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INSIGHT: Misclassifying Employees—Making a Mistake Can Be Costly

March 8, 2019, 9:00 AM

Employers continue to wrongly classify their employees as independent contractors, posing financial and reputational risks. The damages from such errors can cost millions, depending on the number of misclassified workers and the degree of harm.

Both federal and state governments are increasing enforcement measures to protect employees and increase revenue collection. Although lawmakers have made strides to clarify the rules, ambiguity still exists as the economy diversifies.

The IRS definition of a common-law employee is anyone who performs services for you if you can control what will be done and how it will be done.

For independent contractors, you are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). The IRS goes so far as to describe independent contractors as “self-employed.” This serves as the premise for many lawsuits.

Employers often classify their employees as independent contractors to evade necessary payments. Others are miseducated and are genuinely unaware of the difference.

Potential Consequences

In any case, the possible implications of not correctly filing your employees correctly include:

  • Wage Claims
  • Fines and Penalties
  • Back Taxes
  • Class Action Lawsuits
  • Employee Benefit Coverage
  • Damage to Reputation

Comparing Misclassification Cases over the Decade

Independent contractor misclassification lawsuits notably proliferate transportation, technology, construction, and now the gig economy.

Over a decade apart, the following two cases have strikingly similar patterns and different outcomes, illustrating how the role of an independent contractor has evolved.

The Evolution of FedEx (1999 - 2014)

In the 1999 case Estrada vs. FedEx Ground Package System Inc, the plaintiffs filed a lawsuit against FedEx Ground, claiming drivers were unfairly responsible for expenses (cost of uniforms, fuel, insurance, maintenance for their vehicles, and other operating necessities).

Estrada called the FedEx contract “[a] brilliantly drafted contract creating the constraints of an employment arrangement with [the drivers] in the guise of an independent contractor model — because FedEx not only has the right to control, but has close to absolute control over [the drivers] based upon interpretation and obfuscation.”

Due to the control that FedEx exercised over the drivers, as well as unfair working conditions for the drivers, the plaintiffs were awarded $5.3 million in damages and an additional $12.3 million in legal fees in December 2005. Three years after that court decision, California FedEx drivers were awarded an additional $9 million in damages.

In one of the larger cases, several current and former pick-up and delivery drivers in the state of California also filed a class action employee misclassification lawsuit in 2005, claiming they were due overtime. The evidence showed, among other findings, that FedEx had a mandatory-branded FedEx dress code, supervised work, and set deadlines for performance— demonstrating a strong indicia of control.

Almost a decade later in 2014, the Ninth Circuit Court of Appeals ruled that the individuals were employees protected under California’s overtime laws. FedEx settled the case for $228 million, which covered employment expenses, legal fees, and unpaid wages.

FedEx has since shifted their business model, contracting with other businesses that employ the drivers.

Uber Technologies Inc.

Fast-forward to an age where new industries have emerged, and therefore created an even broader definition for contractors. Uber Technologies and many other companies in the on-demand economy transformed ways in which consumers receive goods and services, and allow just about anyone to make extra money.

With over 150,000 Uber drivers in California alone, many consider “Ubering” their primary income, driving more than 40 hours a week. In July 2016, an Uber driver named Michael Hood filed a lawsuit against Uber, their subsidiary Rasier and 10 other agents. He claimed that the defendants violated several North Carolina statutory laws, common-law and the federal Fair Labor Standards Act. In preliminary motions, the court dismissed all claims except the Fair Labor Standards Act claim.

In July 2017, the court granted a class certification for “all natural persons who have worked or who continue to work as an Uber Driver anywhere in the United States and who have opted out of arbitration” under 29 U.S.C. § 216(b).

With approximately 5,200 class members opting in, Uber closely investigated each class member’s work in the company to calculate the damages owed, such as hours worked and expenses incurred.

Without receiving a final resolution as to whether the drivers were independent contractors or employees, the two parties settled giving the drivers just over $1.3 million on Jan. 3. The rest was allocated to attorney fees and litigation expenses.

The Changing Definition of “Independent Contractors”

As you can see from these cases in two entirely different eras, the “employee versus independent contractor” controversy has not changed. Because the law continues to struggle to keep up with emerging business trends and technology, change is inevitable.

California has already led the charge by establishing a three-factor test in the Dynamex Operations West Inc. v. Superior Court of Los Angeles case:

  1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business.

Will other states adopt these factors in future misclassification lawsuits?

There is only one thing we know for sure with this gray-area issue—people are talking, and hopefully, decision-makers are listening.

Author Information

Travis Crabtree is the president and general counsel of online business filing company Swyft Filings in Houston. Swyft Filings has helped form and maintain tens of thousands of companies in all 50 states with all of their filing and compliance needs.