A U.S. Department of Labor rule that takes effect this month may result in more contract workers being classified as employees, potentially requiring employers to provide benefits and insurance coverage such as workers compensation and possibly exposing them to employment-related lawsuits. 

The Employee or Independent Contractor Classification Under the Fair Labor Standards Act rule, which was finalized Jan. 10 and rescinds a Trump administration rule, covers employment classification under the FLSA, but employers worry it might have broader influence. 

Government officials say the rule provides a clearer analysis for employers to use to determine a worker’s employment status. It re-adopts an enhanced economic realities test for worker classification that was in effect under an Obama administration rule. 

The new rule contains a six-factor test to guide employers in determining a worker’s employment status under the FLSA (see box), whereas the Trump administration rule had a two-factor test. 

The Labor Department says misclassification of employees as contractors may deny workers a minimum wage, overtime pay and other protections. 

Some experts say the change is narrowly tailored and limited in scope, a view shared by the Labor Department. 

“The rule is how the Department of Labor is going to interpret who is an employee under the Fair Labor Standards Act,” said Todd Lebowitz, an attorney with Cleveland-based Baker & Hostetler LLP who represents employers. “So, one agency, one law.”

One group that came out in support of the new rule is the National Electrical Contractors Association, which said the change is a win for its member contractors because it would address the “rampant misclassification across industries, particularly the construction sector.”

But others are concerned the change may have consequences beyond just minimum wage and overtime pay protections. 

“Once you’re an employee for wage and hour reasons then I think everything else just starts to morph into the rule,” said Robert Boonin, a labor and employment attorney with Ann Arbor, Michigan-based Dykema Gossett PLLC.

The rule faces court challenges, but if it proceeds, certain workers would be considered employees for wage and hour purposes, a change that some labor unions and others support.

App-based gig workers, though, may prefer to remain independent contractors, some business advocates say.

“The concern if gig workers were suddenly reclassified would be that there would be fewer opportunities and less flexibility, which we know that they value,” said Ruth Whittaker, director of civic innovation policy for the Washington-based Chamber of Progress, a technology trade association.

Possible confusion could result if workers are classified as independent contractors under one statute and as employees under another, said Alex MacDonald, a shareholder with Washington-based law firm Littler Mendelson P.C. and a core member of the Workplace Policy Institute, a division of the firm.

“It gets very confusing very quickly, and it is even different from state to state and within a state,” Mr. MacDonald said. “So, there’s like a Byzantine web of classification tests.” 

This confusion, experts say, could lead to more employment-related litigation. 

Mr. MacDonald is lead attorney in Coalition for Workforce Innovation et al. v. Walsh et al., one of the lawsuits challenging the rule. 

The suit, which is pending in the Eastern District of Texas and targets procedural issues associated with the law, was filed by various groups, including an organization representing independent workers, small businesses, start-ups, entrepreneurs and technology companies. 

Advocates of the new rule say many workers themselves pushed for reclassification. Some say the federal rule was inspired by California Assembly Bill 5, which was passed in 2019 and created a new test for determining employee classification (see related story). 

Those who pushed for AB 5 to become law included labor unions and legislators who voiced concern that independent workers were being deprived of employment protections such as overtime pay and sick leave. 

Matthew Estipona, director of government affairs and community engagement for the Northern California chapter of the Associated Builders and Contractors, said if the federal Labor Department rule proceeds, it may lead to more confusion and potentially expensive litigation as employers navigate how to determine employee status. He said that has been the effect of the California law.

“The final rule will jeopardize the ability of construction firms to continue the industry’s longstanding practice of utilizing legitimate independent contractors,” Mr. Estipona said. “Under the rule’s multifactor test, employers will now be forced to guess which factors should be given the greatest weight in making the determination.” 

Some experts said the DOL rule will have employers rethinking insurance coverage. 

“There may be more confusion about whether certain claims are covered by a policy that the employer has or whether employers would consider getting additional coverage,” said Bill Kennedy, a partner with Philadelphia-based Montgomery McCracken Walker & Rhoads LLP. 

Experts say companies may consider adding employment practices liability insurance or directors and officers liability insurance.

California law paved way for federal change

In 2019, California Gov. Gavin Newsom signed into law Assembly Bill 5, which created a new test for employers to determine whether workers should be classified as employees or independent contractors. 

As the U.S. Department of Labor prepares to implement a similar rule at the federal level, opponents are pointing to the impact of the California law. 

Matthew Estipona, director of government affairs and community engagement for the Northern California chapter of the Associated Builders and Contractors, said the law has led to a drop in employment. 

Mr. Estipona cited a January study from the Mercatus Center at George Mason University in Arlington, Virginia, that found California self-employment fell by 10.5% and overall employment dropped by 4.4% following the passage of AB 5. 

The study, however, noted that a drop in employment due to the pandemic could also be taken into consideration. 

Alex MacDonald, a shareholder with Washington-based law firm Littler Mendelson P.C. and a core member of the Workplace Policy Institute, a division of the firm, said the belief that employment would rise as companies classify more workers as employees is a “reductive way to think about it.” 

“If businesses stop using contractors, that reduces overall economic activity, which could affect the number of traditional employee jobs in that industry,” he said. 

Fallout from California’s AB 5 passage has included lawsuits by the trucking industry, which claims the law represents a huge cost burden for employers forced to cover independent drivers with workers compensation insurance, and by the ride-sharing industry, which contends the law has negatively affected its business.

In December, the U.S. Court of Appeals for the Ninth Circuit agreed to rehear a case by Uber Technologies Inc. seeking to overturn a judge’s dismissal of the company’s challenge to AB 5.