Employment Law Commentary Volume 23, No. 11 November 2011

Independent Contractors: Recent Developments in the Courts

The Internal Revenue Service (IRS), the Department of Labor (DOL), and various states have recently been devoting additional resources to remedy alleged worker misclassifications. If the IRS or a state agency brings an enforcement action, it's a fair bet that private actions claiming wage and hour and other violations will follow close behind.

This Employment Law Commentary looks at recent case developments that could impact how these actions come out.

2012: The Year of Enforcement

Independent contractor misclassification means big tax losses for federal and state governments, and they're doing something about it. The recent IRS initiative designed to remedy misclassification is expected to reap at least $7 billion in additional federal revenue over the next ten years.

In 2009, the IRS and the DOL announced a massive three year Misclassification Initiative designed to determine if independent contractors are properly classified. In 2012, the IRS is focusing its sights on big employers after honing its audit, investigation, and prosecution skills on small employers over the past two years.

And the states aren't just standing by: many states, including California, Illinois, Massachusetts, New Jersey, New York, and Wisconsin, have adopted legislation with the purpose of targeting independent contractor misclassification. In last month's Employment Law Commentary, we discussed California's recent legislation, S.B. 459, and its increased penalties for "willful" misclassification of independent contractors.

Further, on September 19, 2011, the DOL, the IRS, and 11 state agency leaders signed memorandums of understanding (MOU) to improve the agencies' coordination on employee misclassification. The Secretary of Labor Hilda L. Solis explained that the various agencies are "standing united to end the practice of misclassifying employees." Under the MOU, the DOL will share information and coordinate law enforcement with the IRS and participating states. The MOU "takes the partnership between the IRS and the Department of Labor to a new level," said IRS Commissioner Doug Shulman.1

Recent Case Developments

Courts are constantly reassessing the law on independent contractor classification. This section looks at recent case law that may have an effect on how companies determine whether individuals are independent contractors and, once they have made the determination, how they structure those relationships.

First, we discuss significant updates in the tests courts use to determine whether an individual is an independent contractor or an employee. Next, we discuss a recent California Supreme Court case that broadened the definition of employer and could create liability for affiliated companies if a court determines that an alleged independent contractor is actually an employee. We next turn to a discussion of recent cases that limit a company's ability to enforce choice-of-law and venue provisions in agreements with alleged independent contractors. Finally, we consider the degree to which courts will hold a company responsible for the actions of an independent contractor.

The Various Tests

Defining an "independent contractor" is among the more difficult and frustrating undertakings for companies. Not only do government agencies have their own multifactor fact-intensive tests, but getting it wrong exposes businesses to government audits, enforcement actions, substantial fines and penalties, individual and class actions, and even criminal prosecution.2 Businesses need to stay on top of significant developments in the various tests as they could alter the outcome of any given lawsuit or enforcement action.

Title VII. In Murray v. Principal Financial Group Inc., 613 F.3d 943 (9th Cir. 2010), the Ninth Circuit clarified for the first time in 2010 what test to use to determine whether an individual is an employee or an independent contractor under Title VII. In so doing, the court looked at the tests variously applied in the lower courts (the economic realities test, the common law agency test, and the hybrid test) and concluded that there was no functional difference among the three. Nonetheless, the Darden common law test is the appropriate test to determine whether an...