Employers across the country are increasingly utilizing independent contractors to fill an ever-expanding array of positions. These jobs range from sophisticated, high-tech engineers and logistics professionals to doctors, nurses, construction workers, and food service providers. But employers who seek to classify workers as independent contractors to avoid the expenditures associated with payroll, taxes, benefits, and capital improvements, or feel further incentivized to do so by the Affordable Care Act, should take note: Courts are sending a clear message that such practices can be costly.

Most recently, a publicly traded national chain of gentlemen’s clubs has come under fire for misclassifying as independent contractors the dancers it employs. Peregrine Enterprises Inc., which operates Rick’s Cabaret in Manhattan, has been ordered to pay $10.8 million in back wages to 1,900 dancers. The damages figure is only expected to rise, as trial has yet to begin. The club argued that the dancers were independent contractors and therefore were not entitled to hourly pay. However, Judge Engelmayer of the U.S. District Court for the Southern District of New York decided last year that the club exerted supervision and control over the dancers to the extent that management created an employer/employee relationship and therefore wages were owed pursuant to the Fair Labor Standards Act and New York Labor Law. On November 14, Judge Engelmayer went one step further and ordered that the fees and gratuities paid by patrons could not be used to offset the back wages owed. Pursuant to that decision, the club not only owes the back pay — it also owes the dancers portions of fees paid by patrons that were collected by the club for private dances. 

Employers beware, as this decision only further underscores the need to engage workers in accordance with business needs instead of pursuing an employment relationship that is artificially tailored to absolve the employer of obligation. The Rick’s Cabaret decision means that even when workers are paid gratuities or other fees, employers are not absolved of their obligation to pay wages.

As a result of the increased liability and scrutiny on misclassification, employers with independent contractors should enhance their efforts to perform internal audits to determine whether those individuals classified as independent contractors are truly independent and acting as their own bosses. Although there are many tests for determining employee versus independent contractor status, all inquiries rely on the extent of control the employer has over the individual performing the job functions. The inquiry is focused on the manner in which the job is performed rather than the outcome of the efforts made. The usual trappings of self-employment including incorporation, contracts, titles, independent equipment, scheduling, and insurance are not necessarily enough to establish an individual as an independent contractor if the employer continues to control the individual’s work or work product.

Courts, the Department of Labor, and the IRS examine whether an individual designated as an independent contractor has freedoms — freedom to work from home, freedom to set their own schedule, and freedom to choose their own equipment. In holding that the dancers were misclassified, Judge Engelmayer said Rick’s Cabaret exercised an “immense degree” of control over the women by monitoring and overseeing almost every aspect of their actions within the club. Rick’s management required the dancers to clock in and out via thumb print scanner and prohibited the dancers from using cell phones, purses, and body glitter.

Documentation establishing a worker’s independence — including certificates of incorporation, insurance, and business marketing — is also helpful for successfully responding to complaints and audits. Employers that plan to continue utilizing independent contractors but have concerns about misclassification should consider hiring a third-party staffing agency so that the workers will be considered a member of the third party’s organization.

If you have questions regarding the classification of workers, or about the potential impact of this case on your business, please contact:

• Caroline J. Berdzik (609.986.1314; cberdzik@goldbergsegalla.com)
• Or another member of the Goldberg Segalla Employment and Labor Practice Group.