$6.5 Million Class Action Settlement Imparts Four Lessons for Companies Seeking to Minimize Independent Contractor Misclassification Liability

by Pepper Hamilton LLP
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A $6.5 million settlement between Lowe’s Home Centers and a class of its home improvement contractors was approved by a federal court judge in California earlier this week. The contractors claim that they had been misclassified as independent contractors instead of employees. The maximum settlement amount, depending on the number of contractors who file claims, is $6,500,000. In addition, the court awarded plaintiffs’ class counsel $1,625,000 in legal fees. Shepard v. Lowe’s HIW, Inc., No. 12-CV-03893-JSW (N.D. Cal. Jan. 12, 2015).  The settlement of this lawsuit permits us to focus on four takeaways (i.e., lessons) for other businesses that rely upon the use of independent contractors to supplement their workforce or that utilize an independent contractor or 1099 model.  Those lessons can be best addressed following a brief description of the lawsuit and its settlement.

The Lawsuit and Settlement

As first reported in our May 28, 2014 blog post, the plaintiffs in this case were home improvement contractors comprised of both individuals and businesses. They alleged that Lowe’s Home Centers offered its customers the opportunity to hire contractors to install products purchased from Lowe’s. Such products included appliances, kitchens, bath and plumbing fixtures, flooring, doors and windows, garage doors, lighting, outdoor fixtures, and insulation. The complaint, which was originally filed in state court, alleged that Lowe’s had the right to control, and did in fact control, all aspects of installation jobs by, including requiring that the installers to identify themselves as “installers for Lowe’s” or by saying “I work for Lowe’s”; wear Lowe’s hats and shirts at work sites; use signs stating “Lowe’s Installation”; attend training by Lowe’s; and comply with Lowe’s production requirements.

The complaint also alleged that:

  • Lowe’s Production Office managed each installation project;
  • Lowe’s set the fees to be earned by each home improvement contractor;
  • Lowe’s imposed a non-compete covenant on installers; and
  • Lowe’s marketed the contractors’ services on its website on an “Installation” page that provided “Let Us Do The Installation For You” with our “trained installers,” who services were “guaranteed by Lowe’s warranty.”

The installers further alleged that Lowe’s failed to provide the installation contractors with an array of benefits that were available to employees, including comprehensive group medical insurance, prescription drug coverage, vision care, group life insurance, paid sick leave, paid vacation, tuition reimbursement, employee discounts for purchases, short and long term disability coverage, a stock purchase plan, and a matching 401(k) savings plan. They also claimed they were entitled to reimbursement, as employees, for all necessary expenses incurred in performing their services.

Lowe’s denied the allegations and has maintained that the installers are independent contractors. After numerous motions and extensive discovery including the exchange of thousands of pages of documents and depositions of both the class representatives and Lowe’s personnel, the parties settled their disputes at a private mediation.

Had the case gone to trial, the maximum amount recoverable for the class would be approximately $33 million. Plaintiffs’ counsel acknowledged, though, that the case presented “complex legal and factual issues” including the risk that class certification would be denied. Those issues, the plaintiffs’ counsel claim, make the maximum settlement amount of $6.5 million for class members a fair and reasonable compromise that is in the best interests of the class members.

Four Takeaways (i.e., Lessons)

1.  Retaining contractors who operate in the form of business entities, such as LLCs, do not necessarily insulate companies from independent contractor misclassification exposure

A common misconception by many businesses is that contracting with an LLC, corporation, or other form of business entity eliminates the likelihood of misclassification liability. Here, the class members covered by the $6.5 million settlement by Lowe’s Home Centers include installation contractors that operate in the form of business entities. Recently, the U.S. Court of Appeals for the Ninth Circuit and the Kansas Supreme Court both held that FedEx Ground had misclassified employees as independent contractors who were operating as business entities or subcontracted additional routes to other drivers.

Some state laws expressly carve out from their definitions of “employee” status a business entity where the hiring party does not exercise direction or control over the performance of the services and meets other requirements. Thus, companies that wish to minimize independent contractor misclassification liability wisely do not rely solely on the fact that the independent contractor is a business entity.

2.  A failure to properly structure, document, and implement independent contractor relationships

It appears from the allegations that Lowe’s Home Centers may not have structured its relationship with home improvement contractors in a manner that enhanced compliance with a state’s independent contractor laws. The laws in almost all states allow companies like Lowe’s to contract with individuals or businesses to provide services to customers and clients of the company, yet many companies that do so fail to take steps to structure, document, and implement properly their independent contractor relationships to fully comply with those laws.

Prudent businesses that use independent contractors or pay workers on a 1099 basis tend to address the issue of their independent contractor compliance before being served with a class action summons and complaint or before receiving a notice from a state unemployment or workers compensation office, the IRS, or state revenue department.

This and similar class action lawsuits illustrate the value of using, in advance of a legal challenge, a methodology such as IC Diagnostics™ to evaluate whether an existing or proposed independent contractor relationship can be legitimately structured as such, and if so, whether it needs to be restructured, re-documented, and re-implemented to maximize the likelihood that those workers will be regarded by the courts and government regulators as independent contractors and not employees.

3.  The “hidden costs” of class action settlements and other misclassification exposures

While Lowe’s itself continues to deny any wrongdoing, the cost of the lawsuit, when the company’s own legal fees are included, is likely to exceed $10 million, and Lowe’s is reportedly involved in other independent contractor misclassification lawsuits as well.

Notably, the costs of worker misclassification do not always terminate once a class action is settled and all monies are paid to the workers involved, their counsel, and the legal fees of the business sued.  Companies that settle class action cases may also be facing claims for unpaid payroll taxes at the state and state levels, unpaid unemployment tax payments, and unpaid workers compensation premiums – although there may be defenses to those types of claims.

4.  Companies that can financially survive class action misclassification settlements or judgments in court or before an administrative agency need not necessarily reclassify the workers as employees

Lowe’s Home Centers reportedly is involved in other independent contractor misclassification litigation.  So, perhaps it is not ideal for a company facing other legal challenges to its classification of workers as independent contractors to restructure, re-document, and re-implement their independent contractor relationships immediately after a class action settlement is approved.

Many companies, however, treat the termination of a class action lawsuit or an adverse determination by a regulatory agency as imparting upon them an obligation to treat the workers in question as employees on a going-forward basis. This overlooks the fact that many businesses can adopt an independent contractor model, even after  the termination of a class action lawsuit or an adverse regulatory ruling, that may well survive future scrutiny under federal and most state laws – provided the business properly engages in bona fide restructuring, conducts proper re-documentation, and implements and follows new, state-of-the-art independent contractor practices. This is one of the reasons some businesses have resorted to methodologies such as IC Diagnostics™ and its proprietary tools such as 48 Factors-Plus™ and the IC Compliance Scale.™

While efforts today to enhance independent contractor compliance cannot eliminate past exposure to misclassification liability, any changes that enhance compliance with the independent contractor laws going forward will not only minimize or avoid future liability but also lessen the likelihood that the business will become a target for class action lawyers and government agencies.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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