Court Says Workers Are Employees, Not Independent Contractors, and Can Make Claim for Overtime Wages
October 30, 2008
Mark G. Alexander- Jacksonville
On October 13, 2008, the Fifth Circuit Court of Appeals decided an important case on the increasingly litigated question of whether workers are independent contractors or employees. The consequences of improperly classifying employees as independent contractors can be huge. The company discussed in the following case faces a significant risk of loss because of an improper classification.
Hopkins v. Cornerstone America
In Hopkins v. Cornerstone America, 2008 WL 4542491, the Fifth Circuit addressed whether sales leaders for the marketing division of a life insurance company were properly characterized by the company as independent contractors. A group of former sales leaders sued, alleging they were employees and, therefore, entitled to unpaid overtime wages under the Fair Labor Standards Act (FLSA) even though the company treated them as independent contractors. The improper classification of a large number of workers as independent contractors can expose a company to very significant claims for overtime wages.
The Law
The FLSA was adopted by Congress in 1938 as part of the New Deal legislation of the 1930s along with laws such as the National Labor Relations Act of 1935 and the Social Security Act of 1935. The FLSA requires employers to pay their employees minimum wages and overtime, but does not apply to independent contractors. However, the definition of “employee” under the FLSA is particularly broad and may cover some workers who may not meet the definition of “employee” for other purposes, including other federal employment statutes. As early as 1947, the U.S. Supreme Court held that the test for determining who was an employee under the FLSA was not the common law test of control, but instead focused on the underlying economic realities of the relationship. Rutherford Food Corp. v. McComb (Sup. Ct. 1947). This “economic realities” test focuses on whether, as a matter of economic reality, the worker is economically dependent on the alleged employer or is instead in business for himself. The “economic realities” test is the law today in every circuit in the United States that has considered the issue.
The Decision
The company in this case, Cornerstone America, sells various insurance products through a pyramid system of about 1,200 sales agents, each of whom works as an independent contractor on a commission basis. The company also has “sales leaders,” who are sales agents promoted into leadership roles to manage the sales agents. The company treats these sales leaders as independent contractors as well, even though their primary responsibility is recruiting, training and managing a team of subordinate sales agents. It was members of this group who sued.
The trial judge held that the sales leaders should have been characterized as employees and that the sales leaders who sued could proceed with their collective action against the company for overtime wages. Through a collective action, the claimants are challenging the company’s actions on behalf of themselves as well as other sales leaders in the company. Such a claim can sometimes put a company’s entire business model in jeopardy and have ramifications beyond the monetary liability at issue in a given lawsuit.
The company appealed the trial judge’s decision to the Fifth Circuit, which agreed that the claimants are employees for FLSA purposes and could proceed with their collective action for overtime wages. It is important to note, however, that the Fifth Circuit did not address any exemptions that might provide a defense to the employer to the overtime wage claims. The court ruled only that the collective action for wages could proceed because the claimants are employees, not independent contractors.
In evaluating the economic realities, the Fifth Circuit in Hopkins considered five non-exhaustive factors:
1) the degree of control exercised by the alleged employer;
2) the extent of the relative investments of the worker and the alleged employer;
3) the degree to which the worker’s opportunity for profit or loss is determined by the alleged employer;
4) the skill and initiative required in performing the job; and
5) the permanency of the relationship.
None of these factors alone is determinative. The question of the company’s control is considered as one of the factors, but the primary focus of the multi-factored test under the FLSA is whether the worker is economically dependent on the company. If so, the worker is an employee rather than an independent contractor.
Economic Dependence
In the Hopkins case, the Fifth Court considered all the facts concerning how the sales leaders function in the context of the company’s business. Those facts are outlined in detail in the Court’s decision. The Court held that as a matter of economic reality, the sales leaders were dependent on the company to such an extent that they could not plausibly be considered to be in business for themselves. It found significant that the company controlled the foundation of the sales leaders’ ultimate success – the hiring, firing, assignment and promotion of the subordinate sales agents on whom the sales leaders relied for their own compensation. In light of the sales leaders’ economic dependence on the company for their livelihood, they were employees for purposes of the FLSA, the Fifth Circuit ruled.
An interesting twist to this case is that one of the sales leaders was previously accused of sexual harassment. In that harassment case, he had testified that he was an independent contractor, not an employee as he now claimed. The trial judge ruled that the individual’s earlier testimony that he was an independent contractor “judicially estopped,” or precluded, him from now claiming that he was truly an employee. But the Fifth Circuit reversed, noting that a worker can be properly characterized as an independent contractor for one purpose and as an employee for another purpose. The sales leader’s seemingly contradictory statements were not necessarily inconsistent because the standard for determining whether he was an employee under the FLSA is broader than it is under the applicable civil rights law governing sexual harassment. This twist provides a tangible example of how a worker can be an independent contractor for one purpose or one law but an employee for another.
Is Your Business Model at Risk?
The result of this decision is that the case will be remanded to the trial court so that the claimants can move forward on their collective action for overtime wages. Of course, the company will be entitled to assert whatever arguments it might have under the FLSA in defense of the claim for wages. However, the claim exposes the company to significant risk of loss and requires the company to evaluate its business model.
This case illustrates the considerable risk for companies that operate on a business model that relies on large numbers of independent contractors who might be considered economically dependent on the company for their livelihood. It further shows that companies may be at risk of FLSA claims from individuals it has properly classified as independent contractors for other purposes. The challenge to companies is particularly complicated because of the multitude of statutory and common law frameworks for analysis.
For more information, contact:
Mark G. Alexander
904.798.5460
mark.alexander@hklaw.com
toll free: 1.888.688.8500
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