Employee or Independent Contractor? Employers Need to Know DOL’s Proposed Rule
This blog will be updated with relevant developments
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Misclassification of workers by employers is a big problem, according to the Department of Labor (DOL).
“The misclassification of employees as independent contractors remains one of the most serious problems facing workers, businesses, and the broader economy,” it says in a 10/13/2022 notice of proposed rulemaking (NPRM) from the Wage and Hour Division of the DOL, discussed below.
To combat worker misclassification, the NPRM proposes modifications to regulations regarding how workers should be classified. This is a big deal because if the proposal is adopted – which it almost certainly will be – it would make it more difficult for workers to be classified as independent contracts and easier to be classified as employees, compared to current regulations.
Further, the DOL and the Internal Revenue Service (IRS) entered into a Memorandum of Understanding (MOU) in mid-2022, replacing a similar MOU from 2011, that lays out how the two agencies will work together to combat worker misclassification. More on this below, too.
These developments are of great importance to employers in South Carolina and across the country. It could mean reclassifying some workers that are currently independent contractors as employees, with all that entails.
Here’s what to know.
Proposed Rule by the DOL on Worker Classification
On October 13, 2022, the Wage and Hour Division of the DOL published a notice of proposed rulemaking (NPRM), Employee or Independent Contractor Classification Under the Fair Labor Standards Act (FLSA). You can read the NPRM in its entirety here on the Federal Register.
The rule would provide clear guidance on how to classify workers, making it “more consistent with judicial precedent” and with the FLSA’s “text and purpose,” says the DOL. Workers classified as employees have protections and benefits at the federal level under the FLSA, such as minimum wage and overtime pay, which independent contractors do not have.
The practical effect would most likely be that many workers who are now currently classified as independent contractors would need to be reclassified as employees. An article from the Small Business Administration on the topic notes that “In its Initial Regulatory Analysis, DOL estimates that millions of small businesses could hire and/or be independent contractors,” so this rule could affect a large number of people.
The Six Factors of the Economic Reality Test for Worker Classification
Classification would involve a totality-of-the-circumstances analysis using a multifactor economic reality test comprised of six specific factors and one additional, nonspecific factor. They are:
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the employer
- Degree of permanence of the work relationship
- Nature and degree of control
- Extent to which the work performed is an integral part of the employer’s business
- Skill and initiative
- Additional factors
In this blog we won’t go into too much detail about each of these factors, but here’s a little bit of explanation for each one. (For more discussion on the history and application of these tests, follow this link to go straight to factor #1 in the NPRM, which goes into great detail about all the factors.)
- Opportunity for profit or loss depending on managerial skill. This considers several factors such as whether the worker determines their own pay, can accept or decline jobs at will, engages in marketing or advertising to secure more work, and has an opportunity for loss.
- Investments by the worker and the employer. This should also consider how the worker’s investment (if any) compares to the employer’s investment in the business.
- Degree of permanence of the work relationship. This should also consider whether the worker works for the employer exclusively or works for others, too.
- Nature and degree of control. This considers factors such as scheduling, supervision over the performance of work, setting rates, and the worker’s ability to work for others.
- Extent to which the work performed is an integral part of the employer’s business. This is not the same as the degree of contribution a worker makes; for example, one person in a call center of hundreds is still performing work that is essential to the business, even if that individual worker’s contribution is minimal.
- Skill and initiative. Specialized skills and business-like initiative are factors that favor independent contractor status, while work that’s unskilled, requires no training, or requires training from the employer favors employee status.
- Additional factors. Other factors, not enumerated here, may be considered if relevant to determining a worker’s classification.
No one factor is more important than the other, and no single factor is determinative on its own. Rather, this is a totality-of-the-circumstances approach to determine worker classification.
How is this rule different from current rule?
If finalized, which is very likely, this rule would rescind and replace the 2021 Independent Contractor Rule (2021 IC Rule). That rule was finalized in January 2021 shortly before President Trump left office and President Biden was inaugurated, and it was scheduled to take effect in March 2021.
The 2021 IC Rule focuses on two core factors to determine classification: 1, the nature and degree of control over the work, and 2, the worker’s opportunity for profit or loss. Additional factors may be considered if the first two are not clearly determinative. The purpose of this streamlined approach is to “promote certainty for stakeholders, reduce litigation, and encourage innovation in the economy,” according to the final rule published by the DOL.
The current NPRM notes that the approach of the 2021 IR is not in keeping with past approaches, which have included multifactor economic reality tests that looked at the totality of the circumstances, it does not “fully comport” with the FLSA’s text and purpose, and it goes against long standing case law.
In practice, the 2021 IC Rule makes it easier for workers to be classified as independent contractors rather than employees. The rule that’s currently being proposed would make it harder for workers to be classified as independent contractors.
DOL and IRS working together to identify employers misclassifying workers
The interest in codifying and enforcing rules on worker classification is not new.
The DOL and the IRS entered into a Memorandum of Understanding (MOU) in 2022, replacing a similar one from 2011, in which the agencies agree to collaborate and share information. This is less in the pursuit of protecting workers and ensuring they are afforded the protections under the FLSA due to them and more about collecting revenue.
The point of the collaboration is to “promote employer compliance with obligations to properly pay employees and to pay employment taxes.” The MOU outlines, among other things, how the DOL can evaluate businesses to refer to the IRS to look into whether workers have been misclassified. In addition, in reference to whether the DOL should refer a particular case to the IRS, it says “Given scarce IRS resources, the focus is where there is a likely source of collection.”
In short, the IRS appears to be looking for sources of revenue. (Another recent initiative announced by the IRS is a “proposed revenue procedure” called the Service Industry Tip Compliance Agreement program, a voluntary program for employers that would improve reporting of tips to the IRS.)
What this means for employers
Employers need to pay attention to if and when the DOL finalizes the rule proposed in October 2022 and ensure that they are correctly classifying their workers under the new rule once it takes effect. Some employers may be able to easily reclassify existing independent contractors as employees, if needed. Others may not have the resources to do so, because of the associated costs of employment taxes, workers’ compensation insurance, additional benefits, and so forth for employees. Employers may have to significantly change their relationship with their workers in order to meet the qualifications of being an independent contractor, or possibly let these workers go entirely.
The DOL notes in its NPRM that businesses that are already in compliance and are correctly classifying workers will benefit from this new rule, as businesses that misclassify employees as independent contractors gain a competitive advantage. This advantage will be eliminated or reduced if and when the new rule is finalized.
Additionally, an increase in the number of employers could mean an increase in unions and labor organizing. Labor unions generally are not allowed to organize independent contractors, but they can organize employees. The connection between worker classification and the drive to increase organizing and unions was made explicit on Joe Biden’s campaign website page for “Strengthening worker organizing, collective bargaining, and unions.” One of the promises was to “drive an aggressive, all-hands-on-deck enforcement effort that will dramatically reduce worker misclassification.”
Employers should also be aware that even if/when this rule from the DOL is passed, this is not the one and only way to determine whether a worker is an employee. The IRS has its own guidance on determining whether to provide a 1099 or a W-2 (read more on that here), and individual states may have their own rules or precedents, too; in South Carolina, the four-factor model is the standard (read more on that here).
Contact Business Attorney Gem McDowell for Advice and Guidance
If you’re an employer in South Carolina and are seeking legal advice, call Gem McDowell. He has over thirty years of experience helping South Carolina business owners start, grow, and thrive in their businesses. Changing classifications of workers could have a large impact on your business, as could noncompliance, and Gem can advise you on how to navigate this change.
Call Gem and his team at the Gem McDowell Law Group at the Mount Pleasant office at 843-284-1021. In addition to an office in Mount Pleasant near Charleston, Gem also has an office in Myrtle Beach for your convenience.
At-Will Employment in South Carolina: New Supreme Court Rulings
You may know that South Carolina is an at-will employment state. But what does that really mean?
In an at-will employment state, work is presumed to be at-will unless otherwise defined by contract. In an at-will employment arrangement, both the employer and the employee have the right to end the arrangement without notice and for any reason, without incurring liability. (There are a few exceptions to this, mentioned below.)
The South Carolina Supreme Court recently accepted three certified questions asked by the US District Court for the District of South Carolina to clarify state law on at-will employment matters. Here are the three questions put to the SC Supreme Court in Hall v UBS Financial Services Inc, 2021 (find it here) with more discussion on each issue below.
- Are terminable at-will employment relationships contractual in nature as a matter of law?
- Does the implied covenant of good faith and fair dealing arise in the context of terminable-at-will employment relationships, and can an employer’s termination of an at-will employee constitute a breach of the relationship such that it may give rise to a claim by the former employee against the employer for breach of the implied covenant of good faith and fair dealing?
- Can an employer’s termination of an at-will employee, which results from a third-party employee’s report to the employer, constitute a breach of the relationship such that it may give rise to a claim by the former employee against the third-party employee for tortious interference with a contractual relationship?
The SC Supreme Court discusses the law rather than the particular facts of the case, but here’s some quick background before we delve into the court’s legal reasoning behind its answers:
Curt O. Hall sued his former employer, UBS Financial Services Inc., and a former co-worker, Mary Lucy Reid, after he was fired by UBS. Hall was a manager of the Greenville branch of UBS, and in September 2017 he organized a happy hour that a number of employees, including Reid, attended. Reid said she was scared to go home because of issues with her boyfriend, and Hall offered to let her stay at his home for the night. At the end of the night, Reid’s friend drove Hall home after the three of them had gone to dinner, with Hall and Reid sitting in the backseat together. Before getting out of the car, Hall again asked Reid if she was okay, then gave her a “European-style consolatory cheek kiss” (in the words of the district court) before getting out of the car. He texted her later that same night repeating his offer to let her stay, which she ignored. Soon after, Reid reported the incident to the HR department, and HR questioned Hall about his version of events. He was fired a few weeks later.
Hall brought a claim against UBS for breach of implied covenant of good faith and fair dealing and a claim against Reid for tortious interference with contractual relations, among other claims.
Question 1. Are terminable-at-will employment relationships contractual in nature as a matter of law?
The Supreme Court of South Carolina says yes.
The answer lies in general contract law. The court quotes itself in Prescott v Farmers Tel. Coop., Inc., 1999, in which it said “[T]o prove the existence of a definite contract of employment, the employee must establish all of the elements of a contract. The elements are: 1. A specific offer, 2. Communication of the offer to the employee, and 3. Performance of the job duties in reliance on the offer. The court says in Hall, “We agree with the majority of jurisdictions that have addressed this issue, and we hold those elements are present in every at-will employment arrangement.”
However, the court cautions that answering yes doesn’t “light a path” to make valid breach of contract claims when an employee is terminated. “[O]ur recognition that at-will relationships are contractual does not alter the established rule allowing an employer to discharge an at-will employee for any reason without incurring liability. That is because under South Carolina law, the right to fire the employee at any time and for any reason is an integral term of the at-will contract.”
(Note that there are exceptions that can impose liability on the employer for terminating an employee, such as termination in violation of the terms of the employee handbook or in violation of public policy, but here the supreme court answers the district court’s questions on the assumption that there are no exceptions.)
Question 2 Part A. Does the implied covenant of good faith and fair dealing arise in the context of terminable-at-will employment relationships?
The Supreme Court of South Carolina says yes.
“There exists in every contract an implied covenant of good faith and fair dealing,” says the court quoting Adams v. G.J Creel & Sons, Inc., 1995.
The court admits that both the SC Supreme Court and the SC Court of Appeals have previously found on occasion that the covenant doesn’t arise in at-will employment relationships. However, having answered a definitive “yes” to the first question, rationales denying the existence of the covenant in at-will employment relationships are no longer valid. “The implied covenant of good faith and fair dealing exists in all at-will employment contracts,” says the court in Hall.
Question 2 Part B. Can an employer’s termination of an at-will employee give rise to a claim by the former employee against the employer for breach of the implied covenant of good faith and fair dealing?
The South Carolina Supreme Court says no.
This question implies that breach of the implied covenant of good faith and fair dealing could be the basis for a cause of action. The SC Court of Appeals has held that it is not a cause of action separate and distinct from a cause of action for breach of contract. As answered in Part A, because every contract includes this covenant, then if the covenant has been breached then so has the contract, and the cause of action would be breach of contract.
In a separate opinion from the majority, Justice Few further explains the issue well, stating that while contracts have the covenant implied, the law superimposes over that the express provision that the employer may terminate an employee “at any time, for any reason or for no reason at all” (quoting Prescott). “This includes a reason that may not be in good faith,” writes Justice Few. “Stated differently, the implied promise to act in good faith does not protect the employee from being fired – no matter the reason – because the law specifically provides that the contract of employment permits any firing, even if it is not in good faith” (emphasis added).
In the majority opinion, the court answers Question 2 in its entirety as follows: “The implied covenant of good faith and fair dealing exists in an at-will employment contract; however, the employer’s termination of the employee cannot form the basis of a claim that the employer breached the covenant of good faith and fair dealing.”
Question 3. Can an employer’s termination of an at-will employee, which results from a third-party employee’s report to the employer, give rise to a claim by the terminated employee against the third-party employee for tortious interference with a contractual relationship, even when the termination itself was not a breach of the at-will contract?
The SC Supreme Court says yes.
The question the court poses and answers here is different from the one posed by the district court as stated at the top. The court revised the question because, it explains, the viability of a tortious interference claim brought by a terminated employee doesn’t depend on whether the termination was a breach of the at-will contract, but whether the third-party employee, without justification, made a report to the employer which led to the termination.
From Eldeco, Inc. v Charleston Cty. Sch. Dist., 2007, the elements of a claim for tortious interference with contractual relations are: 1. The existence of a contract, 2. Knowledge of the contract, 3. Intentional procurement of its breach, 4. The absence of justification, and 5. Resulting damages.
The court states that the majority of jurisdictions addressing this issue find that there can be a cause of action against a third party for tortious interference, even if there is no underlying breach of contract. It concurs, recognizing the validity of such a claim, and holds that “the absence of an underlying breach by the terminating employer does not shield the third party from liability when she intentionally and unjustifiably procures the termination of an at-will employee.”
Help with Contracts, Employment Matters, and Business in South Carolina
For help with contracts, corporate governance documents, starting or selling a business, and insightful advice from a legal perspective, contact business attorney Gem McDowell of the Gem McDowell Law Group. Gem has over 30 years of experience working with individuals and businesses in South Carolina, and he and his team can help you grow your business and protect your assets. Call the Mt. Pleasant office at 843-284-1021 today to schedule a free consultation.
