Ryder Kaplan – On January 10, 2024, the Wage and Hour Division of the U.S. Department of Labor promulgated a new rule on how to distinguish independent contractors from employees under the Fair Labor Standards Act (“FLSA”). This rule, known as the “Employee or Independent Contractor Classification Under the Fair Labor Standards Act,” updates and replaces the 2021 Trump-era rule on how to distinguish independent contractors from employees for the purposes of the Fair Labor Standards Act (known as the “Independent Contractor Status Under the Fair Labor Standards Act”).
The misclassification issue has spawned a major debate regarding the role of the FLSA in this arena. Misclassification of independent contractors is a crucial issue due to the ramifications of various tax and employment laws, including the FLSA, which entitles employees to overtime wages and minimum wages. The FLSA applies to actual employees, but not independent contractors properly classified under the law. This setup incentivizes employers to classify their workers as independent contractors as a way to circumvent the FLSA’s requirements and save on labor costs. Moreover, some employers misclassify workers unintentionally due to the law’s complexities or based on the false impression that is acceptable so long as the worker requests it.
The importance of this issue led the Trump administration to pass the 2021 rule, which was the first-ever formal regulation defining what it means to be an independent contractor under the FSLA (as opposed to a regular employee). Prior to this regulation, the U.S. Supreme Court in 1947, in United States v. Silk, dealt with misclassification of employees and independent contractors using the multi-factor “economic realities test.” The test employed six factors, to be weighed together, to determine whether a worker is considered an employee or an independent contractor: (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the potential employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed as an integral part of the potential employer’s business; and (6) skill and initiative.
The 2021 Trump-era rule demanded that the courts place added focus on “the individual’s opportunity for profit or loss” and “the nature and degree of the individual’s control over the work,” the first and fourth factors of the test, arguing these inquiries are the “most probative” and should “be afforded greater weight”. By focusing on the work itself rather than the employer’s role in the completion of the work, application of this test would inevitably favor employers seeking to classify their workers as independent contractors rather than employees–thereby reducing the number of workers entitled to FLSA protection.
The Biden-era Department of Labor has rescinded and replaced this 2021 rule with the aforementioned new rule, effective on March 11, 2024. Said rule appears to be more favorable to workers seeking to validate their employee status. As stated by the rule, “economic dependence is the ultimate inquiry for determining whether a worker is an independent contractor or an employee,” which indicates that the crux of the analysis is whether the worker is in business for their own gain. “The Final Rule” promulgated in the Federal Register demands for a return to equal application of each factor in the six-factor economic realities test, stating that no factor is to be weighed more heavily than another.
While beneficial for employees, this new ruling spells trouble for employers, specifically those in the construction industry. In a growing number of states (nine thus far, including California and New York), there are statutes imposing liability downstream for FLSA violations—meaning that a general contractor would be directly liable for the unpaid wages of a subcontractor’s worker as a result of their misclassification of the worker as an independent contractor. This is true even when the employee was really more like an employee in the eyes of the law. In addition to penalizing misclassification, these statutes impose direct liability on general contractors for their subcontractors violating requirements such as minimum wage, overtime, off-the-clock work, failure to provide meal breaks required by some state laws, and/or improper wage deductions.
This greatly heightens the obligation of a general contractor in the scheme of construction. In order to avoid direct liability for their subcontractors’ misclassification-related errors, general contractors are now forced to supervise and monitor the way their subcontractors classify and compensate their workers. This new obligation imposes significant risk and responsibility on the general contractor, as well as costly administrative burdens, which place tremendous strain on the industry as a whole. Inevitably, work will slow down as a result of the Biden-era 2024 rule, especially in the growing number of states adopting statutes similar to those discussed above.
The new rule will mostly impact smaller general contractors and subcontractors, as these contractors often employ separate subcontractors as labor-providers for a job. By obligating that general contractors vet each separate employer they contract with on a job, it is less likely that they will seek out a subcontractor to provide the labor and more likely that they will hire workers directly. This places even more strain on general contractors who are too small to manage hiring their own employees directly, further tipping the scales in the direction of massive general contractors and ensuring their success in the competitive marketplace. The same can be said about general contractors who cannot afford the additional expense demanded by the now-heightened supervision obligation. The Department of Labor should consider these effects, as their new approach on the issue of misclassification seems to both slow down construction as a whole, while also providing an advantage to larger general contractors with adequate resources to comply.
