The legal landscape with regard to who must be paid for their work, and what and how they must be paid is collectively shifting as a result of recent developments from the U.S. Department of Labor (DOL) and the federal courts. A recent decision by the Second Circuit U.S. Court of Appeals has cleared the way for employers to hire more students as unpaid interns by rejecting a rigid six-factor DOL test that had precluded virtually all unpaid internships. At the same time, though, the DOL has tightened other standards to push many more workers into the classification of employees (not freelancers or independent contractors) and the DOL projects its new proposed regulations on overtime eligibility will annually entitle millions of more employees to overtime pay.
The Good News – Clarified Standard for Unpaid Internships
Considering a claim by several unpaid interns who worked for Fox Searchlight Pictures, Inc. and Fox Entertainment Group, Inc. who argued that they should have been paid as employees for the work they performed, the Second Circuit federal appellate court in a July 2, 2015 decision rejected a long-standing six-part test outlined by the DOL for determining whether interns are employees entitled to be paid. The DOL test had spawned numerous class action lawsuits over the past several years, particularly in the publishing and media industries. It classified interns as employees entitled to be paid at least minimum wage unless, among other things, they did not displace regular employees in their work and the employer derived no immediate advantage from their activities. For a discussion of how the DOL test, and particularly these two factors, applied in practice to generally require compensating interns, see the Spring 2014 Life’s Lessons column, available on the Levy Employment Law, LLC website.
In lieu of that test the Court adopted a standard, under both federal and New York law, that is based on whether the intern or the employer is the “primary beneficiary of the relationship.” The Court presented a non-exhaustive set of factors to be considered under the primary beneficiary standard including:
1. the extent to which the parties understood there was no expectation of
compensation (any promise of compensation suggests an employee relationship);
2. the extent to which the internship provides training similar to clinical, hands-on
or other training in an educational environment;
3. the tie between the internship and the intern’s formal education program,
such as through integrated coursework or the receipt of academic credit;
4. the internship’s alignment with the academic calendar and accommodation
of the intern’s academic commitments;
5. the extent to which the internship is limited to the period in which it
provides the intern with beneficial learning;
6. the extent to which the intern’s work provides significant educational benefits
and complements, rather than displaces, the work of paid employees; and
7. the extent to which the parties understand that there is no entitlement to
a paid job at the conclusion of the internship.
The Court further explained that no one factor is dispositive, and all need not be satisfied to support a finding that the intern is not an employee entitled to be paid. This is a notable change from the former, rigid DOL test and will permit more employers to offer unpaid internships, even if the employer also derives some economic benefit from the student interns’ work. At the same time, however, the Court’s decision does not give employers carte blanche to bring on new student interns. The crux of the Second Circuit’s primary beneficiary test is that there exist a sufficient educational nexus between the internship experience and the intern’s academic studies, and that, on balance, the internship is primarily of benefit to the intern (not free labor for the employer). Employers should seek legal guidance on how to appropriately structure their internships to comply with the new legal standard.
The Bad News – DOL Guidance on Classification of Workers
Expressing concern that misclassification of employees as independent contractors denies individuals workplace protections and creates an uneven playing field relative to employers that abide by the wage and hour laws, in July the U.S. Department of Labor’s Wage and Hour Division issued its first Administrator’s Interpretation of 2015 (Guidance) to clarify the extremely broad definition of “employee” under the Fair Labor Standards Act (FLSA) and curtail misclassification. Applying that definition, the Guidance declares that most workers are employees under the FLSA.
The Guidance is helpful in pulling together caselaw and practical examples to provide a more comprehensive picture of how the DOL distinguishes between an independent contractor and an employee. This is achieved primarily through an in-depth discussion of the six factors that comprise the “economic realities test” that the courts apply when analyzing FLSA claims concerning worker classification.
Economic dependency on the employer, the Guidance declares, is central to the economic realities test and all six of the test factors are important, with no single factor being determinative. Employers that rely on independent contractors, or freelancers, are advised to confer with legal counsel after reviewing these factors closely. As summarized below, the factors present a collective portrait of an independent contractor as someone who is operating a truly separate business operation, and whose livelihood is not dependent on any one employer either as a source of direct income or referral to work for others.
The Guidance stresses that the parties’ written agreement, and whether the worker is paid on a 1099 or W-2 basis, are not relevant to the analysis of the worker’s status. Rather, considerations that are relevant under the economic realities test are:
1. the extent to which the work performed is an integral part of the employer’s business
Workers are more likely to be employees if the work they perform aligns with the primary purpose of the employer’s business, and this is the case even if the work is performed away from the employer’s premises, at the worker’s home, or on the premises of the employer’s customers;
2. the worker’s opportunity for profit or loss depending on his or her managerial skill
Managerial skills that affect opportunity for profit or loss are decisions by the worker such as hiring helpers to assist with the work, purchasing materials and equipment, advertising, renting space, negotiating contracts, recruiting clients and managing time tables. If the worker’s opportunity for profit or less turns solely on whether he/she decides to work more hours or has sufficient work available, then he/she is likely an employee.
3. the extent of the relative investments of the employer and the worker
The worker’s investment should be viewed in relative terms to the employer’s investment. For example, investment in tools and equipment is not necessarily indicative of an independent contractor if the employer is making a proportionately much more substantial investment in machinery, materials, land, advertising, insurance, and finding clients.
4. whether the work performed requires special skills and initiative
This factor needs to be considered relative to independence and business-like initiative. Determining the sequence of work, ordering additional materials, or bidding on future jobs are suggestive of an independent contractor, while using specialized skills to perform the work that has been assigned simply equates to being a skilled employee.
5. the permanency of the relationship
If impermanence is due to operational characteristics intrinsic to the industry (such as seasonal work) that suggests an employee relationship, while impermanence due to the worker’s own business initiative (in deciding not to take on further projects for a particular employer) suggests an independent contractor.
6. the degree of control exercised or retained by the employer
The Guidance stresses that the “control” factor should not be given undue weight, but rather considered in totality with the others to determine whether a worker is economically dependent on the employer. To be an independent contractor, the worker must actually exercise control over meaningful aspects of the work performed such that it is possible to view the worker as conducting an independent business. The Guidance clarifies that employer control is control, even if it is for the purpose of assuring consistent quality, complying with regulatory requirements, or ensuring customer satisfaction, and control indicates employee status. From the worker’s perspective, mere control of work hours, particularly for a remote worker, does not evidence he/she is an independent contractor.
Notably, satisfaction of these factors is expected only for compliance with the FLSA, which concerns federal minimum wage and overtime eligibility. State wage and hour laws, unemployment insurance laws, and other laws pertaining to workers may have different definitions of employee status. Compliance with the federal law is the minimum requirement for all employers, and to the extent state laws are even more restrictive in defining independent contractors, those standards would apply with respect to local workers.
The Pending Bad News – New Proposed DOL Regulations on Exempt Status
Under the FLSA, all employees are entitled to be paid overtime at one and one half times their regular hourly rate for hours worked over 40 in a given workweek unless they fall into one of the FLSA exceptions that make them “exempt” from this obligation. Among these exceptions are the “white collar exemptions” for employees (1) who are paid a fixed weekly or annual salary, regardless of the hours they actually work, that meets a minimum salary threshold (currently $23,660 per year), and (2) whose primary job duties are in an executive, administrative or professional capacity. In late June, the DOL issued long-awaited proposed regulations that narrow the scope of these FLSA exceptions in several key respects:
- more than doubling the annual base salary threshold to qualify for exempt status, so that most employees who earn less than $50,440 per year in base pay (not inclusive of bonuses, incentive compensation or other financial rewards) would automatically be classified as overtime eligible, regardless of the nature of the work they perform;
- increasing to $122,148 per year the compensation standard for qualifying as a “highly compensated employee,” who is presumed to be ineligible for overtime without the necessity of analyzing the nature of the work the employee performs;
- possibly permitting up to 10% of the $50,440 annual salary level threshold to be satisfied through nondiscretionary bonuses or incentive compensation schemes but only if they are paid out on a monthly or more frequent basis;
- annually updating both the standard and highly compensated employee salary thresholds by pegging them either to respectively match the 40th and 90th percentiles of earnings for full-time salaried workers in the U.S., or to rise with inflation; and
- potentially considering modifications to the standard for assessing whether an employee’s primary duties qualify under the white collar exemptions.
We refer to these changes as the “pending” bad news for employers because they are only proposals at present. The public has 60 days (until September 4, 2015) to comment on the regulations; those comments will then be considered and the final regulations are not expected to be issued until the first half of 2016. Although some changes, such as modification of the primary duties test, seem rather speculative at this time, it is highly likely that the final version will include substantial increases in the annual base salary and highly compensated employee thresholds, as well as some process to automatically update those thresholds on an annual basis.
Given the broad impact of those two changes alone, employers would be well-advised to begin taking stock of their workforces and identifying roles that are likely to be impacted by the FLSA regulatory changes. The DOL estimates that 4.6 million workers will potentially be affected by the base salary level change in the first year of implementation, and an additional 6.3 million workers who are currently classified as non-exempt based on their primary duties will more clearly be classified as overtime-eligible simply by virtue of their compensation falling below the new base salary level threshold.