Misclassifying Employees as Contractors Can Cost Millions

While classifying workers as independent contractors rather than employees may seem hugely attractive from a financial standpoint, if the classification is found to be incorrect, it could end up costing you millions, said Robert Hulteng, an attorney with Littler Mendelson in San Francisco.

Hulteng recently represented Express Messenger Systems, a courier agency that operates in California as California Overnight, in a class action brought under the state’s wage and hour law by drivers contesting their designation as independent contractors. Express successfully defended against the claims, but not all employers have had such a positive outcome.

Independent Contractors Overnight?

Prior to 2002, Express had used employees for local pick-up and delivery. The company decided to use independent contractors instead but elected to use the same individuals, changing the requirements of their positions and reclassifying them. According to Hulteng, this raised some “healthy skepticism.” How could employees become independent contractors overnight?

Several drivers sued the company under California’s wage and hour law, seeking overtime, reimbursement of expenses and “everything that they would have received as employee benefits if they had been employees,” Hulteng told HR News in a Feb. 20 interview.

The suit was certified as a class action in 2004 and tried before a jury, which issued its verdict on Feb. 1. The jury decided that all of the drivers in the class were independent contractors and therefore were not entitled to any damages.

However, similar litigation against FedEx Ground, a sister company of FedEx Express, came to quite a different conclusion in 2005.

FedEx Ground also classified its drivers as independent contractors, requiring them to buy or lease their own trucks and uniforms and pay for fuel, oil, tires, repairs and liability insurance. In 1999, three drivers in California brought an action under state wage and hour law challenging this practice. The suit was expanded to a class action including about 200 drivers.

A superior court ruled in July 2004 that, although those contractors with multiple routes were legitimate contractors who operated more like businesses than employees, single-route contractors should be classified as employees and were entitled to reimbursement for their expenses.

The judge noted that the contractors had only one client, FedEx Ground. They were required to drive trucks with company logos, wear uniforms with company logos, report daily to company distribution hubs and attend regular briefings on company concerns.

In December 2005, a final judgment was issued, awarding the class $5.3 million in damages and $12.3 million in attorneys’ fees.

FedEx drivers have raised similar claims, under the federal Fair Labor Standards Act and state laws, in more than 40 suits filed in more than 30 states, which have been consolidated and are currently being tried in federal court in Indiana.

Degree of Control

Both companies called the drivers independent contractors and had them sign detailed “independent contractor agreements.”

However, unlike the FedEx drivers, the Express drivers were not required to wear any particular type of uniform or to drive a truck with a company logo. If they chose to display the company logo, they were paid a marketing fee, but most drivers had no insignia on their vehicles. Drivers were also free to work for other companies and to hire their own employees.

According to Hulteng, even elaborate independent contractor agreements cannot shield an employer from liability, if, in reality, the individuals operate as employees. The key is the degree of control, said Hulteng. “Does the alleged employer surrender control or find ways to exercise it?”

There are many individual factors that a court may consider in deciding this question. In the Express case, the jury was instructed to apply the multi-factor test adopted by the California Supreme Court in S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations (48 Cal.3d 341 (1989)). The “ Borello factors” include the:

• Distinctiveness of the occupation or business, or whether it is a regular or integral part of the principal’s business.
• Skill required in the particular occupation.
• Way in which the tools for the job are provided (e.g., by the business or worker?) and whether the worker has employees.
• Length of time for which the services are to be performed.
• Method of payment, whether by the time or by the job.
• Employer and the employee’s beliefs about whether an employer-employee relationship has been created.
• Worker's opportunity for profit or loss depending on his or her managerial skill.

In addition, the classification of independent contractor should be bona fide and not a subterfuge to avoid employee status. Other states and the federal government have their own similar lists of factors to be weighed in determining whether a company exercises the requisite control.

Hulteng noted that, in deciding what to classify individuals, “employers face a thicket of potential issues” and urged that a company not make the decision lightly. A business’ use of independent contractors can result in large monetary savings because the business does not have to pay those contractors benefits or workers’ compensation and does not have to provide them with vehicles, uniforms or tools.

However, Hulteng emphasized, if a company wants to incur these benefits, it must be willing to give up some degree of control over its workers. This works better in certain industries, he added, such as computer programming and sales, in addition to the courier industry.

Hulteng’s advice to businesses is to “think it through carefully in terms of how you set up your company and how you operate it on a day-to-day basis. To what extent, will there be a mutual dependence and to what extent will there be true independence?”

And employers also should remember that, in addition to potential liability to individuals, misclassification of employees as independent contractors can result in substantial tax problems.

Joanne Deschenaux, J.D., is senior legal editor for HR News.