On July 15, 2015, the U.S. Department of Labor (DOL) issued an “Administrator’s Interpretation” (AI 2015-1) providing guidance on whether workers are employees or independent contractors under the Fair Labor Standards Act (FLSA). The Wage and Hour Division of the Department of Labor ceased issuing opinion letters in 2009 at the beginning of President Obama’s administration. In place of opinion letters, the Wage and Hour Division occasionally issues administrative interpretations designed to provide meaningful and comprehensive guidance to both employers and employees. AI 2015-1 makes it clear that the Department of Labor contends too many workers are misclassified as independent contractors throughout the country.
Wage and Hour Administrator David Weil opens his analysis by highlighting that the FLSA defines “employee” broadly under its “to suffer or permit to work” definition. 29 U.S.C. § 203(g). In order to determine whether a worker is an employee or an independent contractor under the FLSA, AI 2015-1 states that courts use the “economic realities” test, focusing on whether a worker is economically dependent on the company or in business for him or herself. AI 2015-1 goes further and states that a worker who is economically dependent upon a company is “suffered or permitted to work” by that company and therefore an employee covered by the FLSA. Administrator Weil further notes that the “suffer or permit” concept has broad applicability and is critical in determining whether a worker is an employee entitled to the Act’s protections. In the administrative interpretation, the DOL rejects the common law control test and affirms that the economic realities factors guide the proper determination of whether a worker is truly an independent contractor rather than employee.
AI 2015-1 states that the economic realities test is guided by six factors:
- whether the work performed is an integral part of the company’s business;
- whether the worker’s managerial skills affect the worker’s opportunity for profit or loss;
- whether the worker is retained on a permanent or indefinite basis;
- whether the worker’s investment is relatively minor as compared to the company’s investment;
- whether the worker exercises business skills, judgment, and initiative in the work performed; and
- whether the worker has control over meaningful aspects of the work performed.
A key takeaway from the interpretation is that no single factor, including the nature and degree of the company’s control, is determinative. Administrator Weil specifically notes:
Finally, the “control” factor should not play an oversized role in the analysis of whether a worker is an employee or an independent contractor. All possibly relevant factors should be considered, and cases must not be evaluated based on the control factor alone.
Administrator Weil concludes AI 2015-1 by noting that “most workers are employees under the FLSA’s broad definitions.” Make no mistake: the DOL’s position is that workers are covered employees under the FLSA unless they clearly meet the independent contractor criteria under the AI 2015-1 six-factor test.
Impact of AI 2015-1 on Homebuilders
Most large homebuilders operate under a model in which a substantial part of the homebuilding process is subcontracted to trade contractors that specialize in a particular area such as framing, sheetrock, painting, etc. These trade contractors typically operate under a formal independent contractor agreement with the homebuilder and are specifically designated and categorized as independent contractors in that subcontract. Primary interaction with trade contractors is typically conducted through a project manager (or an individual with an equivalent position) who is an employee of the homebuilder.
Recently, the DOL targeted a number of large homebuilders nationwide in an effort to establish that the homebuilders were the “joint employers” of the employees of their subcontractors. In response, the homebuilders generally were able to establish through written agreements and a consistent course of conduct that that their subcontractors were just that—subcontractors—and that the employees of the subcontractors were not employees of the homebuilders. As a result, the DOL’s efforts were largely unsuccessful. Regardless of whether the new guidance (which contains at least two specific “examples” from the construction industry) is designed in part to target the industry, the DOL now will have the new test at its disposal. As a result, builders should review their agreements and practices with the trade contractors with an eye toward compliance with the six-factor test.
The Practical Impact: What are the “Red Flags”?
It is impossible to predict with certainty what the DOL will focus on going forward. Will it again target homebuilders? If so, will the focus be on the relationship with subcontractors or on the more traditional “direct worker” type subcontractors? If the DOL does focus on the subcontractors, what approach will it use? There are no clear answers to any of these questions, but there certainly are some “red flag” issues upon which homebuilders can focus in an effort to be in the best position possible if the DOL returns its focus to subcontractors.
1. Do Not Allow Subcontractors to Become “Economically Dependent.”
In light of the clear intent by the DOL to focus on economic dependence and the “permanency of the relationship” factor, homebuilders should avoid exclusive relationships with subcontractors. These may create the appearance of economic dependence in the eyes of the DOL. To buttress the homebuilder’s position, subcontractors should be freely allowed to work for other builders, and homebuilders should continue to expand the list of trade contractors they use in each of the construction disciplines. Similarly, project managers and others who interact with trade contactors should refrain from suggesting that the trade contractors work exclusively with that homebuilder or from stating that the trade contractors should not work for others. Homebuilders also should consider internal checks to make sure that no individual trade contractor or particular trade crew is working consistently for the builder for extended periods of time.
Additionally, homebuilders should give strong consideration to including specific end dates in subcontracts and requiring that subcontracts be specifically renewed and a new agreement signed once the prior agreement expires. While this practice no doubt imposes additional administrative burdens on homebuilders, it also provides evidence that the relationship is not open-ended or permanent, thereby strengthening the homebuilder’s position that the particular subcontractor is not economically dependent on the builder.
A related issue emerges when key employees depart from a subcontractor and set up their own “companies.” For example, Joe leaves “ABC Subcontracting” to form “Joe’s Drywall” with the hopes of becoming the exclusive provider for a major homebuilder. The exclusive relationship in this scenario creates heightened risk under AI 2015-1 due to the potential that Joe’s Drywall would be economically dependent on the major homebuilder. To strengthen their position, homebuilders should ensure that subcontractors are viable business entities and should require subcontractors to prove that the legal entity has good standing.
2. Stay Out of the Subcontractor’s Business.
Homebuilders should stay out of their subcontractors’ business practices and activities and are best served by refraining from making loans, giving advice, or engaging in any type of relationship other than what is specifically described in the subcontract agreement for building the home.
Homebuilders should further provide subcontractors with the opportunity to realize profit or loss based on managerial skill by allowing them to hire their own employees to assist with services or perform services without prior approval from the homebuilder.
Homebuilders should continue to require subcontractors to make their own investments and provide their own tools and equipment. In addition, homebuilders should not reimburse subcontractors for these expenses.
3. Continue to Avoid Improper “Control” over Subcontractors.
Homebuilders should avoid any semblance of control over the “manner and means” in which services are performed, such as: getting involved in the process of subcontractor hiring, suggesting wage rates, participating in employment discipline or counseling of a subcontractor’s employees, or otherwise becoming involved in a way that could be construed as an employment relationship.
4. Periodic Monitoring and Review
It is a good practice to review the relationship with each subcontractor periodically to ensure that all parties are acting appropriately within the scope of their relationships. Homebuilders should also periodically update internal procedures to ensure that they are updated to reflect any changes in the laws of the applicable jurisdiction.
5. Review Relevant Contract Previsions.
Subcontracts should specifically and prominently make it clear that a subcontractor is just that —a subcontractor—and that subcontractors’ employees are not employees of the homebuilder. Homebuilders should consider bold-face type for these provisions and place them in conspicuous locations within the contract.
6. Monitor Traditional Independent Contract Relationships.
Like most business enterprises, homebuilders also have traditional independent contractor relationships. These include relationships with individuals who identify and assist in the acquisition of land, provide general consulting services on best practices, or serve as hosts or hostesses at model centers. These relationships should be reviewed carefully to ensure they meet the AI 2015-1 standard. Care should be taken to assure that the applicable scope of work is not done elsewhere within the organization by persons classified as employees. Additionally, homebuilders should not simply “transfer” individuals from employee to independent contractor status without a careful analysis of his or her duties and in most cases a change in duties. The examples in AI 2015-1 make it clear that the bar to meet the independent contractor test will be set at a very high level.
7. Educate Management & HR.
A critical aspect of compliance is to ensuring your managers and human resources (HR) professionals are aware of AI 2015-1 and that the independent contractor classification is used with great care. Managers and HR must avoid the temptation to use the classification for purely economic reasons, to cover a “one off” or “short term” situation just because it is more convenient, or because the worker has requested it.
While there has not been a formal change in the legal standard, the interpretation of the independent contractor classification in the eyes of the DOL appears to now be substantially different. While the avoidance of control would historically place homebuilders on fairly solid ground, other issues such as economic dependence are now just as important, if not more important. Homebuilders should reevaluate carefully each independent contractor classification.