At a time when companies are increasingly using “independent contractors” rather than W-2 employees, the risks and liabilities for misclassification have never been higher. And it just got harder for Michigan and other Midwest employers who are accused of improperly classifying their workforce after a 3/26/2015 ruling from the Sixth Circuit Court of Appeals.

Specifically, Keller v. Miri Microsystems LLC, involved cable and satellite installers and whether they were properly classified as “independent contractors” or should have been classified as “employees.” The correct classification means the difference between being entitled to overtime pay under the Fair Labor Standards Act (FLSA) or not. This is because under the FLSA, only “employees” are entitled to overtime and minimum-wage compensation; Independent contractors do not enjoy FLSA’s protections. Businesses are liable to workers for overtime wages even if the company classifies an individual as an “independent contractor” who should be classified as in “employee.”

Determining Whether an Individual is an “Employee” or “Independent Contractor.”

In deciding whether an individual is truly an independent contractor or an employee subject to the FLSA, employers in the Sixth Circuit are subject to a judicial test referred to as the “economic realities test.” Under this test, the following six factors are applied to the employment relationship:

1. The permanency of the relationship between the parties;
2. The degree of skill required for the rendering of the services;
3. The worker’s investment in equipment or materials for the task;
4. The worker’s opportunity for profit or loss, depending upon his skill;
5. The degree of the alleged employer’s right to control the manner in which the work is performed; and
6. Whether the service rendered is an integral part of the alleged employer’s business.

Returning to the Keller v Miri Microsystems, the Court departed from a general rule that the application of these six factors to determine the employment status is a “question of law” to be decided by the judge, and not a “fact question” that must be decided by a jury. More often than not, employers and their attorneys believe they will be better off in terms of cost savings (because there is no trial) and the outcome (a favorable ruling) if a judge is deciding these issues and not a jury.

In doing so, the appeals court reversed the trial court’s dismissal and sent it back for trial for the jury to decided the issue. The Keller decision cited extensively to another cable and satellite installer case from the Eleventh Circuit Court Of Appeals (Scantland v. Jeffry Knight Inc.), which also closely scrutinized contested facts involving the “economic realities test” and reversed a dismissal in favor of the employer to allow the fact questions to be decided by a jury.

The Financial Impact of Misclassifying Employees as Independent Contractors.

The distinction between independent contractors and employees translates into enormous financial differences between the individuals involved and society as a whole, as well as significant financial liability to employers who get the classification wrong. See Employers Cannot Ignore Costly Risks of Mis-classifying Independent Contractors.

Consider for example that a 2000 study commissioned by the U.S. Department of Labor (DOL), found that between 10 to 30 percent of audited employers misclassified workers. Researchers found that misclassifying just one percent of workers as independent contractors would cost unemployment insurance trust funds $198 million annually. Also, a 2009 report by the Government Accountability Office (GAO) estimated that independent contractor misclassification cost the federal government $2.72 billion in revenues in 2006.

So even if the Keller and Scantland decisions do not signal a trend, there are significant financial incentives and pressures for employee/independent contractor misclassification issues to be closely scrutinized.

Is it that Difficult to Correctly Classify an Employee versus an Independent Contractor?

One of the frustrating issues facing employers and individuals when it comes to employee classification is why is it so difficult to make the correct classification? On this point, the dissenting judge in the appeal noted that the trial judge who originally decided the Keller decision in favor of the employer had previously denied summary judgment to an employer in a similar 2014 Michigan case involving individuals who installed cable television services. (Swinney v. AMcomm Telecomm., Inc.).

In other words, two similar cases, two conflicting results. This illustrates that every FLSA classification case evaluated under the six factors – an imprecise test to begin with – may end up with differing results when applying the law to the particular facts of the case. And for this reason, it is important for employers to carefully evaluate their employee/independent contractor classifications.

Employer Take-Aways.

Decisions like Keller will allow more scrutiny over an employer’s decision to classify an individual as an employee or independent contractor. And for Michigan and other other Midwest employers subject to the Sixth Circuit Court of Appeals jurisdiction, the Keller decision and similar cases should cause employers to carefully evaluate their use of classifying individuals as “independent contractor” rather than employees. Whether this is done intentionally to deny workers overtime pay, or due to a mistaken belief as to the appropriate classification, the end result is the same; costly litigation and financial liability for misclassification mistakes.

For more information about employee/independent contractor classification issues and other overtime issues under the Fair Labor Standards Act, contact Michigan employment attorney Jason Shinn. Since 2001, Mr. Shinn has worked with companies to address and document independent contractor and employee classifications, as well as litigating these and other employment related disputes, including overtime pay cases. in federal and Michigan courts.