Lessons Learned From Worker Classification Cases

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1 Portfolio Media. Inc. 648 Broadway, Suite 200 New York, NY Phone: Fax: Lessons Learned From Worker Classification Cases Law360, New York (November 14, 2008) -- It s no secret that worker classification is a hot area of class action litigation. Classification cases traditionally involve challenges under the Fair Labor Standards Act in which employees allege their employers erroneously classified them as exempt personnel to avoid paying overtime wages and certain benefits otherwise due. While FLSA classification challenges have arisen in virtually every industry over the years, recently there has been a steady increase in the number of class actions involving the misclassification of workers as independent contractors. Companies utilizing independent contractors should pay attention. These contractor cases typically involve workers who allege that their companies have erroneously classified them as independent contractors to avoid paying employee taxes or benefits or reimbursing business expenses. These cases pose a significant litigation threat for companies relying on an independent workforce, for example, the insurance industry, where independent agents are often used to sell insurance products. However, an Illinois federal court, in Paradise v. Bankers Life and Casualty, No. 06 C 6906, (N.D. Ill. July 28, 2008), recently awarded a victory to one company that utilizes independent contractors when the court decertified a class of insurance agents who alleged they were misclassified. This decision provides valuable lessons for companies that include independent contractors in their workforce. Background In Bankers Life, Plaintiff Paradise, a former Banker s Life agent in California, filed a class action against the insurance company in Illinois (where Bankers Life is chattered) alleging that Bankers Life intentionally misclassified its agents as independent contractors rather than employees in order to deny them rights and benefits available to employees under California law. Paradise asserted that the misclassification violated California labor, insurance and business statutes. In 2007, Paradise moved to certify a class of all Bankers Life agents employed in California from September 2002 through the conclusion of the action.

2 As a basis for her motion to certify the class, Paradise alleged that provisions of the contract, the policies and training materials created an employment relationship between the parties, noting specifically that: - language in the agency contract stated agents were employed at will; - language in the agency contract stated agents were bound to abide by all Bankers Life policies and procedures; - agents were responsible for promoting the interests of Bankers Life; - agents were subject to a 24-month post-termination nonsolication requirement; - language in agent training and policy manuals stated that the agency contract between the parties was exclusive; and - language in agent training and policy manuals mandated training classes. On Oct. 1, 2007, after limited discovery, the Northern District of Illinois issued an order granting Paradise s motion to certify the class, finding that the Plaintiff had satisfied the requirements for class certification under Fed. R. Civ. P. 23 in that: - the class size was too numerous and widely dispersed to make joinder feasible; - there were common factual issues concerning misclassification; - Paradise s claims were typical of those of the purported class; - Paradise was able fairly and adequately to represent the proposed class members interest in the litigation; - there were common facts regarding Bankers Life agent contracts and policy and training materials; - the common facts predominated over individual agent relationships with the Company in regards to whether the agents were misclassified under California law; and - a class action would eliminate the need for multiple proceedings involving common issues, and thus was superior to other available methods of adjudication. Decertification Of The Class After the close of discovery in the case, Bankers Life moved to decertify the class.[1] Bankers Life argued that indicia of control over its agents varied substantially from agent to agent and from office to office and, thus, class certification was improper. In support of its position, Bankers Life relied on Borello & Sons. Inc. v. Dept. of Indus. Relations, 48 Cal. 3d 341 (Cal. 1989), which identified the relevant factors that California courts use to determine whether a worker should be classified as an employee or independent contractor. These factors included determining, among other things, whether: - the employer exerts control over its workers daily activities; - the work is conducted under the principal s supervision; and - the work is part of the regular business of the company. Bankers Life did not dispute that some indicia of control over its agents exists; instead it offered deposition testimony, declarations and other evidence obtained during the discovery process indicating a disparate level of control over its agents. This evidence focused on variations in agents work hours, the level of training mandated by the Company, and varying polices and procedures. According to Bankers Life, these divergent experiences demonstrated that it would be impossible to determine, on a class-wide basis, whether the Company uniformly controls its agents in a manner consistent with an employment relationship. The court agreed.

3 The Bankers Life court found that, based on evidence produced during discovery, the classification analysis would be an individualized, fact-intensive examination, which is improper for class certification purposes under Rule 23. The court noted that an analysis of the underlying relationship did not reveal the requisite level of uniformity on the critical control issue. Plaintiff Paradise contended, however, that decertification was unwarranted because the divergent experiences of the agents reflected only occasional deviations from Bankers Life right to control its agents under its contracts and policies. The court disagreed, finding that the Company s right to control its agents could not be resolved simply by referring to the agent contract or the policy and training manuals because actual control was as important as the right to control. The court also found that proceeding by class action would require scrutiny of each agent s experience with regard to training, monitoring, practices, and requirements of the job. The Court found that such evidence, viewed in relation to the test of Borello, demonstrated that the case could not fairly or efficiently be pursued as a class action since individual issues would predominate, resulting in inefficient and administratively cumbersome minitrials. Lessons Learned From Bankers Life Several lessons can be learned from the Bankers Life case: Variance Is Important In decertifying the class of agents, the Banker s Life court found that common questions of law and fact clearly would not predominate over the individual questions of each agent s relationship with Bankers Life and, therefore, a class action was not a superior method for adjudication. The Banker s Life court looked favorably upon the Defendant s ability to produce a voluminous compendium of supporting depositions, documents, and sworn summaries outlining the various work conditions for, and varying indicia of control over, its agents. Companies should be mindful of their relationship with their independent contractors, noting that variance whether it be in the form of policies, procedures, requirements, hours, tasks, training, or compensation is a friend of the contractor model in class cases. Of course, companies should be mindful, whether they are facing a collective action suit brought under the FLSA or one based on non-flsa common law or statutory claims that certification standards differ between the two. Under the FLSA, class certification is generally based on a similarly situated standard, which is broader than the strictures of Federal Rule 23, applicable to non-flsa class actions. Even under the broader FLSA certification standard, however, variation is an important tool for defeating certification because it signifies differences rather than similarities. Fact Sensitive Analysis

4 As the Banker s Life court explained in decertifying the class, liability determinations in worker classification cases are not only individual, but also fact-intensive by nature. The circumstances surrounding the relationships between the hiring party and the hired party provide the foundation for a court to make its classification determination. This examination will need to be performed on a case-by-case basis because each relationship is different. While Bankers Life provides insight into successfully defending against certification, it is not guaranteed or even precedent setting given the factual sensitivity of the issue. Second Bite At Certification Apple Because the issue of worker classification is often determined by an individual evaluation of the worker s relationship with the employing unit, employers should direct their discovery efforts not only to establishing those factors supporting their workers independence, but also to finding evidence in opposition to class certification. As Bankers Life makes clear, the various stages of discovery in class actions provide insurance and other companies multiple avenues to establish a record highlighting an employee s individual circumstances and disparate treatment. This fact finding should not stop simply because the Court has already certified a class. Uncertainty Of Legal Criteria For the Bankers Life court, the deviation from the company s original contracts weighed heavily in the court s decision to decertify the class. Different jurisdictions, however, weigh the factors for determining worker classification differently. Another court hearing the Bankers Life matter (or a similar matter) could find that the contractual agreement stating that agents were employed at will or that the work is part of the regular business of the company, in fact, predominates over any individual issues, with the result being a ruling in favor of certification. Complicating this matter further, the standard for determining a worker s classification varies from state to state and even from statute to statute. The lack of uniform application of the classification criteria, therefore, can result in different outcomes on the class certification process. False Sense Of Security Companies should not be lulled into a false sense of security that their contractor workforce is properly classified simply because a worker signed an agreement identifying himself as an independent contractor. As Banker s Life makes clear, a contract designating a worker as an independent contractor can be largely insignificant for classification purposes. With this in mind, companies must examine their individual policies and procedures to determine whether significant indicia of employment are present. The presence of these employment indicators could undermine any contractor model. Why Should Employers Care? To say the independent contractor model is under attack may be an understatement. Several states have commissioned studies analyzing the economic effect of worker misclassification on tax revenues and have enacted new legislation narrowing the definition

5 of independent contractor, establishing a presumption of employment, and criminalizing worker misclassification.[2] Moreover, nine states since September 2007 Connecticut, Iowa, Massachusetts, Michigan, New Hampshire, New York Utah, Vermont and Washington have established on independent contractor task force designed to increase enforcement efforts against companies who misclassify their workers. The Internal Revenue Service identified worker classification as one of its top enforcement initiatives for 2008, following on the heels of a May 15, 2007 vote by the United States Senate's Appropriations Committee to urge the IRS to increase its enforcement efforts on industries in which misclassification is widespread. The IRS has also entered into agreements with state workforce agencies to share results of employment tax examinations to identify questionable employment tax practices such as misclassifying workers. Congress has not only pressured the IRS on worker classification, but members of Congress have also proposed legislation to address the issue. Specifically, on the heels of two House committee hearings a May 8, 2007 Ways and Means Committee hearing and a July 24, 2007 Education and Labor Committee hearing[3] - Senator Obama, along with others, introduced the Independent Contractor Proper Classification Act of This legislation seeks to give the IRS regulatory authority to establish standards for properly classifying workers and seeks to repeal Section 530 safe harbor provisions allowing employers to rely on industry practices as a reasonable basis for classifying workers as independent contractors.[4] Also, Senator Obama, along with others, introduced the Employee Misclassification Prevention Act on Sept. 29, This legislation seeks, among other things, to provide a special penalty for employers who misclassify employees as non-employees. [5] While these pieces of legislation remain under committee review, issues involving the classification of workers appears to be part of a Democratic administration s agenda. Another attack on the use of independent contractors has come from the Government Accountability Office. The GAO has pressured the Department of Labor to increase its scrutiny of worker classification, noting in a 2007 report that DOL has failed to monitor the issue. As a result, DOL identified worker misclassification as one of its top five enforcement priorities for Litigation by workers claiming to be employees rather than independent contractors will continue to increase in the coming years given the scrutiny the independent contractor model is receiving. This scrutiny is motivating workers, unions, and plaintiffs attorneys to organize and bring lawsuits against companies utilizing independent contractors. Companies that fail to take proactive steps to protect their contractor model now will increase their exposure to claims for back taxes (both federal and state), as well as claims

6 for unpaid benefits, pension accruals, 401(k) matching contributions, and risk potential fines from federal and state agencies. --By Gail L. Westover (pictured), Thomas R. Bundy III and Vanessa A. Scott, Sutherland Gail Westover and Thomas Bundy are both partners and Vanessa Scott is a tax associate with Sutherland in the firm's Washington, D.C., office. [1] Paradise cross-moved for summary judgment, but the court denied the motion because of material factual disputes. [2] GAO, Employment Arrangements: Improved Outreach Could Help Ensure Proper Worker Classification, GAO (Washington, D.C.: July 11, 2006). [3] Misclassification of Workers as Independent Contractors: What Policies and Practices Best Protect Workers?: Joint Hearing Before the House Subcommittee on Health, Employment, Labor and Pensions, 110th Cong. (2007); Providing Fairness to Workers Who Have Been Misclassified as Independent Contractors: Hearing Before the House Subcommittee on Workforce Protections, 110th Cong. (2007); Effects of Misclassifying Workers As Independent Contractors: Hearing Before the House Comm. on Ways and Means, 110th Cong. (2007). [4] S. 2044, 110th Cong. (2007) (Independent Contractor Proper Classification Act of 2007). [5] S. 3648, 110th Cong. (2008) (Employee Misclassification Prevention Act of 2008). All Content , Portfolio Media, Inc.