Second Circuit Finds Arbitration Agreement Insufficient to Block Employees’ Misclassification Claims.

With many changes in labor and employment law over the past few years, it’s not unusual for employers to react quickly to each concern as it arises but miss opportunities for a more comprehensive and holistic approach.  For example, an employer might respond to the rising costs of litigation by entering arbitration agreements with its employees, and respond to the Department of Labor’s (“DOL”) new guidance and enhanced enforcement efforts by reconsidering its classification of certain business collaborators as employees instead of contractors, but overlook how these two business decisions, each reasonable on their own, tend to interact.  The Second Circuit’s recent decision in Holick v. Cellular Sales of New York LLC, 14‐CV-4323 (2d Cir. Sept. 22, 2015), may serve as a cautionary tale for employers about the hazards that may be associated with implementing changes in employment practices without pausing to consider their broader implications.

In 2010, Timothy Pratt and William Burrell began selling Verizon cellular service plans and merchandise on behalf of Cellular Sales of New York (“Cellular Sales”).  The two men each formed their own Limited Liability Companies, which entered into non-exclusive commission-based sales agreements with Cellular Sales.  Those agreements provided that these LLCs were independent contractors of Cellular Sales and set forth terms where the parties consented to submit all disputes to mediation, but preserved their right to file a lawsuit if mediation was unsuccessful.  A year later, perhaps wary of a potential misclassification claim, Cellular Sales offered Pratt and Burrell full-time employment; the two accepted, and entered into compensation agreements with Cellular Sales on January 1, 2012.  The compensation agreements indicated that any and all disputes – including wage and hour disputes – related to the agreement or the individuals’ employment would be submitted to arbitration.

Despite the company’s precautionary move, or maybe because of it, Pratt and Burrell then sued Cellular Sales with other employees in a class action suit for – among other claims – unpaid overtime compensation and minimum wage violations, arguing that they were misclassified as independent contractors in 2010 and 2011, and should have been paid as employees.  Cellular Sales moved to compel arbitration based on their current compensation agreements.  The district court denied the employer’s motion to compel arbitration, reasoning that because the earlier independent contractor agreements were in effect at the time of the alleged misclassification, claims relating to employment practices in 2010 and 2011 were not arbitrable under the later compensation agreements’ arbitration clause.

On appeal, the Second Circuit affirmed the decision below, but with a slightly different rationale.  Cellular Sales had argued that, because the plaintiffs alleged they were employees as a matter of law in 2010 and 2011 but had been misclassified as independent contractors, and because they had agreed in 2012 to arbitrate claims related to their “employment,” Pratt and Burrell had – based on their own understanding of their relationship with Cellular Sales – agreed to arbitrate any claims arising during the period when they were classified as independent contractors.  The court rejected this argument, reasoning that while contrived labels of “independent contractor” or “non-employee” would not control whether an individual is an employee for purposes of the FLSA, the parties’ choice of terminology will generally govern the interpretation and enforcement of contracts such as an arbitration agreement.  Because the parties had, by their conduct, not intended to commence an employment relationship until the execution of the compensation agreements, their agreement to arbitrate claims related to Pratt and Burrell’s employment could not be interpreted to cover the period when they were contractually designated as independent contractors.  To put our own gloss on this, the contract derived its force from the parties’ intentions at the time it was formed, and Pratt and Burrell’s subsequent conclusion that they had previously been misclassified could not be used to rewrite their 2012 arbitration agreements.  Any other result would, we imagine, have profound implications for contract interpretation generally, perhaps most significantly for the enforcement of releases of liability.

The Second Circuit’s decision in Holick thus provides a nice illustration of the importance of taking a comprehensive approach to employment practices and litigation strategy.  On the one hand, the employer may ultimately be glad that its argument about contract interpretation was unsuccessful, strictly from the standpoint of stability in business relations.  On the other, it is worth reflecting on the employer’s responses to its perceived business needs; on at least one interpretation, those responses were not wrong, but merely incomplete.  If the company decided that it would be difficult to defend Pratt and Burrell’s continuing designation as contractors, in the face of closer scrutiny from the Department of Labor and potential underpayments in unemployment and workers compensation premiums, payroll taxes, and overtime, reclassifying them as employees was entirely appropriate, but it isn’t clear from the court’s decision that there was any other change in the plaintiffs’ responsibilities or working conditions.  If so, it isn’t necessarily surprising that a lawsuit pertaining to the earlier period quickly followed.  In addition, a growing number of employers regard arbitration as a pragmatic way to limit attorney fees and the risk of unpredictable jury awards.  If the employer was concerned about litigation based on its prior engagement of independent contractors, then it is surprising that it didn’t craft Pratt and Burrell’s arbitration clauses to cover the entire period of their business relationship, rather than only having effect prospectively.

These particular decisions may, of course, be explained by business considerations that didn’t find mention in the litigation or the court’s ruling, but the broader principles are still sound.  When reclassifying workers to realign the employment relationship with regulatory requirements, and when introducing alternative dispute resolution mechanisms or other significant policy changes, it’s important to step back and consider the broader implications of these moves, including any unintended consequences from how the various planned changes may interact with one another.  Experienced counsel can help identify these hidden issues, and offer strategies for reducing the risk of undesirable results.