May 01, 2019 May/June 2019

Risky Business: Misclassifying Gig Employees

If there has been any one evolution in the working world attributable to the always-connected internet, it has been the rise of the so-called gig economy, a free market where participants supposedly would shed their 9:00-to-5:00 existence, work flexible schedules and have the option of constantly reinventing their careers through a series of short-term “gigs.” A number of companies, notably the ride-sharing services Uber and Lyft, have based their entire business model on retaining part-time and temporary workers as independent contractors who are expected to provide their own vehicles, pay their own transportation costs and taxes, and who are exempt from wage and hour laws. However, the gig economy goes well beyond the transportation industry. Independent contractors such as construction workers, contract attorneys and freelance paralegals are now included in the gig economy. A recent Forbes article estimated that some 36 percent of all American workers are currently employed in this manner.

With the growing popularity of telecommuting, work/life balance, economic necessity and employers looking for ways to increase their profit margins, it appears that the gig economy is here to stay. By 2020 the freelance workforce is predicted to rise to 43 percent. So, how will this increase impact the legal industry? More particularly, what does it mean to those lawyers and law firms who employ contract attorneys and/or legal support staff members?

Gig Versus Regular Employees

Law firms hire contract attorneys and/or paralegals for a variety of reasons. Whether it’s for document review projects or having the flexibility to grow their business without the burdensome expenses of salaried employees until the firm establishes financial stability during the incubation period of starting a new practice, contract lawyers provide great benefits to law firms. Undoubtedly, there are pros and cons for hiring gig employees. These risks must be clearly weighed and evaluated. However, this article only focuses on the risks of misclassifying gig employees.

To determine if, in fact, an employee is classified correctly, it’s important to distinguish the difference between a gig employee and a regular employee. For simplicity, the key difference is that gig employees are also referred to as “independent contractors,” and these people receive a Form 1099 instead of a Form W-2. For many years, and perhaps until the recent litigation of federal cases, companies would only look to the Internal Revenue Service to determine whether an employee was a gig employee or not.

The IRS Requirements and Recent Case Law

Typically, as defined by the Internal Revenue Service, “the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” These employees are not considered true regular employees and do not fall under the protection of labor regulations such as the Americans with Disabilities Act or the Occupational Safety and Health Act. Gig employees are also subject to self-employment tax and hence receive a Form 1099.

In contrast, a regular employee receives a W-2, and he or she is required to be compensated at no less than the minimum wage and receives benefits and overtime. The control of the W-2 regular employee rests with the employer. Regular employees have little control over the work as to what and how the work will be done. In relinquishing this control, W-2 employees receive state and federal labor law protection as well as having payroll taxes automatically deducted from their paychecks.

However, two 2018 court decisions have contributed to confounding employers on the perils of the gig economy and the independent contractor employment model.

Razak.

The U.S. Court of the Eastern District of Pennsylvania ruled that Pennsylvania Uber limousine drivers were properly classified as independent contractors and not regular employees under the Fair Labor Standards Act in Razak v. Uber Technologies, Inc., Civil Action No. 16-573 (E.D. Pa. Apr. 11, 2018). U.S. District Judge Michael Baylson said that Uber drivers work when they want to and are free to nap, run personal errands or smoke cigarettes in between rides. These drivers can work as much or as little as they want to; therefore the relationship between Uber and the drivers is not permanent. This was the first ruling of its kind as to the classification of gig employees.

Dynamex.

However, also in 2018, the California Supreme Court case of Dynamex Operations West v. Superior Court, 4 Cal. 5th 903 (2018), called into question the long-term viability of this gig business model from the standpoint of employment wage and hour laws. California wage and hour laws include requirements that employers pay minimum hourly wages, abide by restrictions on the number of hours worked before overtime wages are triggered, provide meal and rest breaks, and provide correct and comprehensive wage statements. These requirements spring from several California wage orders by the Industrial Welfare Commission. These Commission order requirements, in turn, have become part of the California Labor Code strictures that carry significant penalties and fines for violations. However, neither the Commission nor the Labor Code wage and hour restrictions apply to independent contractors engaged in their own businesses.

What Dynamex Has Wrought

The premise of the gig economy is that workers become their own employers or are essentially independent contractors. There are many legal ramifications involved in correctly classifying regular employees versus independent contractors, and court opinions before Dynamex ran the gamut of findings related to third-party tort liability, workers’ compensation eligibility, and wage and hour compensation. As a result there were a number of case-by-case interpretations generally turning on the issue of retention of control by the hiring principal.

The Dynamex court, while relying on earlier decisions, crafted its analysis specifically around the language contained in the relevant Industrial Welfare Commission order that defined the terms “employer,” “employee” and the verb “to employ” in an expansive manner. It further found that the wage orders applied a test for wage and hour eligibility that was “very broad and inclusive.” Moreover the Dynamex court held that the purposes of the wage orders were “fundamental,” particularly with regard to ensuring that a minimum wage was paid and preventing workers who tended to have less bargaining power from being exploited.

On the flip side, the rules pertaining to wage and hour were put in place to prevent unfair competition in the marketplace between companies that abided by the rules and others that saved money by misclassifying workers. Finally, the Dynamex court found that the wage and hour laws protecting workers are liberally construed in favor of finding the worker to be an employee and subject to the appropriate Commission order.

The Dynamex court then streamlined the test, which it described as the “ABC test,” holding that a worker is an independent contractor if (1) the worker is free from control or direction of the principal in the means and manner in which the work is performed, (2) the worker performs work outside of the usual course of the hiring entity’s business or (3) the worker is customarily engaged in an independent trade or business. All of these prongs are independently determinative, and a failure of proof of any one of them will cause the worker to be classified as an employee. In fact, the burden is on the hiring entity to prove that the worker is an independent contractor who is not intended to be included under the auspices of the wage order.

This court decision has indicated clearly that the workers cannot be independent contractors in name only. Drivers were given their customers, told where and when to pick up and deliver packages, and could be terminated at any time without cause.

Employers, Beware

Although these two cases primarily relate to the transportation industry, there are potentially severe and cumulative penalties in the form of fines, back wages and attorney fees and cost-shifting that can be assessed against a company that misclassifies its workers that, in turn, could be multiplied enormously as part of a class action.

Therefore, as the number of gig employees continues to grow, if you currently have contract employees or are looking to employ a freelance paralegal soon, stay abreast of your state laws regarding the classification of employees. Make sure to review your independent contract agreements, as well as your insurance policies, for the treatment of coverage for employees not receiving a W-2. Finally, conduct periodic audits of your gig employees to see if they are still considered gig employees.

Michelle MacDonald

Michelle MacDonald is an associate with Gray Duffy, LLP, in Encino, California. She has more than 20 years’ experience in several areas of litigation, notably personal injury, construction defect, federal statutory claims, employment law, insurance law and governmental tort liability. mmacdonald@grayduffylaw.com

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