Federal Court in Dayton Finds Employer Liable for Not Paying Overtime to Employees Misclassified as Independent Contractors

The federal government has taken a renewed interest in the misclassification of employees as independent contractors. In my view, this is one of the most common management faux pas I see. Employers do not need to pay overtime or taxes, provide insurance benefits, withhold taxes or worry about unemployment compensation liability in connection with independent contractors and this provides a powerful financial incentive for employers to take risks concerning legal requirements when everyone else is doing it. However, if it quacks like a duck . . . . . . About a decade ago, this was a very hot issue because Microsoft found itself on the wrong side of the IRS on this issue (and then had to provide stock to the misclassified employees under its benefit plants because of how it defined eligible “employees.”). Then the issue disappeared. On September 19, 2011, the DOL entered into a highly publicized arrangement with the IRS and 11 state tax agencies to turn over employers who misclassify employees as independent contractors. A recent federal case in the Dayton demonstrates that employers cannot rely on the “but everyone else is doing it” defense – (aka industry practice) to avoid or minimize its liability.

Near the end of September, the United States District Court concluded that an employer and its president misclassified employees as independent contractors and would be, therefore, liable for unpaid overtime and failing to maintain records of hours worked. Solis v. Cascom, Inc., Case No. 3:09-cv-257 (S.D. Oh, 9/21/11). The Fair Labor Standards Act essentially classifies everyone as an employee who is permitted to work and expects compensation (i.e., not true volunteers). However, it impliedly does not include paying overtime to independent businesses (such as those firms advertising in the yellow pages or on their own commercial websites). Courts typically apply the economic realities test, and the outcome depends on a number of factors and the facts of each individual case.

In this case, the Court found a number of factors weighed strongly in favor of finding the individuals to be employees and not independent contractors:

1) Employer’s right to control the manner in which the work is performed.

This factor weighed heavily in favor of employee status. The individuals completed employment applications, were hired for indefinite periods under terms that could be changed at any time by the defendant employer and, for liability reasons, were not allowed to hire their own assistants without the employer’s permission. Moreover, the employer controlled both the manner and means of performing the work: scheduling their appointments on a take-it-or-leave it basis, requiring them to remain on each job until dismissed by their supervisors, providing detailed training and instructions and requiring the completion of the employer’s forms. The employer also required mandatory attendance at meetings, required them to wear shirts and drive cars with the company logo and required them to seek permission in advance to take a day off work. In addition, the employer also made deductions from pay for errors and other customer issues that were sometime beyond the employee’s control. Most importantly, the individuals were performing the primary work of the company. Indeed, they were the only individuals performing the work that constituted the company’s core business: cable installation.

2) Alleged Employee’s Opportunity for Profit or Loss Depending upon Own Managerial Skill

This factor also weighed in favor of employment status because there were no opportunities for the individuals to increase their profit based on managerial skill (such as scheduling, material acquisition, hiring assistants, etc.). The only way to earn more money was to work longer hours.

3) Alleged Employee’s Investment in Equipment or Materials Required for His Task, or His Employment of Helpers

The Court found this factor to be neutral. The individuals did not invest in advertising or hold themselves out as independent entrepreneurs. They were, however, required to purchase their own tools (and could do so from the employer through payroll deduction) and to supply their own vehicle (or lease one from the employer). The employer provided the materials to be installed.

4) Requirement of a Special Skill to Render the Service

This favor also weighed in favor of employment because the job required minimal skill which could be apparently taught to anyone with six weeks of on-the-job training.

5) Degree of Permanence of the Working Relationship

This favor also weighed in favor of employment because the individuals were treated like at-will employees and remained employed for as much as several years.

6) How Integral the Services Are to the Employer’s Business

This favor weighed very heavily in favor of employment. “More than integral, more than core, cable installation was the entirety of Cascom’s business.”

Finally, the Court rejected the employer’s good faith defense that it was simply following an industry practice: “As for industry standards, “the law...is that ‘simple conformity with industry-wide practice’ fails to demonstrate good faith under the FLSA.”

Employers who are found to have misclassified employees as independent contractors can find themselves liable for unpaid overtime (for the past 2-3 years), unpaid state and federal employment taxes, tax penalties and possible liability under health insurance and pension plans. When the DOL announced its new enforcement agreement with the IRS, the IRS also announced an amnesty program encouraging employers to fix misclassified employees by paying only 1% fines, but does not cover any potential liabilities to state tax agencies or to the individual employees for back pay and pension obligations.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.