On September 22, 2020, the U.S. Department of Labor (“DOL”) released its highly anticipated proposed rule for distinguishing independent contractors from employees under the Fair Labor Standards Act (“FLSA”).

When evaluating independent contractor status under the FLSA, courts have traditionally applied what is known as the “economic realities” test. The test varies slightly from circuit to circuit, and, perhaps, court to court, but courts generally consider the following factors on a non-exclusive basis: (i) the degree of control that the putative employer exercises over the workers; (ii) the workers’ opportunity for profit or loss, and their investment in the business; (iii) the degree of skill and independent initiative needed to perform the work; (iv) the permanence or duration of the working relationship; and (v) the extent to which the work is an integral part of the putative employer’s business. No single factor is dispositive, and the determination turns on a holistic assessment of the totality of the circumstances (i.e., the economic reality of the worker’s relationship to the putative employer).

The DOL’s proposed rule adopts a modified version of this test, focusing on certain factors, and clarifying and rearticulating others.

Perhaps most importantly, the DOL’s proposed rule focuses on two “core factors” that bear on a worker’s economic dependence: (i) the nature and degree of the individual’s control over the work, and (ii) the individual’s opportunity for profit or loss. The proposed rule states that these two factors are the “most probative” to the analysis, and that if both point towards the same classification, there is “a substantial likelihood that [the classification] is … accurate,” because the other factors, which are “less probative and afforded less weight, are highly unlikely, either individually or collectively, to outweigh the combined weight of the two core factors.” This is a stark departure from the arguably amorphous “totality of the circumstances” approach under the traditional economic realities test.

More specifically, the new “core” control factor will favor independent contractor status when a worker “exercises substantial control over key aspects of the performance of the work, such as by setting his or her own schedule, by selecting his or her projects, and/or through the ability to work for others, which might include the potential employer’s competitors.” On the other hand, this factor will favor “employee” status if the putative employer “exercises substantial control over key aspects of the performance of the work, such as by controlling the individual’s schedule or workload and/or by directly or indirectly requiring the individual to work exclusively for the potential employer.”

Importantly, the proposed rule further clarifies the control factor by stating that requiring workers to satisfy terms that are typical of contractual relationships between businesses—such as requiring workers to comply with legal obligations, to satisfy health and safety standards, to carry insurance, and to meet contractually agreed-upon deadlines or quality control standards—does not constitute the type of control that would make an individual more or less likely to be an employee under the FLSA.

With respect to the other core factor, profit and loss, the proposed rule states that this factor will favor independent contractor status when an individual has an opportunity to earn profits or incur losses based on the worker’s “exercise of initiative (such as managerial skill or business acumen or judgment) or management of his or her investment in or capital expenditure on, for example, helpers or equipment or material to further his or her work.” This factor will favor “employee” status when a worker “is unable to affect his or her earnings or is only able to do so by working more hours or more efficiently.” If, for example, a worker receives a regular hourly wage and the worker’s earnings depend solely on the number of hours he or she works, this factor would point to “employee” status.

The proposed rule lists three other secondary factors that are “less probative” to the analysis: (i) the amount of skill required for the work, (ii) the degree of permanence of the working relationship between the individual and the potential employer, and (iii) whether the work is part of an integrated unit of production.

Notably, the proposed rule states that the “integrated unit of production” factor differs “from the concept of the importance or centrality of the individual’s work to the potential employer’s business.” In other words, under the proposed rule, the fact that an individual performs work that is important or central to a putative employer’s business operations will not support employee status. Instead, this factor will turn on whether the individual works under circumstances analogous to a production line. In its notice of proposed rulemaking, the DOL explained that “performance of discrete, segregable services for individual customers”—which broadly encompasses a wide variety of independent contractor engagements—“is not part of an integrated unit of production.”

As we wrote about here, in April 2019, the DOL issued an opinion letter concluding that workers who provided services to customers referred to them through an online virtual marketplace were properly classified as independent contractors under the FLSA. Although the DOL applied a traditional formulation of the economic realities test in its opinion letter, the DOL’s 2019 analysis closely aligns with the newly proposed rule, including with respect to the DOL’s stated desire to promote “innovative work arrangements.”

The public will have until October 26, 2020 to submit written comments to the DOL on the proposed rule. The DOL reportedly plans to finalize the rule by the end of 2020 (i.e., before a potential change to a new administration).

If finalized, the rule will provide additional support to businesses that engage independent contractors in a number of industries, including those operating in the “gig economy,” as it provides greater clarity for differentiating between independent contractors and employees in a practical manner.

However, the rule would not override state law, which is often more protective than federal law, including in California, which has adopted a test designed to make it more difficult for businesses to classify workers as independent contractors under state law.

Lastly, it is worth noting that a federal district court recently struck down the DOL’s new final rule on joint employment, which we wrote about here. Like the independent contractor proposed rule, the joint employer final rule addresses the scope of the employment relationship under the FLSA. In that case, the district court found that the final rule departed from the DOL’s prior interpretations on joint employment without adequate explanation, and was otherwise arbitrary and capricious. If the DOL’s new independent contractor rule is finalized, plaintiffs’ attorneys may argue that the rule should face similar scrutiny from the courts.