Private equity firms regularly conduct due diligence of legal risks that could impact potential investments. Yet when considering whether to invest in a target company structured in whole or in part on an independent contractor (IC) business model, few PE firms consider IC misclassification exposure with a sufficient degree of knowledge and insight needed to make well-informed decisions. Further, it is not enough to assess the current liability risks of acquiring a target company operating on an IC business model and then to decide if those risks still make it a  worthwhile investment. Rather, meaningful measures can usually be taken, post-closing, to minimize such risks by substantially elevating the target company’s current level of compliance with applicable IC laws – and doing so in a sustainable and profitable manner. With an enhanced understanding of the current risks and the tools that can be used to minimize such risks going forward, PE firms can obtain a far better appreciation whether to invest in, and how to value, a contemplated acquisition of a target company operating on an IC business model.

We can learn quite a lot from a legal challenge faced by other business organizations in the same industry. In September, we noticed that a large health care system operating in seven states west of the Mississippi had been sued in a class action for allegedly misclassifying registered nurses (RNs) as independent contractors instead of employees. Independent contractor misclassification issues have been front page news for several years in an array of other industries – most notably ride sharing – but this 1099 business model is prevalent in hundreds of other industries, including health care. How many health care systems utilize independent contractors to provide key health care services?  Many, because this business model makes business and economic sense in many instances. But it also runs the risk of very substantial misclassification liability if independent contractor relationships are not structured, documented, and implemented in a manner than enhances compliance with applicable laws and minimizes this type of legal exposure.

The most significant legal development in the past month in the area of independent contractor compliance was the enactment of California’s Freelance Worker Protection Act, which goes into effect on January 1, 2025. We have reported on freelance pay protection laws enacted recently in Illinois and New York, as well as similar laws in municipalities including New York City, Los Angeles, Minneapolis, Columbus, Ohio, and Seattle. These types of enactments impose statutory liabilities on businesses that either fail to pay freelancers the agreed upon fees for services rendered or neglect to enter into independent contractor agreements encompassing the terms required by these laws. As we note below in our summary of this new California law, it actually covers only a limited number of freelancers – those who provide a diverse array of “professional services.” This new California law is unclear as to which companies and independent contractors it covers. While the law states that it governs a business “organization in the State of California that retains a freelance worker to provide professional services,” it is unclear whether it only covers companies operating in California that engage such freelancers located in California, or it if also covers companies engaging those types of contractors where the business or contractor is located outside the state. More importantly, this and other independent contractor payment protection laws only cover workers that have been properly classified as ICs under applicable legal tests. Companies using workers they classify as ICs may mistakenly regard themselves as being free from liability if they comply with these freelancer pay protection laws. But such compliance does not immunize businesses from exposure to IC misclassification liability. Companies using an IC business model also need to structure, document, and implement their IC relationships in manner that maximizes compliance with applicable state and federal tests for IC status. A process such as IC Diagnostics (TM) can enhance IC compliance while also satisfying these new freelance pay protection laws.

Many commentators will likely suggest that the law involving independent contractor misclassification will become more favorable to businesses and less favorable to workers with a change in the White House. While things will not likely get worse, they will not likely improve one iota.

Is independent contractor misclassification, standing alone, a violation of the National Labor Relations Act? Last month, the National Labor Relations Board issued a decision in a case involving workers who were found to be misclassified by a company as independent contractors. While the NLRB did not answer the question above, it dropped a footnote sending a clear signal that the agency is intending to reverse its current position that independent contractor misclassification is not itself a violation of the NLRA. For companies using workers they classify as ICs, this NLRB development creates an even greater imperative for them to enhance their independent contractor compliance. By elevating their IC compliance regarding such workers, businesses will be able to minimize their exposure to IC misclassification liability and union organizing of those they regard as ICs before the NLRB carries out its intention to change its existing law. As noted below in our “Takeaways,” use of a process such as IC Diagnostics (TM) will maximize IC compliance not only under the NLRA but also under other federal and state law tests for IC status. We also offer best practice suggestions below on the steps businesses can take to avoid unfair labor practices under the NLRA related to independent contractor issues.

One of the most important legal developments last month is a new lawsuit filed by registered nurses against a leading health care system alleging that they have been misclassified as independent contractors instead of employees. The proposed class and collective action was filed late last month in a federal district court in the state of Washington by a registered nurse (RN), who alleges that the health care system in which she worked, directed, and controlled contract RNs, who perform duties similar to the RNs employed by the system. As noted in our blog post on March 7, 2024, this new case comes on the heels of another lawsuit being prosecuted by the U.S. Department of Labor asserting that an Illinois health care staffing agency misclassified RNs and other nurses who provided services to nursing homes. These lawsuits do not, however, suggest that all nurses must be classified as employees. Indeed, in July 2018, we reported in a blog post that the Labor Department issued a Field Assistance Bulletin addressing the issue of whether nurses referred by nursing registries are employees of the registries or are independent contractors. That publication concluded that there were instances where the nurses may be independent contractors under the federal Fair Labor Standards Act. To that end, in an article published in Law360 Employment Authority dated February 8, 2022, author Max Kutner discussed how the nation is facing a nurse shortage but online staffing platforms are seeking to meet that need with opportunities for nurses to provide their services as independent contractors. Regarding the specter of misclassification claims, the publisher of this blog was quoted in the article: “You can have nurses who are independent contractors legitimately, and you can have nurses who are not legitimately independent contractors, who are misclassified. You shoot yourself in the foot if you don’t have an independent contractor agreement that is state-of-the-art.” Health care entities can oftentimes structure and document their IC relationships with nurses in this fashion by use of a process such as IC Diagnostics (TM) – even when, as alleged in the new lawsuit described below, the health care entity also considers some nurses to be employees.

The legal developments in the area of independent contractor misclassification and compliance last month include cases against a record label company, an Islamic Center, and a waste recycling company. Lawsuits for IC misclassification come from a diverse array of workers because companies in an endless number of industries have adopted business models that treat workers as ICs. Businesses can minimize, if not avoid, many of these lawsuits by taking steps to structure, document, and implement their IC relationships in a manner that enhances compliance with laws governing ICs. Some types of workers, however, may never fit comfortably into an IC relationship, and one or both of the first two cases that we discuss below may fall into that category. Nonetheless, bona fide arguments can be made to support the IC status of the overwhelming number of workers treated by companies as ICs, provided their compliance with IC laws has been enhanced. Many companies use a process such as IC Diagnostics (TM) to do so, thereby minimizing their exposure to IC misclassification liability under applicable federal and state IC laws.

You may have wondered where New York’s so-called Freelance Isn’t Free Law went after it was enacted into law in November 2023. Well, it was repealed before it became effective and was replaced earlier this year with a new version of the same law. The 2024 edition becomes effective on August 28, 2024. However, it retains all of the flaws that we pointed out in our December 14, 2023 blog post about the 2023 law. Those defects include a double damages provision that can be imposed against a company even if its failure to pay is due to a good faith belief that the services provided by the independent contractor (IC) did not meet contract specifications. The new law also includes a special damages provision that can have a draconian impact on a company. For businesses using ICs in New York and elsewhere, we suggest you consider some of all of the steps in our “Takeaways” below to counteract the law’s serious flaws. Those steps can also serve businesses well as they face similarly defective freelancer pay protection laws enacted so far in Illinois and a number of municipalities, including Los Angeles and New York City.

Last month, two key legal developments in the area of independent contractor misclassification and compliance highlighted the risks posed to customer service companies that use an independent contractor business model. The first involves a Colorado company using agents to provide customer support through an app-based platform. The company was sued in a proposed class and collective action lawsuit based on the allegation that the company misclassified the agents as ICs and not employees. The second involves a $3 million settlement between a nationwide customer service support company and the U.S. Department of Labor, which sued the company alleging it had misclassified as ICs the workers that provide customer service to its clients. Many companies in the customer service industry use an independent contractor business model. Workers in that type of trade or occupation usually can be classified legally as ICs under federal and most state laws if their relationships with the companies engaging their services is structured, documented, and implemented in a manner that enhances compliance with those laws. One way some companies have elevated their level of IC compliance is by a process such as IC Diagnostics (TM), a comprehensive system that minimizes IC misclassification liability in a customized and sustainable manner consistent with applicable laws.

Lawyers representing ride share drivers have argued for years that their clients are being misclassified as independent contractors under federal and state laws. They have attained little success, however, obtaining definitive rulings in their favor, particularly in states that have adopted a multi-factor test for independent contractor status, like the federal standard under the Fair Labor Standards Act (FLSA). Two consecutive hung juries in a Pennsylvania federal district court confirm that the classification status of ride share drivers is unclear. These events serve as a rejoinder to worker advocacy groups that have repeatedly asserted that ride share companies misclassify drivers. While their arguments have led to rulings in favor of employee status in the two states with strict ABC type wage laws (California and Massachusetts), the recent hung jury results in Pennsylvania confirm that independent contractor status of ride share drivers is at best murky in state and under federal law. Nonetheless, ride share and other gig economy companies can tilt the scales in their favor. Many businesses have resorted to a process such as IC Diagnostics (TM) to enhance the structure, documentation, and implementation of IC relationships in a customized and sustainable manner, maximizing compliance with IC laws and minimizing exposure from IC misclassification claims.