THIS ARTICLE WAS FIRST PUBLISHED ON HRLAWS.COM’S TENNESSEE EMPLOYMENT LAW LETTER BY BUTLER SNOW’S Kara E. Shea
Independent contractor classification remains a hot topic for employers that don’t directly employ their workforce. As a recent case from the 6th Circuit (whose rulings cover Tennessee employers) demonstrates, you should consider a number of factors when determining whether your classifications will stand up to a legal challenge.
The case before the 6th Circuit involved a group of insurance agents working for American Family Insurance Company. American Family classified the agents as independent contractors, which meant they were ineligible to participate in employer-sponsored benefits plans available only to employees. The agents filed a class action against American Family, claiming they had been misclassified as independent contractors and were actually employees entitled to receive benefits under the Employee Retirement Income Security Act of 1974 (ERISA).
Like many insurance companies, American Family sells its products primarily through a network of insurance agents, and its classification of agents as independent contractors rather than employees is a common industry practice. The trial court granted the agents’ request for class certification. The case then proceeded to trial on the question of whether the agents had been misclassified as independent contractors.
During the 12-day trial, the following facts were presented into evidence:
- All the agents sign an agreement stating they are independent contractors rather than employees.
- All the agents file their taxes as independent contractors and deduct their business expenses as self-employed business owners.
- American Family pays its agents on commission and doesn’t provide any paid-time-off benefits.
- The agents are referred to as “business partners” and told they will need to “invest” in their business as an agent.
- The agents work out of their own offices, set their own hours, and hire and pay their own staff.
- They are also responsible for providing most of the equipment and resources necessary to run their agencies and aren’t reimbursed by American Family for those expenses.
On the other hand, the proof at trial indicated that American Family exercises a significant degree of control over the agents, who are supervised by agency sales managers employed by the company. The managers assign tasks to agents, require them to complete daily reports, require them to participate in calls and business solicitation activities, and aren’t trained to differentiate their treatment of the independent contractor agents from their treatment of personnel employed by American Family. Also, the company retains some authority over the agents’ hiring and firing of their staff and how they run their agencies.
In addition, the jury heard testimony that American Family conducts a comprehensive twoto three-month-long training program that teaches new agents everything they need to know about how to become licensed, run an agency, and sell the company’s products. American Family requires agents to sell its products exclusively and often engages with the same agents for years, even describing the agent post as a “career position” with the company.
Based on that proof, the trial court ruled in favor of the agents, holding they had been misclassified as independent contractors and were in fact American Family employees entitled to benefits. The company appealed that ruling to the 6th Circuit.
The 6th Circuit noted that common-law agency principles determine whether employees have been correctly classified as independent contractors for purposes of ERISA coverage. The applicable criteria were articulated by the U.S. Supreme Court in a 1992 case, Nationwide Mutual Insurance Co. v. Darden, and are sometimes referred to as the “common-law” standard or the Darden standard. According to the Supreme Court:
In determining whether a hired party is an employee under the general common law of agency, we consider the hiring party’s right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party’s discretion over when and how long to work; the method of payment; the hired party’s role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party.
The 6th Circuit noted that a court considering the issue of employee classification should look at all the factors, with no one factor being determinative and with the relative weight given to certain factors varying depending on the context. According to the court of appeals, based on the application of all the factors in play to the evidence presented, the trial court was wrong in concluding the agents had been misclassified as independent contractors. Specifically, the 6th Circuit concluded that the trial court misapplied the factors pertaining to the skill required of agents and the hiring and paying of assistants.
First, the 6th Circuit pointed out it has been well established by case law that “the sale of insurance is a highly specialized skill” that requires “considerable training, education, and skill,” a factor that weighs in favor of independent contractor classification. The court held that even though American Family may prefer to hire untrained and unskilled agents and train them up, that doesn’t negate the fact that the position requires a high level of skill.
The 6th Circuit also ruled the trial court didn’t give enough weight to the fact that the agents hire and pay their own assistants. The court of appeals said the proof showed the agents have sole discretion in staff compensation matters and sole responsibility for withholding and remitting taxes for agency employees. The court acknowledged that American Family imposes qualifications and screening requirements on agency staff and has the right to hire or fire agency staff members who violate the company’s code of conduct, although it rarely exercises that right. Still, the court concluded, given the totality of the circumstances, the agency staff factor mitigated heavily in favor of independent contractor status.
The 6th Circuit further noted that the agents invest heavily in their offices, covering all their own expenses, and the written agreement between the parties clearly spells out the nature of the relationship. The court found those factors to be particularly important in assessing the concept of “control” for purposes of ERISA coverage. The court noted that factors pertaining to the financial structure of the relationship as agreed to and carried out by the parties should weigh more heavily in the ERISA context than in other contexts in which classification is at issue. The underlying question in an ERISA case is the financial benefits the company should have provided the alleged employees under its ERISA-governed benefits plans.
In the end, the 6th Circuit reversed the trial court’s decision, ruling that the agents are correctly classified as independent contractors. One judge dissented from the opinion, noting that while the agents are skilled, their skills come from being trained by American Family, and pointing out all the ways in which the company exercises control over the agents’ decisions and economic opportunities. Jammal et al. v. American Family Insurance Company et al. (No. 17-2125, January 29, 2019).
Although the employer ultimately won this case (subject to the possibility of further appeal by the agents), employers inclined to cheer this result should bear in mind that the victory came after an initial defeat in the trial court and many months of costly litigation. Also bear in mind that the employer was unable to obtain a unanimous decision at the appellate level, even though its independent contractor agents run their own offices, hire their own staff, and pay all their own expenses, including staff compensation, and even in an industry in which it’s customary to treat agents as contractors.
Finally, remember that this case was specific to determining benefits eligibility under ERISA, and the majority opinion makes clear that certain factors are given more weight in that context than they might be in others. In fact, in some contexts, such as determining classification for purposes of wage and hour law, workers’ compensation coverage, or compliance with federal and state tax law, entirely different factors and standards may be applied.
There are many reasons you may wish to classify workers as independent contractors, including not having to pay for otherwise mandatory benefits, as in this case. But you will pay a steep price if you are found to have misclassified workers. Keep in mind that employee classification isn’t within the discretion of the parties and is subject to being challenged under numerous laws and on numerous grounds, even with a written agreement in place. Nor does an independent contractor even have to complain for an issue to arise because misclassification is regularly discovered in the course of routine audits by the IRS and other federal and state government agencies.
The bottom line is, if you have 1099 workers, you should take a close look at your rationale for classifying them as independent contractors, examining the relevant factors under the various tests. Depending on what you find, you may need to restructure the relationship to meet the applicable criteria or reclassify the workers as employees. When in doubt about classification issues, it’s always best to seek the advice of an experienced employment attorney.