Independent Contractors And Overtime: The DOL Steps Into The Ring With Jarring New Regulations

Hirschfeld Kraemer LLP

The U.S. Department of Labor (DOL) has recently taken a firm stance on two of the most controversial issues facing American employers:  overtime compensation and misclassification of employees as independent contractors.  These controversial actions are likely to spark tremendous debate.  Employee  advocates have already touted the hope that raising salaries and income levels will close the gap of income inequality, a major theme in the upcoming presidential campaign.  At the same time, employers are likely not only to challenge the DOL’s process in implementing these changes (a tactic which has been successful in the past), but also to question their lasting effect on the workplace, specifically maintaining that these changes will cost jobs rather than raise salaries.

A History of the FLSA

The Fair Labor Standards Act (FLSA) is the most broadly applied wage-hour law administered by the DOL.  The FLSA dates back to the New Deal and in the nearly 80 years of its existence, it has been amended only a few times and generally to deal with certain specific issues, like whether the time spent traveling to work is compensable.  The central premise of the law — that employees must be paid a minimum wage and that work should be distributed as evenly as possible throughout the workforce at the risk of paying overtime — remain in tact and have generally been free from challenge.  But, the finer points about when an employee qualifies for overtime have also remained in tact and as a result, critics on both sides of the spectrum challenge the efficacy of the law in a modern, technology and service-based economy.

President Obama vowed in his second term to update the DOL’s regulations implementing the FLSA and on March 13, 2014, he directed the Secretary of Labor to “propose revisions to modernize and streamline the existing overtime regulations,” noting that the regulations were “outdated” and “have not kept up with our modern economy.”    While the President was not specific about the form he expected those regulatory changes to take, most experts agreed that the DOL’s changes would be significant.

In the 15 months that the DOL was drafting a proposal to update the overtime regulations, another trend in employment law became more prominent: the misclassification of employees as independent contractors.  Whether it was a result of a new California law that expanded the penalties for such misclassification, cases alleging misclassification against Uber and other “sharing economy” companies, or something else, the DOL felt it was time to throw its hat into the ring on the issue.

The Changes To Overtime Compensation Under The FLSA

With that background, the DOL set forth to revise the FLSA’s overtime regulations.  Generally speaking, most employees that are exempted from the FLSA’s overtime requirements fall under one of the “white collar” exemptions which apply to certain salaried “executive, administrative and professional” employees.   When the FLSA was enacted, however, Congress declined to define what those terms meant and deferred that responsibility to the DOL, something it has done successfully only a half-dozen or so times in nearly 80 years.  Nevertheless, the DOL’s overtime regulations require three tests to be passed in order to satisfy one of the white-collar exemptions: (1) the employee is paid on a salary basis (“the “Salary Basis Test”); (2) the employee is paid a certain minimum salary level (the “Salary Level Test”); and (3) the employee performs the duties of an exempt “executive, administrative or professional” employee (the “Duties Test”).

Each of those tests has been the subject of litigation over time, but the regulations governing the tests have remained largely static.   That is about to change.  On July 6, 2015, the DOL published a Notice of Proposed Rulemaking which focused principally on the Salary Level Test, namely the amount of salary that must be paid to employees in order to satisfy the exemption.  Under the current regulations, last revised in 2005, an exempt employee must be paid at least $455 per week or $23,660 annually on a full-time basis.  Under the new proposed regulations an employee must be paid $970 a week or $50,540 a year in order to satisfy the exemption, a level that exceeds the Salary Level Test under California law, currently the highest in the country.  In the future, the required salary level will likely increase annually at the rate of inflation.

The DOL also proposed to change the salary requirements for employees exempt under the “highly compensated employee” exemption.  Under current regulations, an employee who earns over $100,000 a year and has at least one duty of an exempt “executive, administrative or professional” employee is exempt from the overtime requirements of the law.  The DOL proposes to raise that salary level to $122,148 annually and also increase that level with inflation.

Last but not least, the DOL is considering – but has not yet decided – to reconfigure the duties test for “white collar” employees are concerned.  Each of the “white collar” exemptions requires that an employee’s “primary duty” involve work that are “executive, administrative or professional,” but they do not quantify how much work is needed to make it primary.  The DOL signaled its interest in revising the overtime regulations to make the Duties Test more like that under California law, where in order to satisfy the exemption, an employer must show that more than half of an employee’s work is devoted to performing exempt tasks.

The DOL’s proposal is just that – a proposal.  It is not (yet) a rule and it is certainly not a law.  But it serves to reason that the DOL took the time to craft this 295-page behemoth of a regulation for a reason and that it fully intends for this regulation to operate in practice later this year.

Independent Contractors And the FLSA

At the same time, the DOL was operating under the radar screen to make its voice heard on the issue on independent contractors, another issue that regularly bedevils employers.  The question could not be more basic:  what is an employee?  Surprisingly (or not, depending on who you ask), Congress made no effort to set the contours of what constitutes an “employee” under the FLSA.  Nowhere in the law is that term defined and, in fact, the FLSA very unhelpfully defines the word “employ” as “to suffer or permit to work,” bringing to mind the Dickensian-style sweatshops from the turn of the century that led to labor unrest and to the FLSA’s enactment.  So, what is an employee?

Yesterday, the DOL issued an Administrator’s Interpretation, which sets forth its believe that “misclassification of employees as independent contractors is found in an increasing number of work places in the United States.”  The DOL believes that the FLSA was intended to apply “very broadly” (the word broad appears 18 times in the document) and it believes that most American workers are employees, not independent contractors.

The DOL believes that the “suffer or permit” standard – again, a “very broad” standard – applies when as a matter of “economic reality, the individual is dependent on the entity.”  One might reasonably ask, wouldn’t that apply to every relationship between a worker (an individual) and a company (a much larger group of people)?  Aren’t the scales of “economic reality” always tilted in favor of an employer?  How could an employer possibly satisfy this test?

Indeed, the DOL’s “interpretation” of the FLSA is a major departure from hundreds of cases across the country which have focused not on the economics of the employment relationship, but rather the degree of “control” imposed by an employer.  Indeed, the “economic realities” test is drawn very tangentially from a 54 year old case involving knitters and crocheters at a Maine cooperative and another case involving truck driver helpers from the mid-1940’s.  At no point has the U.S. Supreme Court affirmatively declared that the “economic realities” test is to be the law of the land.

Yet, the DOL maintains that it will enforce the FLSA consistent with the strict requirements of that test and that it will consider six, non-determinative factors to see if that test is met: (1) how much of the work is “integral” to the employer’s business; (2) can the worker “profit or loss” based on his or her managerial skill; (3) the “relative investments” of the employer and the worker; (4) whether the work requires “special skills and initiative”; (E) whether the job is permanent or temporary; and (6) the degree of control “exercised or retained” by the employer.

This Administrative Interpretation is merely the DOL’s opinion on the topic – an opinion which has no force of law and which courts are free to disregard at their whim.   In all likelihood, the DOL chose the Administrative Interpretation route, rather the more formal (and effective) rulemaking route, because it knew that these regulations would not pass judicial muster.  But still, the fact remains that the DOL – the federal agency with the greatest ability to affect employment laws throughout the country – will actively challenge employers who misclassify employees as independent contractors.

Who Will These Changes Affect Most 

In certain parts of the country, especially on the West coast and in the Northeast, these changes will have less of an impact, as state overtime laws subject employers to more rigorous standards than the FLSA.  But, in much of the country, employers who have been paying exempt employees a salary in the mid-$20,000’s are in for a rude awakening, as those levels will more than double.  What that means is that salaried managers with a relatively low salary will soon become eligible for overtime, barring a dramatic increase in their guaranteed rate of pay.

And if the DOL decides to modify the Duties Test for “white collar” employees, thousands of them will also become eligible for overtime.  Think, for example, of the restaurant manager or retail store manager who “pitches in” to help line employees.  Or the mid-level manager who is given some discretion as to how to perform his job, but by and large follows directions given by his manager.  If the changes that the DOL is considering are included, they too will be eligible for overtime under the FLSA.

With independent contractors, it is much less clear whether the DOL’s Interpretation will have a lasting impact.  That is especially true as the nature of our economy changes along with the types of employers that predominate in the marketplace.  Are Uber or Lyft drivers who shepherd passengers around in their own cars when they want and how much  they want really employees?  What about a person who rents a room on Airbnb – is that company employing him?  The DOL will certainly take the position that they are (as the California Department of Labor did recently with an Uber driver), but those slanted views may not hold water in court.

What is most notable about these changes is that after many years of silence, a reinvigorated DOL has left its footprint smack in the middle of two of the most controversial issues facing employers today.  No one expects them to back off now.

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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