United States: KGB USA, Text Message And Internet Information Provider, Settles Independent Contractor Misclassification Claim With U.S. Department Of Labor For $1.3 Million

Last Updated: January 30 2013
Article by Richard J. Reibstein, Lisa B. Petkun and Andrew J. Rudolph

Last week, kgb USA, which operates a text message and Internet-based information service, consented to the entry of a federal court judgment to pay $1.3 million in unpaid minimum wage and overtime wages to its 14,500 current and former “Special Agents” in settlement of claims brought by the U.S. Department of Labor. Solis v. KGB USA, Inc., no. 5:13-cv-00227 (E.D.N.Y. Jan. 15, 2013)

According to the Complaint, kgb USA provides an information service by answering text message questions as well as questions posted to its website by the general public. It hired thousands of “Special Agents” whose duties required them to quickly research, write, and send answers to questions posed by kgb USA customers. The Complaint further alleged, among other things, that the Special Agents:

  • were dependent upon kgb USA for their employment,

  • had no capital investment in the company,

  • did not exhibit managerial skill and initiative in marketing or managing a business,

  • were subject to control as homeworkers,

  • had no opportunity for profit or loss,

  • rendered services integral to kgb USA’s business,

  • were paid a non-negotiable rate of five to ten cents per answer,

  • did not receive overtime pay when they worked over forty hours in a week, and

  • were, at times, paid less than the applicable minimum hourly wage.

The lawsuit alleged that from January 19, 2009 to December 4, 2012, kgb USA repeatedly violated the Fair Labor Standards Act (FLSA) by (1) misclassifying the Special Agents as independent contractors instead of employees, (2) failing to pay minimum wage and overtime amounts, and (3) failing to make, keep, and preserve adequate and accurate employment-related records of the “Special Agents.”

Under the terms of the consent judgment, kgb USA not only is required to pay $1.3 million to the Wage and Hour Division of the Labor Department for distribution to thousands of current and former employees, but also  it must comply with the terms of the FLSA, including all applicable minimum wage, overtime, and reporting  requirements.  Further, once the consent judgment is approved by the federal court, it will be enjoined from “classify[ing] any worker as an independent contractor unless such person is a bona fide independent contractor under the provisions of the [FLSA] and does not meet the [FLSA]’s definition of employee.”

Analysis and Takeaway:

1.     This is likely to be the first of a number of costly legal misclassification challenges for the settling company.

Companies that retain workers as ICs, including information technology and other Internet-based businesses, run the risk that their business models will fail to pass scrutiny not only with the U.S. Department of Labor but also with a number of other federal and state agencies if they do not pay attention to the requirements of applicable employment, tax, and benefit laws affecting independent contractors.

While kgb USA did not admit to any wrongdoing in the consent judgment with the Department of Labor, settlements of this nature often lead to other workforce and tax regulators examining whether the settling business may have failed to comply with an array of federal and state laws. In fact, under a Memorandum of Understanding signed on September 19, 2011 between the U.S. Department of Labor and the Internal Revenue Service (IRS), the “DOL will refer to the IRS, at DOL’s discretion and consistent with applicable law, . . . data that DOL believes may raise Internal Revenue employment tax compliance issues relating to misclassification.”

Further, under its “Misclassification Initiative,” the U.S. Department of Labor has entered into Memoranda of Understanding (MOUs) with 14 states and is actively pursuing MOUs with additional states as well.  According to the U.S. Labor Department: “These MOUs will enable the Department to share information and to coordinate enforcement efforts with participating states . . . . Employers that misclassify their employees may not be paying the proper overtime compensation, FICA and Unemployment Insurances taxes, or workers’ compensation premiums.”

Thus, it would not be surprising if, shortly after the consent judgment is entered by the federal court, various state workers’ compensation boards and state unemployment insurance agencies notify the settling company that its “Special Agents” were also misclassified employees under state laws.  If the “Special Agents” were not ICs under those state laws, kgb USA would have been required to have made state unemployment insurance tax payments on behalf of the “Special Agents” and covered them under applicable state workers’ compensation laws for several years in the past. If these state agencies pursue enforcement, they are likely to seek past unpaid unemployment taxes and workers’ comp premiums as well as interest, penalties and fines.

Likewise, it would not be surprising if the IRS made an assessment against the settling business for back payroll taxes including Social Security and Medicare (FICA) payments that had not been made on the earnings of the “Special Agents” it treated as ICs and paid on a 1099 basis instead of treating them as W-2 employees.

The “Special Agents” themselves may also pursue other types of legal claims, including class action claims for employee benefits.

2.  Companies can minimize or eliminate worker misclassification liability, even those with at-home workers in Internet-based businesses, by enhancing their IC compliance before being challenged by a government regulatory agency or a plaintiffs’ class action lawyer.

Companies that rely on ICs as one of their key sources of manpower or simply to supplement their existing workforce can take steps to minimize misclassification liability by ensuring that their relationships with such ICs are properly structured, documented, and implemented.  Bona fide IC relationships are permitted in virtually all states but one in the U.S., although state law tests for IC status often vary from one state to another.

As described in detail in our White Paper, businesses that rely on ICs should consider engaging in a form of IC Diagnostics™ to avoid or minimize exposure to IC misclassification liability. This starts with an assessment of the company’s current level of IC compliance on an IC Compliance Scale, using all applicable federal and state IC tests and an examination of each of the “48 Factors-Plus” found by the courts and administrative agencies to be relevant to a determination of IC status. Some businesses need little if any restructuring of their IC relationships, while others, including some Internet-based companies, are likely to benefit from moderate to substantial restructurings to enhance the likelihood of a successful defense to an IC misclassification challenge.

Regardless of whether a business’s IC relationships need restructuring or not, documentation of the IC relationship can be critical under most state and federal laws governing the status of workers.  Many IC agreements have not been updated since the crackdown on IC misclassification began or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status, is an essential aspect of IC Diagnostics™.

Alternatives to restructuring and re-documentation include reclassification and redistribution of ICs, as described in our White Paper.

Many companies utilizing ICs are well aware that they may not be in compliance with laws affecting ICs, but find themselves in a form of corporate paralysis, unaware that there are a number of ways they can minimize or avoid IC misclassification liability.  Indeed, for most of those businesses, IC compliance is readily attainable.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Lisa B. Petkun
Andrew J. Rudolph
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