Employment Status — A View From Both Sides of the Pond

In recent years, employment status has been an evolving topic globally as various jurisdictions grapple with how to properly categorise increasingly flexible forms of working. A regulatory change in the United States by the Department of Labor has brought renewed focus to employment classification issues. The balance between affording individuals sufficient freedom to determine how their services should be provided and ensuring they are not deprived of minimum protections to which they would be entitled as employees has resulted in courts and governments revising the factors that should be taken into account when assessing employment status. Particularly for businesses with operations in the US and the UK, this client alert provides a high-level comparison of the approach to employee classification.

The US — A Changing Legal Landscape

At a high level, the US has only two classifications of workers: employees and independent contractors. Each law that applies to employees has its own standards for determining whether an individual is an employee, and such standards generally fall within one of three categories.

Common Law Test
Determinations of whether an individual is an employee for purposes of the Internal Revenue Code, which governs federal income taxation, are made by applying a common-law test, which focuses on whether the party engaging the worker retains the right to control not only the result to be accomplished but also the means by which that result is to be accomplished. A similar test is used in a number of other contexts, including under the Employee Retirement Income Security Act, which governs employee benefit plans, and under at least some courts’ interpretations of statutory prohibitions on employment discrimination.

Economic Reality Test and the New DOL Rule
The most significant recent development under US law is the upcoming effectiveness of the new final rule concerning employee classification under the Fair Labor Standards Act (FLSA). The FLSA establishes minimum wage and overtime pay requirements applicable to employees who are not exempted from it. Employee classification issues under the FLSA have long involved applying an “economic reality” test. The “economic reality” test differs from the common law “right to control” test. Under the economic reality test, courts have considered multiple factors that focus on economic dependence of the worker on the business for which he or she provides services rather than on the right to control how the work is performed.

The articulated factors have varied somewhat in court decisions and Department of Labor (DOL) guidance over the years. In 2021, shortly before the end of the administration of President Trump, the DOL published a new rule that makes substantial changes to the factors to be considered (the “2021 Rule”). The 2021 Rule identified two “core factors” and three other factors. The 2021 Rule had the effect of broadening the circumstances in which a worker would be found to be an independent contractor. The DOL under President Biden withdrew the 2021 Rule, resulting in litigation about the permissibility of the withdrawal.

In January 2024, the DOL published a new final rule on employee and independent contractor classification under the FLSA, which is due to come into effect on 11 March 2024 (the “Final Rule”). The Final Rule provides that six factors are to be considered in assessing the “economic reality” of the relationship, all of which are to be considered as part of the ultimate inquiry into whether the worker is economically dependent on the potential employer. The Final Rule will make it more likely that individuals will be categorised as employees than under the 2021 Rule.

The six factors are similar to factors that predated the 2021 Rule, but the Final Rule includes commentary that arguably broadens the scope of employee classification beyond the standards in place before the 2021 Rule. The six factors are: (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and potential employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral part of the potential employer’s business; and (6) skill and initiative. Additional factors that point to either employee or independent contractor status may also be taken into account when determining whether a worker is engaged as an employee or an independent contractor. The DOL indicated that none of the factors will be determinative of employment status on their own; the new factors are intended to focus more closely on the worker’s economic relationship with the engaging entity and take into account the practical realities of the relationship.

ABC Test
Still another test, known as the ABC test, applies to certain employment laws in California and Massachusetts. Applying the ABC test is particularly likely to result in a finding of employment status. Under that test, a worker is an employee unless all three of the following criteria are satisfied: (1) the worker is free from control and direction in connection with performing the services; (2) the worker’s services are performed outside the usual course of business of the recipient of the services; and (3) the worker is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.

In short, the determination of whether an individual is an employee or an independent contractor may be different for different legal purposes. While the Department of Labor’s Final Rule will have significant impact for classification under the FLSA, it does not replace other laws (federal, state, or local) affecting employment status. As a result, the approach to employment status classification will hinge on the state in which the individual is based and whether their employment status is being challenged under the FLSA or in a different context. Therefore, businesses need to consider a number of tests in reaching determinations about classification of their workers.

The UK — An Ongoing Dialogue

While the categories of employment in the UK differ from those in the United States, similar conversations are taking place in the UK on how these should be assessed going forward. The UK currently has three main categories of employment status: employee, worker, and self-employed (i.e., independent contractor). Employees have greater statutory protections and are entitled to additional benefits under law compared to self-employed contractors. Independent contractors, by comparison, have greater flexibility to manage their work without supervision, work for different organisations, and subcontract their services but are not entitled to receive benefits and are entitled to fewer statutory protections. “Workers” refers to an intermediate employment status between independent contractor and employee. Workers have more rights and statutory protections compared to contractors but fewer than employees (e.g., workers are not entitled to protection against unfair dismissal or statutory redundancy pay). The outcome of the next general election will likely influence whether the UK retains three categories of employment status (or whether employees and workers will be combined into a single category of workers, which is what Labour proposes in its Employment Rights Green Paper).

Similar to practices in the US, the assessment of an individual’s employment status depends on how they are engaged in practice — i.e., not determined solely by their written terms of engagement. Factors that should be taken into account when assessing employment status have been developed by case law over time. Key indicators of an employee (or worker) relationship include whether the individual is required to provide the relevant services personally, whether there is a mutuality of obligation to provide and undertake work between the engaging entity and individual, and if the engaging entity exercises a sufficient level of control over the individual and the way they perform their work.

The application of these factors has been tested and refined by recent gig economy cases, with courts determining that wider factors should be taken into account when assessing employment status in certain circumstances, not just the contractual terms between the parties. In particular, the English courts have taken the view that if individuals bring a claim based on having worker status under various statutes, it is relevant to consider whether the individual should be protected according to the purpose of the relevant legislation (i.e., because the aim of the relevant statute is to protect vulnerable workers or those in a relationship of subordination). If so, it is more likely the individual will be considered a worker.

Consequences of Misclassification

Failing to classify individuals in accordance with applicable law can prove costly for businesses. In both the United States and the UK, misclassifying employees can leave employers exposed to claims by individuals for unpaid minimum wages or overtime, unpaid social security contributions, and damages for failing to provide benefits to which misclassified employees were entitled. In addition, in the UK, contractors reclassified as employees may also benefit from dismissal protection in the event their working arrangements are subsequently terminated. The impact of misclassification can extend beyond claims from employees, with organisations being exposed to fines or legal action from regulators or government bodies (including tax authorities in the United States and the UK).

Relatedly, the public relations risk presented by employee misclassification can damage the relationship employers have with their workforce and the financial performance of a business. Notwithstanding changing approaches to employee classification, businesses are expected to swiftly adapt to legislative updates and carefully consider if their arrangements remain fit for purpose. Particularly when companies look to acquire other businesses, set up operations in a different country, or assess how they engage their workforce compared to their competitors, employee classification risks can be easily overlooked. Employers that take a proactive approach to assessing how their workforce is engaged will be best placed to address risks that may arise.

Please contact any member of Goodwin’s Employment team either in the UK or the US if you would like support with employment matters in these jurisdictions.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.