The use of independent contractors (ICs) is nearly as much of a trucking industry tradition as strong coffee, avoiding weigh stations, and lengthy waits at shipping docks. For decades, it has been commonplace for an owner-operator to work under contract to a large trucking company to augment its in-house fleet.

However, the IC model is under closer legal scrutiny than ever before. Drivers and their advocates contend that many so-called independent operators effectively function as company employees. Yet because they are classified as contractors, they are denied the rights, privileges, and benefits that come with being an employee.

Last Wednesday, a three-judge panel of the Ninth U.S. Circuit Court of Appeals struck perhaps the most decisive blow to date against the contractor model. The panel ruled that a class of 2,300 drivers in California who from 2000 to 2007 were classified as contractors for FedEx Ground, FedEx Corp.'s ground parcel delivery unit, were actually employees under California law. The panel reversed a December 2010 lower court ruling that the workers were contractors and remanded the case to a federal district court in California with directives to enter an order changing their classification. The panel also ruled in favor of the plaintiffs in two cases in Oregon.

The panel ruled that FedEx Ground exercised total control over its contractors, making those workers eligible under California's "right to control" test to be considered employees. It dismissed the company's claim that its control of drivers was limited only to pursuing the results it sought, not the manner in which the drivers achieved them. In the lead opinion, Judge William A. Fletcher wrote that company actions that ranged from limiting a driver to operating over specific territories or schedules to dictating their grooming habits and the appearance of their uniforms are not part of a "control of results" strategy as prescribed under California law.

In its defense, FedEx relied on a 2009 decision by a federal appeals court in Washington, D.C., that workers at the company's "FedEx Home Delivery" unit were contractors because the company offered "entrepreneurial opportunities" to them. However, Judge Fletcher said that ruling has no legal standing in California. "There is no indication that California has replaced its longstanding right-to-control test with the new "entrepreneurial-opportunities" test developed by the D.C. Circuit," he wrote. "Instead, California cases indicate that entrepreneurial opportunities do not undermine a finding of employee status."

Much could change if the ruling is upheld because there are more than 20 cases around the country involving FedEx Ground that turn on the worker-classification issue. FedEx could retroactively owe its driver workforce hundreds of millions of dollars in expenses ranging from employee benefits to equipment obligations that had been borne by the workers. It could alter FedEx Ground's operating cost advantage over unionized rival UPS, which has played a pivotal role in the unit's resounding success over the past decade or more. Organized labor could be emboldened to restart its efforts to organize FedEx Ground years after Founder, Chairman, and CEO, Frederick W. Smith, long known for his anti-union animus, beat them back. It could pique the interest of the Internal Revenue Service (IRS) as well as state tax agencies looking for more payroll tax income. The IRS is active in employee reclassification efforts, knowing that it means more income in its coffers; as employees, workers would be unable to employ the same sort of tax avoidance tactics that are abundantly available to them as contractors.

The panel's ruling threatens to upend a highly successful ground parcel operating model FedEx inherited in 1998 when it acquired Caliber System Inc., the parent of Roadway Package System Inc. (RPS). RPS had been using contractors since its founding in 1985, and its low operating costs made it an increasingly viable alternative to UPS, which until the late 1980s held a 90-percent-plus share of the U.S. ground parcel business. Supported by FedEx's vast resources, the rebranded FedEx Ground unit turned the model into a powerful force. It is by far the fastest-growing unit within the FedEx portfolio.

Whether the FedEx legal battle spills into the broader trucking business is anyone's guess. At least 30 percent of all truckload drivers are involved in long-term, exclusive agreements with motor carriers, according to estimates from IHS Economics and Country Risk (formerly IHS Global Insight), a consultancy. Charles W. Clowdis Jr., who runs the firm's global trade and transportation practice, said the relationships are so intimate that many outside drivers function in the same delivery dispatch cycles as company drivers, However, it is unlikely that many driver-carrier relationships in the truckload industry involve the deep level of control that FedEx Ground purportedly exercises over its drivers, according to several observers.

FEDEX APPEAL
FedEx said in a statement that it would appeal the ruling and may seek what's known as an en banc rehearing before the full circuit. Petitions for a full rehearing are usually granted if a panel's decision conflicts with an earlier appellate court order or an opinion issued by the U.S. Supreme Court, or if the issue is deemed to be of exceptional importance. The Ninth Circuit receives about 1,200 petitions for rehearing a year and hears about two dozen cases at any given time, according to Eric Su, a New York-based attorney for FordHarrison LLP, a firm that represents employers in labor-management issues.

FedEx said in the statement that the panel rendered a decision on a model that is no longer in use. Since 2011, FedEx Ground has only contracted with incorporated businesses that treat their drivers as their employees, the company said. FedEx said that over the years it has "significantly strengthened" the operating agreement that served as the basis for the adverse ruling.

The company said in the statement that it would shift to new independent service-provider (ISP) agreements in California, Oregon, Washington, and Nevada, four of the states where the Ninth Circuit holds jurisdiction. Such agreements typically involve larger geographic service areas from which contractors can operate, according to Patrick Fitzgerald, a FedEx spokesman. FedEx Ground operates through an ISP in 17 states; the company plans to provide details on the extended agreement in October, Fitzgerald said.

ARE THE TIMES A-CHANGING?
The panel's decision is the latest gust of wind that seems to be blowing in labor's direction. Courts, regulators, and lawmakers are moving, albeit slowly, toward taking a tougher stand against an employer's classification of workers. A law in New York State that took effect in April required companies to pass one of two tests in their entirety before drivers working trucks over 10,000 pounds of gross vehicle weight (tractor, trailer, and cargo combined) could be classified as independent contractors. The legislature in neighboring New Jersey had passed a similar bill affecting parcel and drayage drivers. However, Gov. Chris Christie vetoed it last year.

Courts in the Northeast and in California, regions with strong organized labor influence and which generally favor positions supporting workers' rights, appear to be leaning in the workers' direction on the issue, attorneys say. Public policy from the White House seems to favor classification of workers as employees instead of as contractors, according to Su.

But if there is one company with deep experience in the employee-classification issue, it's FedEx. It spent years battling the IRS over alleged tax liabilities stemming from the classification of its ground workers. The fight culminated in the IRS withdrawing claims that could have cost the company about $1 billion in back taxes plus interest. The company has also fought in multiple states over the issue. The appellate court ruling had stemmed from a class action lawsuit that had been consolidated.

FedEx has taken its hits. In mid-March, for example, it reached a $5.8 million settlement with attorneys representing 141 Maine drivers who alleged their employment status was misclassified. The presiding judge noted that if the drivers' case was tried, damages could have topped $10 million, with the potential for double damages under state and federal wage laws, according to a note from the law firm Pepper Hamilton LLP.