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Investors Must Confront The On-Demand Economy’s Legal Problem, Part 1

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Editor’s note: Vinay Jain is the chief legal officer at Shake, a mobile platform to sign, send and access legal agreements.

Chances are, no venture capital pitch deck you’ve ever seen had a slide entitled “Worker Classification.” And yet, many companies in the “sharing economy” or “ondemand economy” (ODE) rely on workforces whose legal status may be in jeopardy.

The biggest ODE companies are powered by armies of workers they classify as independent contractors, not employees. These include the drivers that pick you up on Uber and Lyft, the people who clean your house on Handy and Homejoy, and the couriers who deliver you stuff on Postmates.

Because independent contractors aren’t subject to minimum wage or overtime laws, aren’t entitled to disability or unemployment insurance, and are exempt from other benefits, they’re cheaper than employees. That is great for the companies they work for — except that those companies are increasingly being exposed to lawsuits (see Handy and Uber) and penalties for misclassifying these workers and denying them benefits.

Beyond a short-term financial hit, these lawsuits threaten the very business models of many ODE companies.

A Matter of Control

The legal distinction between independent contractor and employee boils down to control. The more control the hirer has over the worker’s behavior, the financial aspects of the worker’s job, and the duration of the working relationship, the more likely that worker is an employee.

Think of a bank teller. He receives training and close supervision, is expected to work set hours, gets paid for his hours rather than by the project, and continues to work for the bank unless he is terminated or quits. He is an employee.

Now think of a plumber you hire to fix your kitchen sink. You don’t tell her how to fix the sink. She has the freedom to turn your job down and, by and large, to set her own hours. You’re just as likely to pay her a flat fee for the job as you are to pay her by the hour. Her working relationship with you ends after the sink is fixed. She is a contractor.

These are black and white examples, but there is a large gray area in between. In fact, there is no single criterion that decisively makes a worker a contractor or an employee. Government agencies and courts examine a variety of factors, which makes the law confusing and undoubtedly leads to cases of unintentional misclassification.

Contractor Status Is Good for Companies, and Maybe Even Some Workers

At first glance, deploying contractors makes a lot of sense for a Handy or an Uber. They can quickly onboard workers, which is crucial to meeting their growth goals. They can rapidly upsize or downside their workforce depending on demand. And of course the cost savings they achieve by foregoing benefits is critical to their bottom line.

It can work out well for the worker, too, particularly the ones who go in with no expectations of a guaranteed income. Take this recent review from a self-identified courier for Postmates:

This is my first month, and I’m loving Postmates so far! It’s extremely flexible, I’m earning decent side income, and I love that it’s app-based…People are expecting companies like Postmates, Uber, Lyft to pay all this money, benefits, etc. when these are simply ways to SUPPLEMENT your income, not to be your primary income!… I know they say you “can” make $25/hr but come on….at the end of the day that is no guarantee. That should already be obvious people. Entrepreneurial-minded people know this, I have no clue why employee-minded individuals don’t.

To be sure, you can find plenty of negative Postmates reviews, as well, including several that claim they never saw the pay levels that Postmates says are typical. And there are powerful stories out there about how just hard it can be for workers to make ends meet in the “gig economy.”

Then again, lots of people are unhappy with their jobs. If they’re not making enough money, they can just quit and find something else, right? (Yes, easier said than done — a reality quickly forgotten when you’re surrounded by programmers who can find new jobs in the time it takes to change lanes on the 101.) But if the workers have a choice, who does misclassification really hurt?

An Uneven Playing Field

Companies that fail to properly classify their workers gain an unfair competitive advantage. A report commissioned by the Virginia state government cited findings that employers who misclassify employees as contractors can save between 10 and 40 percent in payroll costs. Moreover, the companies that play by the rules end up subsidizing the ones that don’t. They face higher unemployment tax and workers’ compensation insurance costs because those rates must be adjusted upward to cover misclassified workers. By law, under certain circumstances, unemployed or uninsured workers who were misclassified are still eligible for some benefits.

It’s hard to escape the conclusion that many emerging ondemand technology companies are able to undercut their old-school competitors at least in part because they’re engaged in regulatory arbitrage. They don’t just live in the gray area where new business models and ambiguous worker classification laws intersect — they exploit it.

Eventually, of course, the regulations will catch up, and when they do, there’s a good chance that the music will stop. Because when you strip away the technology layer, it’s hard to pin down why the law should treat many ODE companies differently from traditional ones providing the same types of services.

The Law Doesn’t Care About Your Fancy App

There’s an inherent tension between the consistent brand experience that a company like Handy is trying to present to its customers and the autonomy that its cleaners are supposed to have as independent contractors. Take the following Handy worker requirements alleged in the lawsuit and ask yourself if Handy really wants its customers to think its cleaners are in business for themselves:

Cleaners are required to follow numerous company guidelines, procedures, and/ or protocols in completing their job, which include, among others, (1) how to dress, including a mandate to wear clothing containing a Handy insignia, (2) what to specifically communicate to the Customer in the event the Cleaner arrives early, (3) when to knock/ring the doorbell, (4) how to announce the Cleaner’s arrival, including identifying that the Cleaner is with Handy (even if no one responds to the doorbell/knock), (5) whether the Cleaner should ask whether he should take off his shoes (Handy directs Cleaners to always ask), (6) whether the Cleaner must shake the Customer’s hands when they arrive at the home or office (always), (7) how to tailor communications with customers, (8) how to interact with the customer once the Cleaner has shaken hands with the Customer but before the cleaning has begun, (9) how to use the bathroom, (10) whether or not Cleaners can accept personal phone calls while on the job (never), (11) whether Cleaners can hire or otherwise bring anyone to helpthem complete the job (never), and (12) under what circumstances a Cleaner can, and cannot, listen to music while performing her job duties.

Given the degree of control Handy allegedly exercises over its cleaners in the name of providing a consistent, high-quality customer experience, how exactly is it different from a traditional maid service where cleaners are employees? The fact that it books and assigns jobs through an app?  So what?

Traditional companies have had to play by the worker classification rules for decades, even when they’re expensive or inconvenient. FedEx Ground recently lost a major class-action lawsuit by drivers that it classified as independent contractors even though it managed them closely. To quote the opinion:

“The drivers must wear FedEx uniforms, drive FedEx-approved vehicles, and groom themselves according to FedEx’s appearance standards. FedEx tells its drivers what packages to deliver, on what days, and at what times. Although drivers may operate multiple delivery routes and hire third parties to help perform their work, they may do so only with FedEx’s consent.”

Sound familiar? The arguments are not so different from some of the misclassification claims against Uber.

The ODE Paradox

Tech entrepreneurs and investors love platforms and marketplaces — tools that efficiently connect people who want goods or services with others who want to sell them. But when the user experience becomes so seamless and controlled that it’s hard to distinguish the platform from the third-party service provider, the platform starts to look a lot like a traditional service company, albeit one enclosed in a slick tech wrapper.

Hence the paradox facing certain types of ODE companies: The better they get at providing a unified customer experience, the more they run the risk of misclassification. No one would ever allege that Craigslist employs the cleaners who advertise on its site — it’s obvious from the very nature of the listings that the company exercises no control over the cleaners’ work. Handy and Homejoy, on the other hand, not only guarantee the quality of the work, they process the transaction. The customer is doing business directly with the company.

So how can these companies get right with the law without compromising their customer experience? In Part 2, we’ll examine some alternatives.

Featured Image: sergign/Shutterstock