What is IC Diagnostics®?

IC Diagnostics® is a trademarked process that examines whether a group of workers not being treated as employees would pass the applicable tests for independent contractor (IC) status under governing state and federal laws, and then offers a number of practical, alternative solutions to enhance compliance with those laws in a customized and sustainable manner consistent with a company’s business model. It also serves to minimize the likelihood of individual, class action, collective and representative action lawsuits alleging IC misclassification, and provides defenses to those legal challenges – defenses on the merits as well as backup and procedural arguments, discussed below. The process has been developed based on insights from reading and reporting on judicial and administrative cases, legislative developments, and administrative initiatives in our blog posts over the past 15 years, together with practical experience over that time in effectively enhancing IC compliance and defending IC misclassification cases for clients in an array of diverse industries.

There is no one standard IC test under all federal laws, and most states have IC tests that not only vary from the federal laws but also differ from the laws in other states – even though some IC tests appear to be similarly worded. This creates a greater challenge for companies operating nationwide or in a number of different states. IC Diagnostics® is designed to assist both local and multi-state businesses.

One factor that is present in virtually all tests for IC status is whether a worker is subject to direction and control – something that companies, understandably, tend to exert in most if not all their business relationships with others. Lawyers are typically educated and trained over years in their practice to structure, document, and implement relationships in a manner that increases their client’s leverage. But that approach in an IC relationship typically creates greater direction and control, which in turn undermines IC compliance. In addition, some federal and state courts and administrative agencies have ruled against IC status based on factors that may seem counterintuitive. A company’s own words or actions that they view as benign may unwittingly subject them to IC misclassification exposure. The IC Diagnostics® process uses legal tools and methods, developed and refined in our IC compliance practice, that substantially reduce or eliminate the type of overt and subtle direction and control that increases the risk of misclassification liability. This can be done while still accomplishing a company’s business objectives and maintaining its optimal return on investment.

The Basic IC Diagnostics® Process

     Step 1 – Assessment, Measurement, Alternatives: The IC Diagnostics® process – first developed in 2007 and consistently refined and improved since – assesses well over 48 relevant factors indicating IC or employee status under federal and state laws governing minimum wage and overtime, wage payments, employee benefits, unemployment, workers’ compensation, discrimination, and employment tax. It then measures the company’s compliance with each of the applicable tests under those federal and state laws on an IC Compliance Scale™, which is calibrated to offer a range of alternative ways to enhance IC compliance, including restructuring, re-distribution, reclassification, or variations thereof. The use of a process such as IC Diagnostics® thereby offers businesses and other organizations (such as non-profits and governmental units) that currently use ICs a thorough understanding of the extent to which each alternative can minimize or eliminate future misclassification liability.

     Step 2 – Restructuring and Re-documentation: If the IC Diagnostics® process indicates that the restructuring alternative is a sound choice, most companies will tend to elect this alternative. For some, restructuring may be modest; for others, it may need to be more substantial – but in either case the objective is not to change the business model but rather to retain its essential components in a customized way that substantially enhances IC compliance and does so for the sustainable future.

Restructuring can be accomplished in tandem with re-documenting the IC relationship. This is a comprehensive undertaking whereby the entire restructured relationship between the ICs and the organization is memorialized in a set of documents. The starting point for this part of the IC Diagnostics® process is the use of a list such as 48 Factors-Plus™, which was developed based on a review of thousands of IC cases over the past 15 years. That list has mushroomed to over 70 criteria used by federal and state courts and administrative agencies to determine IC status, and each factor is weighted to reflect its relative importance in assessing compliance with applicable laws.

Use of a list such as the 48 Factors-Plus™ assures two key business and legal objectives are met: (1) that the restructuring and re-documentation of the IC relationship is thorough, practical, and sustainable, while maintaining the key components of the company’s business model; and (2) that the restructured IC relationship is articulated within an agreement containing state-of-the-art provisions that are designed expressly for the particular business – without any empty recitals or misstatements of how the relationship will be implemented. Re-documentation is an interactive process that relies in part on input from the company’s management to ensure that a new IC agreement is designed to reflect actual practices that ensure the company’s business objectives are fostered.

     Step 3 – Re-implementation: The next step in a process such as IC Diagnostics®  is actually implementing the restructured IC relationship. Companies must ensure that what is set forth in the re-documented IC agreement is implemented in practice on a short-term and long-term basis. Otherwise, businesses are needlessly providing arguments to class action lawyers and government regulators that their IC agreement is nothing more than a piece of paper that is belied by the actual facts and should be disregarded – or worse, can be used to demonstrate that the IC relationship is a little more than a thinly disguised sham indicative of willful misclassification. This step also includes a review of how a company navigates through challenging issues such as background checks under the Fair Credit Reporting Act (FCRA) and applicable state and local credit reporting and criminal background check laws for those ICs that enter a  customer’s residence, have access to personally identifiable or financial information about customers or the business itself, or drive a motor vehicle in the course of performing their services.

IC Diagnostics® includes a number of other key implementation steps designed to ensure lasting conformity with the restructured and re-documented IC relationship, and to provide defenses to claims of IC misclassification.

The Need for Customized and Sustainable Solutions

There are no “quick fixes” or shortcuts when seeking to enhance IC compliance, and “one size fits all” solutions are likely to be ill-fitting and disserve the objective of meaningfully minimizing or eliminating IC misclassification liability. The use of model, standard, or “form” IC agreements tend to cause businesses to overlook the need to structure, document, and implement a sustainable IC model that is far more likely to withstand legal scrutiny under applicable legal tests. The IC solution(s) selected should facilitate the business objectives and be user-friendly and capable of being defended for years to come.

Bona fide restructuring, re-documentation, and re‑implementation need not be a prohibitively expensive or daunting task. Once undertaken and completed in a reasonably short period of time, these steps can place a business in an enviable place: namely, an enhanced state of IC compliance that can minimize the likelihood that a governmental agency, class action lawyer, union, or employee seeking unemployment or workers compensation will attempt to challenge the IC relationship – and if a challenge is mounted, these steps can maximize the likelihood that the IC relationship will be upheld as valid.

Franchise-Type Arrangements

Franchise arrangements are not immune from IC misclassification challenges, and typical franchisor-franchisee agreements with workers or their LLCs or corporations are often laden with provisions exerting direction and control. Those types of contract clauses can and should be eliminated, leaving only the type of control necessary to achieve business results. Further, some state franchise laws provide protections for certain types of worker arrangements, requiring businesses to include provisions in their IC and franchise agreements that comply with these statutes or ensure that enforcement of their agreements is accomplished consistent with these types of laws.

Adding an Effective Arbitration Clause with Class Action Waiver

A well drafted arbitration clause with class action waiver will generally mean, with few exceptions, that a class or collective action cannot be maintained and that each plaintiff’s and class member’s case must be individually litigated. A poorly drafted one will result in the company having to defend itself in a class action because the arbitration language used by the business in its IC agreement did not take full advantage of the current state of the law. Some arbitration provisions drafted by businesses can even needlessly impose contractual obligations or undesirable state laws upon the company. We have focused on drafting state-of-the-art arbitration clauses with class action waivers for many years, and offered drafting tips for such clauses in our November 14, 2018 blog post entitled “How to Effectively Draft Arbitration Clauses with Class Action Waivers in IC Agreements.”

Whether an arbitration agreement in an IC or employment setting will bar a class action depends as much of the wording in the arbitration clause as the applicable law, which is in flux and continues to evolve. Some states may not permit arbitration provisions with class action waivers, but those laws may be preempted by federal arbitration law except for workers involved in interstate transportation. The constant litigation over arbitration clauses with class action waivers strongly suggests that existing arbitration clauses used in IC agreements should be reexamined and updated periodically in tandem with the company’s effort to enhance its compliance with laws governing the use of ICs. 

Effectively drafted arbitration clauses with class and collective action waivers can also facilitate settlements of class and collective action lawsuits on an individual basis or, if on a class-wide basis, on far more favorable terms.

Buttressing ERISA Plan Language

Even if workers have been misclassified as ICs, that does not mean they have been denied benefits as participants in 401(k) plans or employee welfare benefit plans offering group health, disability, and life insurance to employees of the company.  If such workers are properly excluded in the plan documents as participants, consistent with applicable law developed under ERISA, they have no ERISA claims, even if they are found as a matter of law to be common law employees.  Merely excluding “independent contactors” from participation in a plan is not typically enough to protect from liability under these types of claims.

Most employee benefit plans do not include the type of language required by court decisions; indeed, the best plan language to protect from these types of claims is not obvious and is somewhat counter-intuitive. Part of the IC Diagnostics® process evaluates the effectiveness of the eligibility language in plan documents for defined contribution and defined benefit plans as well as employee welfare benefit plans. We determine if suitable wording is already in place or if the eligibility language in some or all of these types of plans need to be updated. Doing so serves as a backstop, in case a class of workers allege its members have been misclassified as ICs and are otherwise entitled to the same ERISA benefits as other “employees” of the company.

IC Diagnostics® Can Be Effective in Defending Class Action, Collective, and Individual Claims of IC Misclassification As Well As Government Audits

Many of the same proprietary tools for enhancing IC compliance can be invaluable in defending administrative agency and court challenges to a company’s IC classifications. Agency challenges can occur in connection with claims for unemployment compensation, workers’ compensation, wage and hour compliance, or employment taxes, such as those conducted by the IRS. The 48 Factors-Plus™ tool can be used in formulating comprehensive and more effective defenses to such legal challenges. 

Creating Backup Arguments

Another means to effectively defend against IC misclassification claims is to structure and document IC relationships in a manner that develops “backup” arguments under the wage and our laws. For example, workers classified as ICs that claim they have been misclassified may, in any event, be exempt from wage and hour and other labor or employment laws under an exemption included in the applicable statutes. Such exemptions may include those for outside sales persons, agricultural workers, or individuals otherwise classified as administrative, professional, or executive employees. Waiting until a lawsuit is commenced can present challenges that can be overcome if the business anticipates a potential lawsuit and builds into the structure and documentation of the IC relationship all of the legal requirements of such exemptions.

Compliance with Freelance Pay Protection Laws

IC Diagnostics® also enhances compliance with the increasing number of laws exposing companies to excessive damage awards if they fail to pay ICs on a timely basis. This type of law, oftentimes referred to by legislators as a Freelance Isn’t Free Act (FIFA), specify precisely what terms must be included in contracts with ICs, and most provide for double damages (or more) if any payment to a contractor is paid more than 30 days after services are rendered – even if there is a bona fide question about the quality of the services or the goods provided by the IC. Artfully drafted IC agreements offer some protection against these new types of laws, some of which can be brought on a class action basis.

The Reclassification and Redistribution Alternatives

Even where restructuring can enhance IC compliance, some businesses may wish to consider other alternatives.  Alternatives include reclassification (either voluntarily or through an available government program) or redistribution through the use of a knowledgeable, fee-based workforce management firm.

Can Misclassification Exposure Be Quantified?

Some businesses ask, is there a quick way to measure the potential amount of misclassification liability to which my company may be exposed?  IC Diagnostics® uses an IC Misclassification Metrics™ tool to allow businesses to determine individual and aggregate amounts of exposure to IC misclassification liability that can be minimized or eliminated using IC Diagnostics.®