Your Own Agreements Can Be Your Worst Enemy in IC Misclassification Cases

by Pepper Hamilton LLP

Pepper Hamilton LLP

A version of this article was originally published in the November 2016 issue of The HR Specialist. It is reprinted here with permission.

Companies that use independent contractors (ICs) typically require ICs to sign a contractor agreement prepared by the company. But, if it is drafted like the one reviewed in late September by the U.S. Court of Appeals for the Third Circuit (which covers all federal courts in Pennsylvania), it can be the kiss of death if not drafted in a manner that complies with IC and labor laws.

The case involved the nation’s largest commercial cleaning company, Jani-King, which operates on a franchise basis and requires its franchisees, some of whom are individuals, to sign company-drafted franchise agreements. Two of the individuals who signed those agreements brought a class action, alleging they were neither franchisees nor ICs but actually “employees” under Pennsylvania wage and hour laws and were owed unpaid minimum wage and overtime. The question decided by the Third Circuit was whether the federal district court properly certified the case as a class action. Williams v. Jani-King of Philadelphia Inc., No. 15-2049 (3d Cir. Sept. 21, 2016).

The Court’s Decision and Rationale

A three-judge panel of the Third Circuit agreed with the district court — the case can be certified as a class action. The Third Circuit first reviewed Pennsylvania law to determine the test for employee status. The court stated, “Although no factor is dispositive, the ‘paramount’ factor is the right to control the manner in which the work is accomplished.” Jani-King had argued on appeal that “actual control, not the right to control, is the key factor in the test.” The court found that argument did not conform to Pennsylvania law.

The Third Circuit looked at the franchise agreement and the policy and training manuals that Jani-King prepared and found that the following provisions in those documents reflected a high degree of direction and control over the manner in which the cleaners performed their day-to-day tasks:

  • how frequently the cleaning franchisees must communicate with customers

  • the manner in which franchisees must address customer complaints

  • the locations where franchisees may solicit business

  • the clothing that cleaners must wear

  • the types of records cleaning franchisees must maintain

  • the way franchisees may advertise

  • when franchisees must inform the franchisor of vacations

  • how quickly the cleaners must respond to the franchisor

  • the control Jani-King had over work assignments

  • Jani-King’s right to inspect the cleaners’ work

  • the franchisor’s right to change the policies and procedures

  • Jani-King’s right to terminate the franchise agreement at any time.

The court said it was not deciding the merits of the case, but it held that the above provisions in the documents prepared by Jani-King, which covered all of the members of the proposed class, supported the district court’s decision to conditionally certify the case as a class action.

The Lesson from Jani-King – and What To Do, With Caveats

The district court and Third Circuit’s reliance on the very documents created by Jani-King is a wake-up call to all companies that use ICs or offer franchises to individuals: The form of your agreements can be the main evidence used by plaintiffs’ class action lawyers in IC misclassification lawsuits, which are becoming increasingly prevalent. What should Pennsylvania companies do if they use ICs? Make sure your IC relationships are properly structured, documented and implemented consistent with IC and labor laws in the states where the business operates.

Some companies that wish to reduce direction and control while maintaining a valid IC model have used IC Diagnostics™, a proprietary process that examines if a group of workers would pass the applicable tests for IC status under governing state and federal laws. IC Diagnostics™ offers companies a number of practical, alternative solutions to enhance compliance with those laws. For existing businesses, those alternatives include restructuring, reclassification or redistribution, as more fully described in Pepper Hamilton’s “2015 White Paper on Independent Contractor Misclassification: How Companies Can Minimize the Risks.”

Companies that wish to retain their IC relationships can use the IC Diagnostics™ process to genuinely restructure their IC relationships in a way that enhances IC compliance under applicable IC and labor laws, while still maintaining the essential components of the company’s business. Once restructured, those IC relationships can be re-documented through IC Diagnostics™ in a state-of-the-art and bona fide manner. In that way, companies can minimize the likelihood of an IC misclassification lawsuit like the one Jani-King is now facing, in large part, because of the very documents it alone created.

Two important caveats: First, merely drafting an IC agreement that properly limits the company’s right to control the manner in which the services are to be rendered is of little value if, in reality, the company exercises direction and control over how the contracted services are actually performed. Thus, the use of form IC agreements or ones that are not customized for precisely the way your company operates is cold comfort. Second, once an IC relationship is restructured and the IC agreement re-documented, the IC relationship must be re-implemented in a way that is consistent with the documentation and the fact that the IC is precisely that — an IC and not an employee. Many companies fail to distinguish the way in which they treat ICs from the manner they treat employees. Enhancing IC compliance is a multifaceted process. Quick IC fixes often lead to legal challenges that can be minimized or altogether avoided.


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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