Construction Companies and Businesses that Misclassify Employees as Independent Contractors Can Face Penalties and Enforcement Actions

Many businesses have sought to reclassify workers who were once employees to contractor status in order to reap an array of apparent cost-savings and benefits from reduced labor costs. However, the days where this practice was little noticed by government officials is long gone. Today, in California and beyond, the failure to properly classify workers in the construction industry and other industries can lead to government enforcement actions that culminate in significant penalties while occupying a significant amount of your time and negatively impacting morale in your company.

Guidance issued by the U.S. Department of labor (DOL) should place all construction companies and other business owners utilizing independent contractors on high alert. Interpretation No. 2015-1 sets forth the proper method of classifying a worker as an employee or as an independent contractor for purposes of the Fair Labor Standards Act (FLSA). However, as a threshold matter, it is important to note that under the FLSA, “employ” is defined expansively under the guidance of economic reality factors.

How Should One Classify a Worker Under the FLSA Interpretation?

The classification of a worker for FLSA purposes should be based on six economic reality factors. These factors are assessed as a whole. These factors are:

• The extent that the worker the worker performs is an essential part of the business – Workers who perform construction work for a construction company or housekeeping services for a cleaning company are highly likely to provide integral services. By contrast, a management consultant for either business would be less likely to perform work that is essential to the business.
• Whether and the extent that the worker’s managerial skills affords an opportunity for profit or loss – If a worker makes managerial decisions such as purchasing, hiring, or deciding whether to enter into contracts it is more likely that he or she is an independent contractor. Individuals who do not exercise managerial discretion affecting their ability to profit are more likely to be considered employees.
• If the worker is retained on a permanent or temporary basis – Workers who do not work continuously for a single employer or who have their own independent company or LLC are more likely to be seen as an independent contractor. However, sham entities will not typically be considered favorably.
• The level of investment of the worker – Workers who make more substantial investments into their independent business beyond investments into the current project are more likely to be viewed as an independent contractor. Investments into equipment, vehicles, and advertising are often indicative of proper independent contractor classification
• If the worker exercises business judgment skills in the work performed – If the worker exercises special skills in the context of a business-like initiative the worker is more likely to be an independent contracts. Typically, employees do not exercise these skills in an independent manner and do so only dependent to a manager or supervisor who dictates parameters.
• Whether the worker has control over meaningful aspects of the work – Workers who are economically dependent or who rely on the guidance and orders of a principle are likely employees. By contrast, workers who exercise real control over an independent business are likely to be considered contractors.

The DOL’s overarching inquiry into contractor status is premised on the question of whether the worker is economically independent or actually an independent business. The DOL does find certain factors more compelling than others. For instance, DOL finds the factor assessing whether the work is integral to the business to be particularly persuasive.

California Businesses Face Increased Likelihood of Misclassification Enforcement Actions

Businesses across the nation have faced additional scrutiny regarding labor practices and enforcement measures stemming from the misclassification of workers. Large enforcement actions spearheaded by the IRS and DOL have taken place in Arizona, Utah and Illinois. These enforcement actions frequently resulting hundreds of thousands of dollars in back wages and civil penalties.

While this risk exists nationwide, it is particularly pronounced in California. Labor misclassification in the state is investigated and enforced by the State of California Industrial Labor Relations’ Labor Commissioner. The agency encourages potentially misclassified workers to file a complaint with the Division of Labor Standards Enforcement. Furthermore, in 2011, the California legislature passed Senate Bill 459 which creates civil penalties for individuals and entities who willfully misclassify workers. Under the law, entities can be fined between $5,000 and $25,000 per a violation. Due to the additional focus on worker misclassification at both the federal and California state level, California businesses must tread carefully and should reassess their classification policies and practices before facing an enforcement action.