US Department of Labor Publishes Its Independent Contractor Final Rule

The US Department of Labor (DOL) published on January 10, 2024 its long-awaited Final Rule regarding independent contractor classification under the Fair Labor Standards Act (FLSA), signaling a return to its pre-2021 totality-of-the-circumstances approach and which may raise the bar for independent contractor classifications depending on the facts and type of work at issue.

On October 13, 2022, the DOL published a Proposed Rule regarding independent contractor status under the FLSA. The Proposed Rule generated a flurry of activity, including the submission of 55,400 comments by industry and employee groups, contractor organizations, and others. After more than a year of anticipation, the DOL has now published its Final Rule, which will become effective on March 11, 2024.

Big picture, the Final Rule marks a return to the DOL’s pre–Trump era guidance and a renewed focus on whether, as a matter of “economic reality,” a worker is dependent on a company/putative employer for work, not income (and thus an employee), or is in business for themself (and thus an independent contractor).

The Final Rule mirrors the Proposed Rule in most respects, but the substantive changes implemented by the DOL in response to the comments it received reflect an acknowledgment that the Proposed Rule lacked clarity in several respects and that it may have led to unintended, potentially disruptive consequences for industries that have been historically reliant on independent contractor business models and workers who enjoy contractor status.

While the Final Rule retains the same six nonexhaustive factors described in the Proposed Rule, the modifications adopted by the DOL and the extensive accompanying narrative guidance soften the anticipated impact for companies and industries engaging independent contractors. Overall, the Final Rule may be more employee-friendly than the Trump-era guidance, but, if upheld from likely challenges, it may not have a material impact on the current independent contractor landscape.

TRUMP-ERA RULE HAS BEEN REPLACED

In January 2021, the DOL published a rule (the 2021 Rule) identifying five economic reality factors to be considered when determining whether a worker is properly classified as an independent contractor under the FLSA. The 2021 Rule highlighted two of the five factors—the nature and degree of control over the work and the worker’s opportunity for profit or loss—as the “core factors” most probative of the nature of the relationship and stated that if those core factors suggest a certain classification there is a substantial likelihood that the worker should be classified that way.

The 2021 Rule further stated that the other three factors—the amount of skill required for the work, the degree of permanence of the working relationship, and whether the work is part of an integrated unit of production—were “highly unlikely” to outweigh the probative value of the core factors. The 2021 Rule also narrowed which facts were relevant to the economic realities inquiry.

The 2021 Rule was set to become effective on March 8, 2021. However, its implementation was delayed, and on May 6, 2021 the DOL withdrew it in its entirety. In March 2022, a Texas federal district court vacated the delay and withdrawal, ruling that the 2021 Rule had become effective as of March 8, 2021. Effective March 11, 2024, the Final Rule will formally replace the 2021 Rule.

RETURN TO TOTALITY-OF-THE-CIRCUMSTANCES TEST

In publishing the Final Rule, the DOL seeks to ensure that more workers receive the protections of employee status and in doing so may make it more challenging for some companies to classify workers as independent contractors. That said, the DOL makes clear that it does not anticipate that workers who have historically been recognized as properly classified independent contractors would be reclassified.

Rather, the DOL views the Final Rule as a return to the pre-2021 totality-of-the-circumstances approach to the economic realities test, but with more detailed guidance as to how the underlying factors should be applied.

The six factors in the Final Rule, none of which is individually dispositive, are outlined below. The Final Rule also notes that other context-specific factors may be relevant to the analysis.

Factor 1: The Worker’s Opportunity for Profit or Loss Depending on Managerial Skill

The first factor in the Final Rule is the worker’s opportunity for profit or loss depending on managerial skill. The Final Rule sets forth a nonexhaustive list of facts relevant to that inquiry: (1) whether the worker determines the charge or pay for the work provided (or can meaningfully negotiate it); (2) whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; (3) whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and (4) whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.

The Proposed Rule had included guidance stating that “a worker’s decision to work more hours (when paid hourly) or work more jobs (when paid a flat fee per job) where the [potential] employer controls assignment of hours or jobs is similar to decisions that employees routinely make and does not reflect managerial skill.” The DOL modified that stance in response to concerns that it fails to consider that a worker’s ability to freely choose among jobs based on the worker’s assessment of their comparable profitability can indicate independent contractor status.

As revised, the Final Rule limits its initial stance to read: “Some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status under this factor.”

As such, the DOL notes that where a worker can accept and decline jobs with varying degrees of potential profit (i.e., “comparable profitability”) and the worker decides which jobs to pursue and how much of their time and resources to devote to the various jobs, that worker is exercising managerial skill, which weighs in favor of independent contractor status.

While the DOL maintains its belief that the opportunity for financial loss (which is absent in many contractor engagements) is a significant consideration for this factor, its acknowledgement that the worker’s consideration and selection of competing opportunities reflects managerial skill that impacts profit or loss is a significant change for companies engaging contractors on a nonexclusive basis.

Factor 2: Investments by the Worker and the Potential Employer

The second economic realities factor is whether and to what extent the worker makes investments in their business. The Final Rule provides that, to suggest independent contractor status, the worker’s investment must be capital or entrepreneurial in nature. For example, the DOL states that investments that “serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach,” support contractor status.

By contrast, costs borne by the worker simply to perform the job (e.g., tools and equipment to perform a specific job, use of a personal vehicle already owned, costs unilaterally imposed by the company) are not viewed by the DOL as capital or entrepreneurial investments supporting contractor status.

On this point, the Proposed Rule had vaguely stated that “the worker’s investments should be considered on a relative basis with the [potential] employer’s investments in its overall business.”

That dollar-to-dollar comparison of the worker’s and the company’s investments spurred numerous comments highlighting that (1) the proportionality between the amount of a worker’s individual business investment and the company’s overall investment in its business was not probative of independent contractor status; and (2) such a comparison would effectively prevent larger companies from engaging independent contractors in the same way as smaller companies. The DOL acknowledged the validity of those concerns and modified its approach.

The Final Rule provides that the worker’s investments should be evaluated on a relative basis with the company’s investments, “not only in terms of dollar value or size of the investments, but [also] on whether the worker is making similar types of investments as the [potential] employer (albeit on a smaller scale) that would suggest the worker is operating independently.”

That shifts the focus from the quantitative comparison of both parties’ investments to an assessment of the qualitative nature of the worker’s investments, with an eye toward whether the worker is making investments so that they can operate independently in the industry. This new approach likely reduces the risk that the size and/or dollar value of investments by the company would be determinative of employment status where the worker invests only a modest amount in their business.

Factor 3: Degree of Permanence of the Work Relationship

The third economic realities factor is the degree of permanence of the work relationship. The Final Rule specifies that this factor weighs in favor of employee status “when the work relationship is indefinite in duration, continuous, or exclusive of work” for other companies and that this factor weighs in favor of contractor status “when the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple entities.”

This was a slight deviation from the Proposed Rule, which stated that the factor weighs in favor of employee status “when the work relationship is indefinite in duration or continuous, which is often the case in exclusive working relationships.”

The Final Rule also provides that where a temporary or finite relationship between a worker and a potential employer “is due to operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, this factor is not necessarily indicative of independent contractor status unless the worker is exercising their own independent business initiative” (emphasis added).

In adopting that language, the DOL modified the Proposed Rule, which had stated that “this factor is not indicative of independent contractor status” when “a lack of permanence” does not result from “the workers’ own independent business initiative.”

According to the DOL, the language in the Final Rule is meant to acknowledge that “operational characteristics of particular industries and the workers they employ” (such as the type of work, when the work is typically performed, and who typically performs the work)—as opposed to “workers acting independently to obtain business opportunity”—may be the catalyst for when, how long, and why a worker performs work, and that “short periods of work” do not alone suggest independent contractor status.

In light of this, the DOL acknowledges that “industry specific analyses for the permanence factor” are “highly relevant” and “should certainly be considered” in assessing whether a temporary or finite relationship “result[s] from the worker’s own independent business initiative,” which would indicate independent contractor status. Similarly, the DOL further acknowledges that long-term independent contractor relationships do exist, and this factor, as with others, “is best understood in the overall context of the relationship between the parties.”

The Final Rule also makes clear that a worker may be economically dependent on multiple employers, and the mere fact that a worker performs work for multiple companies, while a relevant consideration, is not determinative of independent contractor status. Relatedly, the Final Rule provides that “the mere ability to work for others is not necessarily an indicator of independent contractor status.”

Factor 4: Nature and Degree of Control

The fourth economic realities factor in the Final Rule is the nature and degree of control that the potential employer exercises over the worker. In contrast to the 2021 Rule, which designated this as a “core” factor, the Final Rule does not place heightened emphasis on this factor.

The Final Rule highlights setting a worker’s schedule, compelling attendance, or directing or supervising the work as examples of “direct” control, but notes that companies may also exercise control in other, indirect ways. “Indirect” control may include setting prices for services, restricting a worker’s ability to work for others, and relying on technology or digital tools to supervise a workforce.

The Final Rule’s approach to this factor differs from the Proposed Rule in a number of key respects. First, the Proposed Rule specified that it may be appropriate to consider whether a worker is required to comply with legal, safety, or quality control obligations as part of the control analysis. This was an area of substantial concern for many companies (such as those in the financial and insurance industries) whose workers are subject to substantial externally imposed regulation.

Those concerns prompted a spate of comments noting that (1) such guidance would be inconsistent with well-established precedent and (2) it would place companies operating in highly regulated industries in an untenable position of choosing between regulatory compliance and avoiding “control.” The DOL considered those comments and modified its stance on regulatorily required control.

Specifically, the Final Rule provides that company actions taken to ensure compliance with laws and regulations are not indicative of employer control. Rather, only “[a]ctions taken by the potential employer that go beyond compliance with a specific, applicable Federal, State, Tribal, or local law or regulation and instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control.” For companies subject to strict legal obligations, this clarification will be a welcome change from the Proposed Rule.

The DOL also thoroughly considered comments related to whether a company’s use of technology to track business information should be considered evidence of employer-type control. Highlighting the fact that companies may use technology to track critical business information, the Final Rule clarifies that “the relevant consideration is not simply the employer’s use of technology to supervise, but the use of technology ‘to supervise the performance of the work.’”

Put differently, the mere fact that a company collects, tracks, or retains data or information related to the work performed by the worker does not suggest employer control. And, according to the DOL, such data can be collected and used for a number of business purposes, and its existence (if not used to control performance) does not support a finding of control.

Other areas related to the control factor addressed by the DOL include the following:

• Control Over Prices or Rates. The DOL rejected commenters’ suggestions to “de-emphasize the relevance of control over prices or rates of service” in the control analysis, but acknowledged that some roles and industries do not allow for such control and noted that the absence of such control is not singularly determinative of employment status.
• Schedule Control. The Final Rule notes that a worker’s purported ability to set their own schedule provides only “minimal evidence” of independent contractor status if the worker’s ability to pick one’s hours or “arrange the sequence or pace of the work” is dictated by stringent requirements imposed by the potential employer that limit the number of available hours or negate meaningful scheduling flexibility. Moreover, under the Final Rule, the power to decline work and maintain a flexible schedule is “not alone” persuasive evidence of independent contractor status when the company may discipline a worker for refusing work.
• Need for Supervision of the Role. The Final Rule indicates that where the nature of the employer’s business or the work to be performed makes direct supervision unnecessary, a lack of physical supervision does not automatically compel a contractor finding.
• Remote Supervision. The DOL states that remote supervision through technology—for example, monitoring systems that track a worker’s location and productivity—may be indicative of employer control depending on the circumstances. That said, the absence of in-person supervision is not determinative of whether there is employer control.
• Unexercised or Reserved Control. The Final Rule departs from the 2021 Rule’s statement that “unexercised powers, rights, and freedoms” are “less relevant” than those that are actually exercised. The DOL declined to create a bright line rule that assigns a predetermined and immutable weight or level of importance to reserved rights, viewing that as incompatible with the totality-of-the-circumstances inquiry. Thus, “unexercised” or “reserved” rights remain part of the control analysis with the weight to be determined on a case-specific basis.

Factor 5: Extent to Which the Work Is an Integral Part of the Company’s Business

The fifth economic realities factor looks at the extent to which the work performed by the worker is an integral part of the potential employer’s business. The Final Rule calls for a “common-sense” approach to this factor that asks whether the company could function without the service performed by the type of worker at issue (not the services of the individual worker).

The Final Rule focuses this factor on the question of whether “the potential employer could not function without the service performed by the workers.” To answer that question, the Final Rule suggests that courts should consider “whether the work is important, critical, primary, or necessary.”

According to the DOL, where a potential employer’s primary business is to make a product or provide a service, the workers who make the product or provide the service are integral. The DOL further states that the focus of the inquiry is on the level of the work performed, and not whether the individual worker possesses some unique qualities that render them indispensable as an individual.

Factor 6: Skill and Initiative

The sixth economic realities factor is the level of skill and initiative required to perform the work. This factor considers whether a worker uses specialized skills to perform the work and “whether those skills contribute to business-like initiative.” To that end, where the work does not require previous experience, the worker is dependent on training from the potential employer to perform the work, or the work requires no training at all, the DOL states that such work likely does not require specialized skill and initiative.

Importantly, the DOL’s comments note that unskilled workers may be independent contractors, and the Final Rule notes that the DOL “cannot say that a particular occupation always lacks specialized skills” even if that has historically been true.

Additional Unspecified Factors

The Final Rule notes that the six enumerated factors are intended to be nonexhaustive and that “additional factors which indicate that the worker is economically dependent on the potential employer for work or in business for themself can be considered.” However, similar to the Proposed Rule, the DOL again declines to state any particular additional factors that may be considered.

IMPACT ON STATE WAGE AND HOUR TESTS

The Final Rule only applies to the FLSA. It has no impact on any state wage and hour laws that do not follow the FLSA for determining whether a worker should be classified as an employee or independent contractor. For example, California, Massachusetts, and several other states apply an “ABC Test” (with some exceptions) under which a worker is considered an employee and not an independent contractor unless the hiring entity satisfies three conditions distinct from (but in some instances similar to) the factors in the Final Rule.

Additionally, the Final Rule does not define who may qualify as an independent contractor under other federal statutes or laws such as the Internal Revenue Code or National Labor Relations Act.

Accordingly, regardless of the DOL’s guidance on who qualifies as an independent contractor under the FLSA, companies should always review whether and how different federal and state laws may apply to their workforce.

PRACTICAL EFFECT AND COMPANY OUTLOOK

As expected, the Final Rule marks a departure from the 2021 Rule insofar as

• the DOL moves away from considering the exercise of control and the opportunity for profit and loss as the “core factors” in the economic realities analysis;
• evidence of work performed for multiple companies may not in all instances be dispositive of independent contractor status;
• a potential employer’s “control” regarding safety, health, or customer or quality standards that goes beyond legal obligations may in some instances be seen as one factor supporting employee status; and
• the DOL believes that only worker investments that are capital and entrepreneurial in nature—and not unilaterally imposed by a potential employer—will weigh in favor of an independent contractor finding.

Those changes may impact whether certain workers, in certain industries, may be classified as independent contractors.

The DOL will use the standard set forth in the Final Rule in its FLSA enforcement efforts. However, it is unclear how much deference courts will give the new standard, particularly considering the DOL’s significantly vacillating approach to determining independent contractor status in recent years.

Regardless, the issue of whether a worker qualifies as an independent contractor will likely remain the subject of frequent litigation under the FLSA and applicable state wage and hour laws.

As the Final Rule provides, “[t]he analysis . . . cannot be conducted like a scorecard or a checklist,” and one or more factors in one situation may be more probative than a host of other factors going the opposite way. As such, companies should continue to review how their workers are classified and be mindful of how the classification of their workers may be viewed under the Final Rule’s new test.

NEXT STEPS

The DOL’s Final Rule is effective March 11, 2024.

Depending on the individual facts and circumstances, the Final Rule could expand the FLSA’s coverage to additional workers who may be currently classified as independent contractors. Companies should consider the following actions:

• As compared to the 2021 Rule, the Final Rule includes a test that, depending on the particular facts and type of work at issue, may result in a finding that a worker is an employee. Litigation challenging the classification of workers is likely to increase as a result, and companies should consider auditing their current independent contractor population to determine what changes can be made to staffing models to address the classification of “close to the line” positions. Those changes may include restructuring how certain workers are managed or reclassifying workers from independent contractor to employee. Reclassifying workers from independent contractor to employee, in turn, requires considering a broad range of issues, including communication strategy, manager and employee training, timekeeping policies and practices, scheduling, compensation structures, calculation of the overtime rate, and benefit eligibility, among many others. Sophisticated workers (and their counsel) will take note of any changes made, so careful consideration of each issue in advance is important.
• The publicity generated by the Final Rule may cause a number of workers to question whether they are properly classified as independent contractors. Companies should be prepared for questions from independent contractors inquiring as to why they are not, and should not be, classified as employees and provided with all attendant employee benefits.

HOW WE CAN HELP

Morgan Lewis has a dedicated team of lawyers who specialize in analyzing employee versus independent contractor status, protecting existing independent contractor models, and implementing changes where needed. We are happy to work with you on assessing your workforce to locate potential workers whose classification status may be affected by the Final Rule as well as offer strategic advice regarding how to ensure that workers remain properly classified under the FLSA and other federal and state laws.