Misclassification of workers has increasingly become a target of the U.S. Department of Labor, the National Labor Relations Board, and plaintiffs’ attorneys who believe that many companies incorrectly use and identify employees as independent contractors. The construction industry, particularly in the South, has been flagged by the Department of Labor, and the former head of the department’s Wage and Hour Division has written that “the problem has been long entrenched” in the industry.
Whether a regulator takes action or an independent contractor sues, claiming to be misclassified, these cases pose significant risks for companies. In late 2023, two national companies paid $55 million and $30 million to settle misclassification claims. In most cases, the settlement is just the start of the impact to the bottom line: fees and penalties — including criminal penalties — are possible, and reclassifying independent contractors as employees results in substantial increases in labor expenses going forward.
These disputes are likely to continue to rise this year after the Jan. 9 release of the Department of Labor’s final version of a new rule that is considered “employee-friendly” in how it approaches classification.
From our experience litigating these kinds of disputes and advising clients on independent contractor agreements, construction companies can take several steps to limit or avoid these types of cases. They include ensuring the use of clear and up-to-date contracts, training employees at all levels of the company (top to bottom) on how to interact with independent contractors, and navigating potential joint employer issues that arise in the construction industry.
An 'Employee-Friendly' Rule
The Department of Labor’s final rule, which took effect on March 11, may result in more independent contractors being classified as employees under the Fair Labor Standards Act. In turn, that will increase compliance and cost burdens on companies — even those using legitimate independent contractors.
The rule replaces a 2021 rule that never went into effect but that emphasized two factors in determining whether workers are employees: the nature and degree of control the workers had, as well as their opportunity for profit and loss. The 2024 rule focuses on six factors that “do not have a predetermined weight and are considered in view of the economic reality of the whole activity.” They are:
- The worker’s opportunity for profit or loss
- The worker’s financial stake and investment in the work
- The degree of permanence of the work relationship
- The degree of control the potential employer has
- Whether the work is essential to the potential employer’s business
- The worker’s skill and initiative
These factors should be familiar as they essentially reinstate the Obama-era “totality of the circumstances” rule. Examples of what will be considered include:
- Whether workers can determine or negotiate the pay or charge for work provided, or choose the time the work will be performed
- Whether investments are capital or entrepreneurial in nature or simply imposed unilaterally on workers
- Whether the relationship between the company and the worker is exclusive or whether the worker is engaged in projects for other companies
- Whether the worker maintains control over the method and manner of the work performed
- Whether the work is critical, necessary or central to the potential employer’s principal business.
It remains to be seen how these factors will continue to evolve in the courts — which is where they were initiated in the first place. But we expect to see more cases brought by workers seeking to shift from the independent contractor column to that of an employee with the attendant benefits.
Lessons Learned for Construction Companies
So, how can construction companies avoid such a monumental shift? Our experience tells us that to come out ahead of this rule and misclassification claims, companies need to do the work upfront. It is critical to have contracts that clearly demonstrate, both in words and actions, that workers are independent contractors. It is also critical to make sure everyone in the management chain understands the legal distinction and basis for it.
When crafting contracts, it is important to understand that the test for independent contractor status also varies depending on what state you are in and whether you are looking at classification under the Fair Labor Standards Act (FLSA), the Internal Revenue Code, the National Labor Relations Act or the Employee Retirement Income Security Act (ERISA). Thus, one size may not fit all. For a construction company working with a lot of independent contractors, looking at each contract anew can be time-consuming and difficult, but the “bones” of the basic contract should be adaptable and flexible enough to meet different issues appropriately in each signed agreement. Each agreement should also have a well-crafted arbitration clause consistent with cases in that area of the law, including language waiving class actions.
The contract is not the end of the story. Courts look at the economic reality of the relationship, including the six factors the Department of Labor laid out in its “new” rule, and ask questions such as:
- Do the independent contractors control their own work environment?
- Can they hire people to work for them?
- Do they get to decide prices?
Not every answer has to be “yes” or “no,” but the totality must suggest that the worker is running their own business and not simply working for the company.
Often, we see issues in litigation where a lower-level manager or new member of the team makes comments or behaves in a way that makes the relationship look more like an employee relationship. Thus, in addition to ensuring an up-to-date contract, it is important to train everyone who is an employee, from senior managers to those on the frontline, on what is required for nonemployee workers to remain independent contractors.
A simple example that has come up in court is senior managers telling independent contractors, “If you don’t do what I’m asking, I’m going to fire you.” That kind of language can provide a strong argument that a worker is really an employee and not “independent” at all.
Training employees on what it means to be an independent contractor and how they should interact with independent contractors is vital. Employees should have an arsenal of phrases such as: “You are an independent contractor, so you are able to make your own decision on that,” and they should repeat those phrases often, so they stick in both the employees’ and the independent contractors’ minds.
Navigating Potential Joint Employer Issues
Whether a company counts as a joint employer under federal labor laws is a related issue that can come up for construction companies. Some courts and agencies have found the prime contractor on a project, for example, is a joint employer of a subcontractor.
This is another area that will likely lead to additional disputes, as the National Labor Relations Board issued final rules in October broadening the definition of joint employers. Specifically, prime contractors need to be careful in their dealings with subcontractors not to maintain complete authority over essential terms and conditions of employment, or they may invite legal risks as a joint employer. Importantly, the 2023 standard focuses not on whether a prime exercises this control, but whether they have the authority to do so. The same tips and training from above apply in these cases.
Final Takeaway
Companies that win misclassification fights are the ones that have a clear internal understanding of their independent contractors’ roles, that support their flexibility, and that avoid taking or exerting too much authority over them. Companies can accomplish these goals by investing on the front end to develop contracts and provide training on how the independent contractors should — and should not — be treated.
