An Introduction to Employment Law:

Why You Should be Concerned

Texas Lawyer’s In-House Counsel Summit

May 17, 2012

Daniel D. Pipitone

Jacqueline T. Coyne

1200 Smith Street, 14th Floor

Houston, Texas 77002

Telephone: (713) 654-9637

An Introduction to Employment Law: Why You Should be Concerned

Current trends in litigation indicate that employment law issues, especially those related to the Fair Labor Standards Act (“FLSA”), are of increasing concern to employers. In fact, FLSA lawsuits have recently been described as one of the “fastest growing areas of litigation.”[1]This is likely due the August 23, 2004 revisions to the FLSA,[2] as well as a strategic crackdown on employers by the Wage & Hour Division of the Department of Labor (“DOL”) for the misclassification of employees.[3]

Between 2010 and 2011, the number of wage and hour lawsuits filed in federal court has increased by 15%.[4]Since 2008, the number has increased by 32%.[5]Already, between January 1 and March 31 of this year, over 200 employment law cases have been filed in the Southern District of Texas alone that remain active, with at least 100 of them alleging FLSA violations by employers.[6]

These statistics should be of particular concern to employers, as the penalties for violations of the FLSA can include back wages and overtime, liquidated damages, attorney’s fees, fines, and court costs.[7]The value of settlements in these wage and hour lawsuits has been rising as well. In 2009, the value of the top ten private settlements totaled $363.6 million, increasing nearly 44% from the 2008 value.[8] In addition to these penalties, employers can be potentially subjected to government audits and tax penalties as a result of a DOL investigation. Further, the FLSA allows for one or more employees to file a “collective action,” which isin essence a special type of class action lawsuit where other employees can elect to “opt in” to the suit.[9]

Accordingly, it is imperative that employers understand the basic provisions of the FLSA so that they cancorrectly classify employees, implementcompany policies to reduce the risk of inadvertent violations of the law,andeffectively navigate any DOL investigation or FLSA litigation that may occur.

FLSA Basics: What You Need to Know

The FLSA creates a standard guide for employers to follow by establishing minimum-wage, overtime pay, record keeping, and child labor standards for both full and part-time workers.[10]Although the functions and protections of the FLSA are broad, the most pressing issues for both employers and their workers are those relating to minimum wage and overtime pay. These two issues form the basis for most wage and hour claims, which constitute the bulk of FLSA litigation.

Under the FLSA, employers must pay employees no less than the federal minimum wage, which is currently $7.25 for all hours worked in a workweek.[11]A workweek is defined as “a fixed and regularly recurring period of 168 hours—seven consecutive 24-hour periods. It need not coincide with the calendar week but may begin on any day and at any hour of the day.”[12]Overtime compensation for all hours worked over 40 in a workweek must be at least 1.5 times the employee’s regular rate of pay.[13]

In order to incur liability under the FLSA for minimum-wage and overtime violations, an employer-employee relationship must first exist.[14]The FLSA defines an employee as an individual that is “employed by an employer.”[15] In order to be employed, the individual must “suffer or [be permitted] to work.”[16]Clearly, these definitions provide employers with little guidance as to how to classify their workers, and much litigation has ensued as a result of their ambiguity and “striking breadth.”[17]

To further complicate the issue for employers, the FLSA exempts certain classes of employees from theseovertime requirements.[18]In order to be classified as an exempt employee, the employee must receive a total compensation of at least $455 per week on a salary or fee basis.[19] Further, the employee must fall within the FLSA’s list of exempted employee classes, which include executive, administrative, professional, computer, and outside sales employees.[20]Each ofthese terms is defined by the DOL.[21]

Penalties for noncompliance with the FLSA can be very problematic for employers. The FLSA defines an employer as “any person acting directly or indirectly in the interest of an employer in relation to an employee.”[22]A person is defined as “an individual, partnership, association, corporation, business trust, legal representative, or any organized group of persons.”[23]Thus,in addition to a business organization, individuals can be held personally liable for FLSA violations, and multiple circuits have determined that the FLSA definition of an employer can even include corporate officers with economic or operational control.[24]

FLSA penalties are severe, and include:

(1)Back Pay. Back pay is equal to the difference between the amount the employee was paid and the amount that he or she should have been paid by the employer, including the minimum hourly wage as well as overtime.[25]

(2)Liquidated Damages. Liquidated damages may be recovered in addition to back pay in an amount equal to the back pay award unless the company can establish that it had a good faith belief that its pay practices complied with the FLSA.[26] A court may deny or reduce liquidated damages if the employer proves that it (1) had a subjective good faith belief that it was not violating the FLSA; and (2) the employer’s belief was reasonable.[27]

(3)Attorney’s Fees and Court Costs.Employees who prevail can recover attorney’s fees and court costs.[28]

(4)Fines and Imprisonment. Employers who have willfully violated the FLSA are subject to fines of up to $10,000. If the employer repeatedly violates the FLSA, he or she can also be subject to up to six months of imprisonment.[29]

Employees have up to two years to seek recovery of back pay, and they have up to three years if the violation is willful.[30]They can also file a “collective action,” which amounts to a class action suit in which other employees can “opt in” to the lawsuit.[31] These collective actions can quickly add up to very steep penalties for employers, as claims by multiple employees can be aggregated into one. For example, in 2009, Wal-Mart settled a collective action in California for $86 million, whichwas brought by 232,000 current and former employees whoalleged that Wal-Mart had failed to pay them vacation, overtime, and other wages.[32]

Not surprisingly, most FLSA compliance and litigation issuesfor employers arise within this FLSA framework. Such issues generally result from:(1) the misclassification of a worker as an independent contractor,rather than an employee subject to the FLSA; (2)the misclassification of employees as exempt or non-exempt;and (3)the failure of employers to pay non-exempt employees for time actually worked. Accordingly, each of thesesubjectswill be discussed in greater depth below.

Misclassification of Workers

The misclassification of workers as independent contractors, when they qualify as employees, and as exempt employees, when they are actually non-exempt employees, are two of the largest wage and hour issues currently facing employers. The tests used to determine the worker’s status are both vague and complicated, and as outlined above, the penalties for misclassification can be severe.Thus, a basic understanding of the classification of workers by employers is imperative to ensure proper compliance with the FLSA.

  1. Employee vs. Independent Contractor

To determine a worker’s status as an employee or an independent contractor for purposes of the FLSA, the DOL uses the “economic realities” test.[33]Under this test “[w]here the work done, in its essence, follows the usual path of an employee, putting on an ‘independent contractor’ label does not take the worker from the protection of the [FLSA].”[34] Thus, whether a worker is actually an employee depends upon the “economic reality” of the situation.[35] To help in this determination, the DOL has published a set of factors to assist employers in determining whether an employee is an independent contractor.[36] These factors include:

(1)The extent to which the services rendered are an integral part of the employer’s business;

(2)The permanency of the relationship;

(3)The amount of the worker’s investment in facilities and equipment;

(4)The nature and degree of control by the employer;

(5)The worker’s opportunities for profit and loss;

(6)The amount of initiative, judgment, or foresight in open market competition with others required for the success of theworker; and

(7)The degree of independent business organization and operation.[37]

No single factor is determinative;[38] rather, one must “evaluate the totality of the circumstances, focusing on the economic realities of the particular employment relationship.”[39]

It is important to note that the Internal Revenue Service (“IRS”) and the DOL use similar, but different, tests to determine whether a worker is an employee. This is important because incorrect classification of an employee as an independent contractor may result in employers being held liable for employment taxes for that worker[40] as well as costly health insurance ramifications.Employers must generally withhold federal income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee.[41] By contrast, an employer does not generally have to withhold or pay any federal taxes on payments to independent contractors.[42]

Further, employers are increasingly concerned withthe classification of workers as independent contractors due to the recent passage of the Patient Protection and Affordable Care Act, better known as ObamaCare.[43] Under ObamaCare, which is set to take effect on January 1, 2014, employers with 50 or more full-time employees are obligated toprovide health insurance coverage to full-time employees, but not to drivers who meet the IRS independent contractor test or part-time employees.[44] Should an employer not offer a health care plan to its employees, it will be penalized ifat least one of the employer’s full-time employees takes a government subsidy to buy coverage on his/her own.[45]This penalty amounts tothe lesser of $3,000 for each employee who obtains subsidized coverage, or $2,000 for each full-time employee beyond the first 30, which are automatically excluded.[46] Notably, the term “full-time employee” is defined as an employee who is employed on average at least 30 hours of service per week.[47]As such, proper classification of workers as independent contractors is a key concern for employers.

It is important to note that the test used by the IRS to distinguish independent contractors from employees has recently changed from the “right to control” test, which considered a set of 20 factors, to a more simplified test which considers three characteristics to determine the relationships between workers and employers.[48]Under the new IRS test, the IRS will consider an employer’s behavioral and financial control over a worker as well as the type of relationship between the parties.[49]This new IRS test is set forth as follows:

(1)Behavioral Control

  1. Instructions the business gives the worker. An employee is generally subject to the business' instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work:
  1. When and where to do the work
  2. What tools or equipment to use
  3. What workers to hire or to assist with the work
  4. Where to purchase supplies and services
  5. What work must be performed by a specified individual
  6. What order or sequence to follow

The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right.

  1. Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

(2)Financial Control

  1. Facts that show whether the business has a right to control the business aspects of the worker's job include:
  1. The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their business.
  1. The extent of the worker's investment. An employee usually has no investment in the work other than his or her own time. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.
  1. The extent to which the worker makes services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.
  1. How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
  1. The extent to which the worker can realize a profit or loss. Since an employer usually provides employees a workplace, tools, materials, equipment, and supplies needed for the work, and generally pays the costs of doing business, employees do not have an opportunity to make a profit or loss. An independent contractor can make a profit or loss.

(3)Relationship Between the Parties

  1. Facts that show the parties' type of relationship include:
  2. Written contracts describing the relationship the parties intended to create. This is probably the least important of the criteria, since what really matters is the nature of the underlying work relationship, not what the parties choose to call it. However, in close cases, the written contract can make a difference.
  1. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. The power to grant benefits carries with it the power to take them away, which is a power generally exercised by employers over employees. A true independent contractor will finance his or her own benefits out of the overall profits of the enterprise.
  1. The permanency of the relationship. If the company engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
  1. The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of the company's regular business activity, it is more likely that the company will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.[50]

Accordingly, whether under the DOL test or the IRS test,the classification of a worker as an independent contractor, rather than an employee,does not depend on the worker’s title. Instead, the employer must consider its overall relationship with and control over the worker, and establish clear agreements and company policies with regard to his or her independent contractors. Thus, employers should:

(1)Execute and abide by an independent contractor agreement. The following terms should be included in the agreement:

  1. Lack of control by the company over the means by which the worker performs his or her duties;
  1. The term of the agreement (employers should complete a new agreement for each term);
  1. The intent of both parties that the worker is an independent contractor;
  2. A requirement that the worker uses his or her own equipment or tools;
  3. A statement that the worker may perform services for other businesses;
  4. The ability of the worker to assign tasks to others;
  5. An agreement that the worker provide his or her own workers’ compensation insurance, unemployment insurance, and liability insurance;
  1. An acknowledgment that the worker is ineligible for employee benefits; and
  2. A requirement that the worker has his or her own tax identification number.

(2)Require independent contractors to be incorporated and have business cards.

(3)Insist on invoices for work done.

(4)Allow workers the opportunity for profit or loss.

  1. If a contracting company supplies workers, the contracting company should have the opportunity for profit or loss depending on the quality of the work performed.
  1. The contracting company should have exclusive control over promoting, demoting, or changing the pay of its employees.

(5)Have workers perform work off the premises.

(6)Do not hire independent contractors to perform an integral function of the business’s functions.

(7)If a contracting company is used, the employer should not control the rate and method of payment to workers.

(8)Do not maintain employment records of independent contractors. If there is a contracting company, it is responsible for maintenance of employment records. However, conducting an audit is permissible.

(9)Do not have permanent relationships with contractors.

(10)Do not retain the workers as independent contractors after terminating their employment relationship. That is, the employer should not lay off or terminate an employee and then hire him or her back as an independent contractor if he or she is performing the same job.