United States: U.S. Department Of Labor Releases New Independent Contractor Rule

On January 10, 2024, the U.S. Department of Labor (DOL) published its long-awaited final rule regarding how to determine whether an individual is an employee or independent contractor under the Fair Labor Standards Act (FLSA or the Act), which will go into effect on March 11, 2024. The notice of the DOL's proposed change, published on October 13, 2022, received over 55,000 comments in the 61-day comment period. In short, the new rule rescinds Independent Contractor Status Under the Fair Labor Standards Act rule published on January 7, 2021 (2021 IC Rule) and replaces it with an analysis that, according to the DOL, "is more consistent with the FLSA as interpreted by longstanding judicial precedent." While the final rule largely mirrors the proposed rule, the DOL has modified some language that commentators noted was confusing and/or created potential unintended consequences.

Background

The FLSA was enacted in 1938 to, amongst other things, protect the "general well-being of workers." To achieve this goal, the FLSA generally requires employers to pay non-exempt employees at least the federal minimum wage for all hours worked and overtime at a rate of one-and-one-half times the employee's regular rate of pay for all hours worked in excess of forty hours in a defined workweek.¹ In addition to the payment obligations, the FLSA requires employers to provide reasonable break time(s) and a place for covered nursing employees to express breast milk at work, prohibits retaliation against employees who engage in protected activity (such as filing a complaint regarding their pay), and requires employers to make, keep, and preserve certain records.²

The Act, however, does not apply to independent contractors. While the FLSA does not define "independent contractor," the DOL defines such individuals as workers who, as a matter of economic reality, are not economically dependent on an employer for work and are in business for themselves. Such individuals may commonly be referred to as "freelancers," "self-employed," etc. Based on this definition, it follows that an "employee" is a worker that is economically dependent on an employer for work and is not in business for themselves. As independent contractors do not receive the protections of the FLSA, the Department of Labor is particularly concerned with ensuring employees are not misclassified as independent contractors.

Historically (since the 1940s), this analysis of economic dependency (economic reality test) has been conducted by examining the totality of the circumstances: considering multiple factors in a way that does not view any one factor as having a predetermined weight, importance, or significance over any other factor. The 2021 IC Rule sharply departed from this longstanding analysis. The 2021 IC Rule elevated two factors (the nature and degree of control over the work and the worker's opportunity for profit or loss) as "core factors" that were the most probative and would therefore be weighted greater in conducting the analysis.

DOL Justifications and Considerations

Despite stating a goal of establishing a "streamlined" economic reality test that improved on prior articulations described as "unclear and unwieldly,"³ the DOL concluded that the 2021 IC Rule improperly included several new concepts that neither the courts nor the DOL had previously applied, which resulted in a further lack of clarity. In addition, as the DOL could not locate a single federal court that applied the 2021 IC Rule's analysis, the DOL's new rule cites concerns as to whether federal courts would have adopted the 2021 IC Rule due to its departure from longstanding judicial precedent. Ultimately, the DOL determined that the 2021 IC Rule resulted in confusion and, if left in place, could result in misapplication of the economic reality test and thus an increased risk of FLSA-covered employees being misclassified as independent contractors.

Changes

The new rule will rescind the 2021 IC Rule and replace it with detailed regulations. Specifically, the final rule returns to the longstanding totality-of-the-circumstances analysis of the economic reality test in which factors do not have a predetermined weight and are considered "in view of the economic reality of the whole activity." The six factors included under the new rule for analyzing whether a worker is an employee or independent contractor are as follows:

• The worker's opportunity for profit or loss depending on managerial skill;
• Investments made by the worker and the employer;
• The degree of performance of the work relationship;
• The nature and degree of control over performance of the work;
• The extent to which the work performed is an integral part of the [potential] employer's business; and
• Use of the worker's skill and initiative.

Such factors are not exhaustive, and additional factors may be considered if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.

Finally, the new rule includes a severability provision, which provides that if any provision of the new rule is held to be invalid or unenforceable, the provision shall be: (a) construed so as to give the maximum effect to the provision as permitted by law; or (b) severable from the law and not affect the remainder thereof if held to be fully invalid or unenforceable. As the new rule fully rescinds the 2021 IC Rule, to the extent any provisions of the new rule are found to be invalid or unenforceable, employers can look to prior subregulatory guidance on employee or independent contractor classification, as was done by the DOL prior to the 2021 IC Rule.

What to Expect and How Employers Can Prepare

• Evaluate present practices. Review the existing worker classification of all independent contractors by analyzing the economic realities of each worker's relationship to determine whether the worker is economically dependent on the [potential] employer for work or is in business for themself.
• Prepare for a Wage and Hour audit. As stated previously regarding the Department of Labor's proposed updates to the salary basis requirements under the FLSA, in the past year, the Wage and Hour Division hired over 100 new investigators and included "misclassification" as one of the Division's top priorities. As such, employers can expect that enforcement of the new regulations will be prompt.
• Retain records. The final rule does not create any new reporting or recordkeeping obligations for businesses. Accordingly, employers that comply with the reporting and recordkeeping requirements set forth under the FLSA do not need to make any such changes in light of the new rule. However, while not required, keeping records of any internal analyses regarding a worker's proper classification, under the stated factors, could demonstrate attempted compliance with the new rule and ease potential risks associated with noncompliance.
• Discuss questions with legal counsel. Though the rule regarding the classification of employees and independent contractors changed, penalties for misclassification did not, and such consequences can be costly. To deepen your understanding of how to analyze the factors stated above, and/or to discuss workforce considerations to ensure all classifications are in order by the March 11, 2024 effective date, consider working with experienced labor and employment counsel.

Footnotes

1. 29 U.S.C. 206(a), 207(a).

2. 29 U.S.C. 218d (added by the PUMP for Nursing Mothers Act, Public Law 117-328, 136 Stat. 4459 (Dec. 29, 2022)), 211(c), 215(a)(3).

3. 86 FR 1172, 1240.

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