California Among 18 States that Successfully Challenged "Vertical Employment" Liability Rule

Portions of the U.S. Department of Labor's new rule regarding vertical joint employer liability were tossed out by a federal judge this week following challenges by 18 states, including California. In State of New York, et. al. v. Eugene Scalia, et. al, the court said the new rules were arbitrary and capricious — leaving other joint employer rules susceptible to similar scrutiny and employers with uncertainty.

Joint employers, meaning more than one employer that meets the Fair Labor Standards Act's definition of "employer" for the same employee and thus all share in liability to the employee, can arise in two different scenarios: "horizontal" and "vertical" employment relationships. Generally speaking, horizontal employment relationships arise when two employers independently hire an employee, but are sufficiently associated (for example, agreeing to share the services of the employee) that the employers are jointly responsible for the other's compliance with the FLSA (including total hours worked and payment of overtime). Vertical employment often arises in a contractor-subcontractor scenario. The court explained vertical joint employment as follows:

"Imagine that an employee works for a contractor. A corporation hires the contractor. The contractor fails to pay the employee the minimum wage, as required by the FLSA. If the contractor and the corporation are the employee's joint employers, the employee can sue both the contractor and the corporation for back wages. In other words, the contractor and the corporation are both on the hook for the employee's damages. But if the contractor and the corporation are separate employers, then the employee can sue only the contractor. Note that the wages due to the employee are the same in either scenario."

Following almost 57,000 comments on the proposed rulemaking and years of legal challenges to the longstanding and evolving doctrine of joint employer liability, the Department adopted a new joint employer rule on March 16. That new rule maintained the distinction between "vertical" and "horizontal" employment relationships but adopted an unambiguous four-factor balancing test for determining whether employers are vertical employers subject to joint liability. Specifically, the test considers whether the putative employer:

  1. hires or fires the employee,
  2. supervises and controls the employee's work schedule or conditions of employment to a substantial degree,
  3. determines the employee's rate and method of payment and
  4. maintains the employee's employment records.

In spite of this fully vetted rulemaking process, the court rejected the Department's new rule as arbitrary and capricious. While the court analyzed how this new "control-based" test for joint employment may be more narrow than the standard had evolved to become, the dispositive statement by the court as to why it rejected the rule was that "[i]f the Department departs from its prior interpretation, it must explain why ... And it must make more than a perfunctory attempt to consider important costs, including costs to workers, and explain why the benefits of the new rule outweigh those costs. Because the Final Rule does none of those things, it is legally infirm."

Unfortunately, the court's ruling has two significant effects.

One, the court's ruling that the Department's adoption of this new test was arbitrary and capricious places a higher burden on the Department and other government agencies' rulemaking process. Indeed, based on the court's rationale, it is highly likely that the National Labor Relations Board's recently published rule clarifying the "joint employer" definition will face the same scrutiny and may be overturned.

Two, the court's ruling only increases uncertainty for employers who are trying to grapple with the joint employer issue. Since 2012, joint employer liability has been a hotly contested and ever evolving topic with numerous government agencies, federal courts and state courts crafting and revising their own joint employer tests related to the FLSA, NLRA, OSHA, etc. This cacophony of joint employer rules places employers in the uneasy position of trying to determine what various and current joint employer standards are applicable to them, adopting policies based on the most stringent of those standards, and then questioning whether even that standard will be the one by which they are judged should their actions face legal challenges. Said differently, until such time as the United States Supreme Court renders a ruling on this issue, it is likely that employers will be left in limbo.

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