The on-demand economy, also referred to as a platform, gig or sharing economy, is generally characterized by the use of technology to deliver goods and services to users "on demand." That demand is satisfied using websites and apps that connect users with transportation, accommodations, food delivery and more. The workers who deliver the goods and services are often independent contractors who can accept or reject work opportunities, or gigs, based on their own schedule and availability.

Recently, those contractors and regulatory agencies such as the US Department of Labor (DOL) have challenged their independent contractor status under state and federal law. The tests for independent contractor status under the Fair Labor Standards Act (FLSA) and analogous state laws, which can be difficult to apply even in traditional work arrangements, are especially difficult to apply to on-demand work relationships. Practical Law reached out to Thomas McInerney and Justin Scott of Ogletree, Deakins, Nash, Smoak & Stewart, P.C. for their thoughts on the labor and employment issues involved in the on-demand economy.

Thomas McInerney is the Managing Shareholder of Ogletree's San Francisco office. Tom has extensive employment litigation experience in complex litigation matters, with an emphasis on class actions, multi-plaintiff cases and trade secret and other complex business disputes. Arbitrations and mediations are also a large part of Tom's practice. Tom has assisted clients in developing arbitration and mediation programs, and he has represented a wide variety of clients in these alternative dispute resolution proceedings. Tom also serves on Ogletree's Management and Pro Bono Committees and is an elected official in Marin County, California.

Justin Scott has extensive experience with the FLSA and state wage and hour laws, having litigated the applicability of exemptions, allegations of off-the-clock work, issues related to an employee's regular rate of pay and retaliation claims in both federal and state courts. Justin has recently defended numerous companies in putative class actions brought under California employment law.

The terms "on-demand" or "sharing" or "gig" economy refer generally to the new wave of businesses that use application technology to connect an individual who needs a service with another individual who is willing to perform the service.

A well-known example is Uber, a platform that connects people who need rides with drivers who are willing to pick up and drop off those individuals in the drivers' own cars. Several companies have sprung up to provide a variety of services, such as grocery shopping, delivery of take-out and delivery of household items.

The biggest issue is the classification of the individuals performing the services (for Uber, they are the drivers) as independent contractors or employees.

A majority of on-demand companies have classified the service providers as independent contractors. Using that classification, companies avoid various obligations associated with an employment relationship, including ensuring that the workers are appropriately paid under federal and state law (minimum wage and overtime pay), provided with mandatory benefits (such as California's new paid sick leave), reimbursed for business expenses and accounted for in payroll taxes, unemployment insurance taxes and workers' compensation insurance policies.

Much of the recent litigation in this area has centered on the independent contractor classification.

Because multiple tests for independent contractor status exist, how a company makes that determination depends on the jurisdiction and the statute. Under the FLSA, federal courts apply the economic realities test, which addresses whether the workers depend on someone else's business for the opportunity to work or are in business for themselves.

In addition, the DOL recently issued interpretive guidance on the economic realities test, explaining that the correct focus of the independent contractor analysis is the individual's economic dependence on the company. The DOL takes the position that only those who are truly in business for themselves can be properly classified as independent contractors. According to the DOL, the broadest possible scope of the employment relationship should guide any independent contractor determination (see Legal Update, DOL Issues Guidance on the Economic Realities Test and Independent Contractor Classification).

State law may also influence the classification. Some states, such as Florida and Ohio, defer to the analysis under the FLSA. Other states have adopted their own tests for independent contractor status, either by statute or common law, and many are more difficult to satisfy than the FLSA's test.

Companies must be careful to comply with both the FLSA test and any applicable state or local test.

Regardless of the test, the independent contractor analysis is based on several factors applied to the unique circumstances of the worker's relationship with the company. There is no "one size fits all" test. Variations in the tests and how courts or regulatory agencies apply them can result in the same position being analyzed differently.

Companies and their counsel should understand the tests used in the jurisdictions where they do business.

The FLSA's economic reality test generally includes these six factors:

No single factor is dispositive and application of these factors will vary by worker and jurisdiction. The ultimate determination is whether the workers are truly in business for themselves.

Though the DOL has recently reiterated its position that no single factor is dispositive, a company's contractual right to terminate a worker from the platform for any reason has emerged as a significant argument against independent contractor status. Arguably, the ability to terminate a worker with or without cause represents ultimate control over the worker's activities. If the company can terminate the relationship at any time, it presumably has sufficient leverage to impose its will on the details of the individual's day-to-day work.

State law tests use similar factors, though some criteria may be given greater emphasis. For example, in California, the dispositive factor is the company's right to control the means and manner of the worker's performance. Recent California case law has clarified that the control analysis turns on whether the company has the right to exercise control (normally governed by the applicable contract) as distinguished from the control the company actually exercises.

So, in California, if the company requires all independent contractors sign the same, or virtually the same, agreement giving the company the right to exercise control over how the worker performs the service at issue, the fact that the company does not actually exercise this control may not be relevant to the classification inquiry. This approach is quite different from the FLSA's analysis, particularly as interpreted by the DOL (see Legal Update, DOL Issues Guidance on the Economic Realities Test and Independent Contractor Classification).

The traditional independent contractor tests are not well suited to evaluate the relationship between companies and workers on an app platform. Many of the tests were developed decades ago and did not contemplate a platform business model where workers login remotely, accept or decline gigs, set their own hours and use their own computers, vehicles, tools and other property.

Courts overseeing misclassification cases have expressed frustration with the existing framework for litigating these disputes. For example, while concluding that the independent contractor status of Uber drivers could not be determined on summary judgment, the US District Court for the Northern District of California noted that the modern on-demand economy evolved under a very different economic model than the traditional test for employment and that many of the factors appear outmoded compared to the new model (O'Connor v. Uber, No. 13-cv-3826, , at *15 (N.D. Cal. Mar. 11, 2015)).

As another example, in a decision involving Lyft, an Uber competitor, the same court concluded that applying the current independent contractor test to the on-demand economy is like handing the jury a square peg and asking it to choose between two round holes (Cotter v. Lyft, Inc., 60 F. Supp. 3d 1067, 1081 (N.D. Cal. Mar. 11, 2015)).

Ultimately, if on-demand workers are considered employees, then this technology creates an unprecedented level of personal autonomy for workers. At the same time, the platform model also creates an incredible level of indirect and automated oversight, such as automatically tracking worker locations and performance through the app. For example, the Northern District of California noted that the level of monitoring of Uber drivers, where they were potentially observable at all times, arguably gave Uber a tremendous amount of control over the drivers' performance (O'Connor, , at *14).

Despite the widespread publicity about legal challenges to the platform work relationship, no court has yet concluded that Uber or Lyft drivers are employees. Case law is currently limited to decisions finding that the classification issue cannot be decided on summary judgment.

Various regulatory agencies, including the DOL, are taking a hard look at the use of independent contractors for potential misclassification issues. We can expect participants in the on-demand economy will be part of that scrutiny.

A common component of on-demand work relationships is some division of tips or gratuities between the company and the worker. As independent contractors, the division is simply a contractual term the parties negotiate. But if on-demand workers are employees, the company must comply with state and federal (and sometimes local) wage and hour laws that govern the distribution of tips. For example, under the FLSA, employers cannot keep any portion of an employee's tips. State law, such as in Massachusetts, can also prevent employers from taking a portion of an employee's tips.

So, if a court concludes on-demand workers should have been classified as employees, the company opposing that classification may be liable for unpaid tips in addition to unpaid minimum wage and overtime pay. If the individuals are properly classified as independent contractors, then the parties' contract dictates compensation matters, including the division of any gratuities.

Companies and their counsel should evaluate the independent contractor tests applicable in the jurisdictions where they do business. They should audit their agreements with contractors using the economic realities test factors and factors considered under state or local law.

For example, on-demand companies and their counsel should carefully consider contract terms such as: