uniforms were not required, but preferred. If the driver wore a uniform, it had the courier company’s name on one shoulder and “Independent
Contractor” on the other. The court held this factor weighed in favor of independent contractor status.
Relative investment of worker and alleged employer. Under the agreement, drivers also paid the costs of their gasoline, vehicle maintenance, and insurance. Drivers also had to furnish their own uniforms, radios and pagers, as well as the biohazard bags and dry ice required for
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transporting medical samples. The company did supply some of the items through leases to the drivers, deducting the costs from their first few paychecks. Drivers had to supply their own hand trucks, “MAPSCO,” and, if needed, their own tarps and cords for covering and securing items.
But the court noted that most drivers also used their automobiles for personal and recreational purposes as well as for business, so that the capital risk on the part of the drivers was not substantial. On the other hand, the courier company’s relative investment was greater because it operated offices in two locations, used a sophisticated computer system, purchased the equipment that it leased to its drivers, paid to license a closed-channel radio frequency from the
Federal Communications Commission, and paid the salaries of twenty-five office employees.
This factor weighed in favor of employee status.
Opportunity for profit and loss.
Since the drivers were compensated on a commission basis, a driver's profit or loss was determined largely on his or her skill, initiative, ability to cut costs, and understanding of the courier business. Drivers who made the most money appeared to be the most experienced and most concerned with efficiency, while the less successful drivers tended to be inexperienced and less concerned with efficiency. Drivers had the ability to choose how much they wanted to work and the experienced drivers knew which jobs were most profitable. This factor pointed toward independent contractor status.
Skill and initiative required. No prior experience was necessary to become a courier driver.
Once a job was offered to the driver, the driver was not told which route to take--the driver had to rely on his own judgment, knowledge of traffic patterns and road conditions in the Dallas-Fort
Worth metroplex, ability to read a MAPSCO, and ability to anticipate the need for an alternate route. But the legal test for this factor was whether the person showed “initiative” not
“efficiency.” Because the company was in the business of generating the deliveries as a basic
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part of its business, the drivers’ efficient carrying out of the deliveries actually pointed to employee status, not independent contractor status.
Permanency of the relationship. D rivers worked for the courier company for varying lengths of time, with the majority working for relatively short periods. Several drivers had worked for other courier companies in the Dallas-Fort Worth area either prior to or after working for Express. One driver testified that he worked for another courier company while working for Express. The
"Independent Contractor Agreement" did not contain a “covenant-not-to-compete.” This factor weighed in favor of independent contractor status.
Case Study 3: Exotic Dancers 1
Operators of “gentlemen’s clubs” often run afoul of the various employment laws when challenged by the “exotic dancers” who work at the clubs. A federal district judge in
Pennsylvania recently addressed Fair Labor Standards Act claims in this context. Verma v 3001
Castor, Inc., CIV. A. 13-3034 (E.D. Pa. .June 30, 2014) (Brody, A.). In this case, the nightclub had written agreements with all of its dancers in which they dancers expressly agreed they were independent contractors. But based on all of the factors, the court rejected the nightclub’s argument that the dancers were independent contractors.
Right of control.
The club’s numerous written and unwritten guidelines for dancers’ conduct weighed in favor of employee status.
Customers paid for stage performances and private dances. The nightclub mandated a uniform price of $30 for a four-minute private dance in a private room; dancers were not permitted to charge more than the set price and were not permitted to perform private dances on
1
Adapted from Ronald Miller, J.D.
Employment Law Daily , WAGE-HOUR—CLASS ACTIONS—E.D. Pa.: Exotic dancers granted conditional certification of FLSA collective action, but Rule 23 certification denied (July 1, 2014).
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the main floor. Similarly, the nightclub set the price for a half-hour or one-hour private dance in a skybox room. The nightclub tracked the number of private dances that a dancer performed during a shift and collected the cash payments from the customers. The club kept a room rental fee. Dancers decided for whom to dance and how to use their shift time. If a dancer did not perform any private dances and did not receive any payment from customers while performing on stage, she received no compensation for her time spent at the club.
The club imposed numerous written and unwritten guidelines for dancers’ conduct. The nightclub decided whether a dancer could perform at the club, and the club manager evaluated a prospective dancer. The manager also evaluated a prospective dancer’s “social skills, hygiene,
[and] actions.” The club preferred dancers who would rent stage time for at least four days in a given week. Prior to their first performance, the nightclub provided instruction to dancers regarding their physical appearance. The nightclub installed a salon on its premises and, in some cases, paid for services. It dictated the dancers’ choice of dress and hairstyle, and threatened dancers with fines for failing to comply with its directives. In addition to rules regarding appearance, the nightclub imposed other scheduling policies, fee structures, and fines applicable to all dancers. The nightclub’s policy required all dancers to be on its premises for the entire duration of their scheduled shifts. Dancers could be fined for being late or leaving the premises prior to the end of their shifts. All dancers were also subject to mandatory “tip-outs” — a requirement that they tip the club’s disc jockey, the house mom, and the podium host.
The nightclub controlled the club’s atmosphere, operations and marketing. It determined what stages would be open during a given night and the music played at the club. Club management was also responsible for the maintenance of the facility. It determined the hours of operation and paid the licensing fee associated with the use of the Penthouse Club logo. The
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nightclub was responsible for the club’s advertising, its alcohol inventory, and food menu.
Opportunity for profit, loss.
The court rejected the nightclub’s argument that a dancer controlled her time in a way that shows entrepreneurial opportunity for financial gain or loss indicative of independent contractor status. The risk of loss faced by the dancers — the cost of costumes, the stage rental fee, and the mandatory tip-outs — was not the kind of capital investment and risk-reward profile typical of someone in business for herself, the court noted.
The fact that the nightclub controlled a dancer’s opportunity for profit and loss was in favor of finding employee status.
Investment in operation.
While the defendant had made a significant investment in the nightclub and its operations, the dancers invested primarily in hair, make-up, nails, and clothing.
As a result, this factor also weighed in favor of employee status.
Specialized skill.
Noting that many other courts have found that little specialized skill is required to be a nude dancer, the court also concluded that none of the skills evaluated in the audition process rose to the level of a special skill set that would distinguish the dancers here from other exotic dancers held to be employees. Accordingly, this factor was in favor of finding an employee relationship.
Permanence of relationship.
Typically, “the more permanent the relationship, the more likely it is that a court will find a worker to be an employee.” Many courts have found exotic dancers to be employees despite finding that the employment relationship lacked a high degree of permanence. The record here reflected a lack of permanence in the dancers’ relationship with the nightclub. The relationship could be terminated at any time without notice and without cause by either party. Dancers were under nearly continuous review by management, and at any time, the nightclub can ask a dancer to leave the club. Dancers also could move from the defendant
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nightclub to another club as they pleased. Thus, while this factor weighed in favor of the nightclub, it was not dispositive.
Integral to business.
Finally, the service rendered was an integral part of the defendant’s business. The nightclub marketed itself as an “adult gentlemen’s club.” Given that it marketed itself on the basis of providing topless dancers, it could not credibly argue that the services performed by the dancers were not an integral part of its business. This factor also weighed in favor of employee status.
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