The New Department of Labor Rule: Impact on Real Estate Independent Contractors Explained

The DOL's New Rule

REALTORS® are experiencing firsthand, the many significant changes to the landscape of real estate and the laws governing it. The next six-months do not appear to be an exception to this trend of significant changes. Beginning March 11, 2024, the Department of Labor (the “DOL”) has issued new rules for courts and agencies to use to determine whether someone is an independent contractor or an employee under federal labor laws. While the full extent to which the regulatory changes may impact the day-to-day business of brokerages and real estate agents is to be determined, there are some noteworthy issues brokers and agents could benefit by addressing.

California’s Current Law and The New Rule

As many readers may recall, it was only four years ago when the California Legislature passed a law defining the term “independent contractor” as it applies to real estate licensees. Under this law, a real estate agent is an independent contractor if they are: 1) licensed as a real estate agent; 2) substantially all of their renumeration is based on sales or output (i.e. commission); and, 3) have a written contract with the person/entity to whom they provide services. If they meet the requirements of this test they will not be treated as an employee for state tax purposes with respect to the services they provide. (Bus. Prof. Code, § 10032(b) [incorporating the definition of independent contractor utilized in the Unemployment and Insurance Code, section 650].) This article will refer to this 3-part test in the Business and Professions Code, section 10032, as the “California Rule” hereinafter. In terms of laws that are on the books, this 3-part California Rule seems relatively straightforward and simple to apply.

Further, as you may also be aware, it has only been a year-and-a-half since the California Court of Appeals formally recognized this definition of independent contractor as valid under California law. (See California Association of Realtors®, Legal Department, New Case Upholds Real Estate Licensees’ Choice to be Independent Contractors, https://www.car.org/-/media/CAR/Documents/Broker-Insight/March-2023.pdf [discussing Whitlach v. Premier Valley, Inc. (2022) 86 Cal.App.5th 673, reh'g denied (Dec. 5, 2022), review denied (Mar. 22, 2023)].) Despite the novelty of the California independent contractor law, it provided clear and relatively simple guidance for brokerages and agents alike, to know whether the relationship between them was one of an independent contractor or one of an employer-employee. Was the agent licensed as a real estate agent? Did the substantial majority of their income come from commissions? Did their written contract with the brokerage state that they were an independent contractor for the purposes of taxes? If these three questions were answered in the affirmative, they were an independent contractor under California law.  

THE “NEW RULE”

Beginning March 11, 2024, there is another test which will come into play, and what it means for California’s current independent contractor laws may not be clear. Specifically, the DOL will start using a “totality-of-the circumstances” test (across all industries) to determine whether someone is an independent contractor or whether they are an employee for the purposes of enforcing Federal labor laws. (29 C.F.R. § 795.110 (referred to hereinafter as the “New Rule”).) Under the New Rule, the DOL encourages authorities to consider whether the real estate agent has: “(1) [An] opportunity for profit or loss depending on managerial skill [...]; (2) [The] investments by the worker and the potential employer […]; (3) [The] degree of permanence of the work relationship[...]; (4) [The] nature and degree of control [the potential employer exercises over the performance of the agent [...]; (5) [The] extent to which the work performed is an integral part of the potential employer's business [...]; [and,] (6) [The agent’s] skill and initiative.” (29 C.F.R. § 795.110(b)(1)–(6).)

Why is the Department of Labor issuing this new guidance? There are various reasons, but part of the self-stated purpose of the New Rule is to, “answer the question of whether the worker is economically dependent on the potential employer for work or is in business for themself.” (29 C.F.R. § 795.110(a).) Answering this question has significant implications for whether the brokerage must pay overtime, follow DOL record keeping regulations, etc..

In providing the New Rule to answer the question whether a “worker is economically dependent” on an “employer,” the DOL noted that its previous rule concerning independent contractors (adopted by the DOL in 2021) was at odds with existing federal case law and the legislative intent of the Fair Labor Standards Act (the “FLSA”). (Federal Register, Rule, Employee or Independent Contractor Classification Under the Fair Labor Standards Act, https://www.federalregister.gov/documents/2024/01/10/2024-00067/employee-or-independent-contractor-classification-under-the-fair-labor-standards-act#h-22 (referred to hereinafter as the “DOLs Rule Commentary”).)

Legal and Practical Implications for Real Estate Professionals

There are a few legal and practical issues which merit discussion when it comes to the New Rule. While the full range of the legal implications of the New Rule are unclear, there are potentially significant issues that can arise. Some of these issues can be typified by the following scenario and the questions it raises.

Scenario

Let’s say you own your own brokerage and that you employ a number of real estate agents by way of a written independent contractor agreement that specifies they are an independent contractor for the purposes of the tax code. Each agent in your office works for the brokerage under such an agreement. Additionally, all your agents are licensed in California, and they make the majority of their money based on commissions of sales they perform on behalf of the brokerage. Under California law, the relationship you have with each agent that works for your brokerage satisfies the California Test for an independent contractor. Easy enough.

Further, imagine you are a dutiful and law-abiding broker. Pursuant to California law, you fully comply with your duties to oversee and supervise your agents in the performance of their jobs. You manage your brokerage in such a way that you regularly ensure compliance with the rules and laws implemented by the Department of Real Estate, the Business and Professions Code, and other relevant State authorities.

Not only is your business compliant with these requirements, let’s say your business consistently outperforms its competition and it is well known in the real estate community as a great place for agents to work. This success is due in part to the business’s reputation for performance, but it is also due to the fact that you, as the owning broker, have a reputation for genuinely caring for your team and their individual success. To maximize their success, you provide them with ample resources, tools, and flexibility so they can perform their jobs well and maximize their own value. Each agent has different needs, but if the circumstances require it, you jump in to help manage and organize the agent’s day-to-day responsibilities. This is all great, you run one heck of a business!

Now let’s introduce a challenge into the picture. As it happens, you entered into a written contract with an agent who satisfies the California Rule for independent contractors. Despite your best efforts to motivate and provide tools to the agent to succeed, the agent has missed their commission goals as designated in their contract. To make matters worse, despite your brokerage’s stellar hiring record, the interview process did not reveal that this agent would be a troublemaker in the office, but they are. This one agent is simply a bad fit. Not only do they not perform and meet expectations, they have a cousin who is an attorney who told them about the new DOL regulations. Seeing an opportunity to stir the pot, as troublemakers are prone to do, this agent files a complaint with the DOL under the FLSA for non-payment of overtime wages for the time they have spent working with the brokerage. You take stock of the situation and think: “Well, good thing our contract and relationship meets the California test for an independent contractor. I do not have any duties related to overtime pay to this agent.” And here, we arrive at our first issue.

Question: Which law is going to apply to determine the dispute?

Answer: Given the lack of DOL guidance on how it intends to interact with existing state laws, it is not clear which rule will be applied in California or if the rules even lead to the same outcome.

It is not entirely clear from the DOLs Rule Commentary how it will handle a situation like this.  The DOL is the agency in charge of enforcing the FLSA, and your agent sued you for back-overtime wages under the FSLA. But, your agent is licensed in California, does all their business in California, and your brokerage has structured all its agreements to meet the requirements of California law, which up until March 11, 2024, seemed to comply with the relevant Federal rules. Under the California Rule, your agent is an independent contractor. But on the Federal Rule, it is not so clear. Nor is it clear if the DOL will defer to the California Rule to make a determination brought under the FLSA. Here, there are significant issues involving some relatively lofty legal terms and principles at play such as the Supremacy Clause,  “preemption”  and principles of “federalism.”  Much more could be said as to how each of these principles impacts the implementation of the New Rule, but such discussion is outside the scope of this article.

While the DOL might choose to follow existing state law in a specific dispute, it is by no means absolute that they must follow state law in determining whether an agent is an employee or independent contractor. Given the DOL has indicated which rule it will apply, this begs our next question.

Question: Will the result turn out different under the New Rule versus the California Rule?

Answer: Maybe, it just depends on the totality of circumstances.

Forgive me for using the most overused lawyer “answer” to a simple question, “maybe” or “it depends.” From the perspective of a broker or agent who works in the industry every day, I understand that it probably is not even a little bit helpful. While it may not be “helpful” in the sense of providing a definitive answer as to how each rule will function in practice, the truth is, the outcome of the DOL applying the New Rule over the California Rule, or vice versa, it really does depend on the circumstances of each particular case. Part of this is due to the “totality-of-the-circumstances” nature of the Rule as described by the DOLs Rule Commentary. (See DOLs Rule Commentary, section II.D [“[T]he [New Rule] return[s] to a totality-of-the-circumstances analysis … in which the factors do not have a predetermined weight and are considered in view of … whole activity.”].) In non-legalese, “totality-of-the-circumstances” is essentially the DOL telling us: “This New Rule is so broad and undefined we have to look at each case individually. This New Rule is unpredictable even to us.” In other words, each determination of whether someone is an independent contractor or employee will be made on a case-by-case basis with no apparent predictability for us to rely on.

It is important to note, that the National Association of REALTORS® ("N.A.R.") has raised questions about how the New Rule also conflicts with the current Internal Revenue Service ("IRS") rules regarding independent contractors specific to the real estate industry. Under the United States Code, a real estate agent is not treated as an employee when they are licensed as a real estate agent, their remuneration is substantially based to their services related directly to sales or other output, and there is a written contract between the agent and the person to whom they provide services that states they are not to be treated as an employee for Federal tax purposes. (26 U.S.C.A. § 3508(a)-(b).) To date, the DOL has not specified how its Rule interacts or differs from the IRS treatment of independent contractors in the real estate industry.

Scenario Analysis: The New Rule in Action

Let’s run our scenario above through a couple provisions of the New Rule to illustrate the ambiguity related to provisions that are very likely to impact existing California law.

Factor 4: The DOL wants agencies and courts to examine the nature of degree and control a potential employer has over the individual’s work at issue. In California, as most of you already know, there are explicit state laws and rules that require brokers to exercise control over their agents. Will brokers be punished for ensuring their agents comply with such laws? It depends.

According to the DOL, one factor that will matter is if a broker puts rules in place in their brokerage that go beyond the safety, regulatory, or statutory requirements of the state, leading to a more supervisory type of control over the agent’s duties, and it may indicate the broker’s relationship to the individual is that of an employer. (DOLs Rule Commentary, section V.C.4.a.) This approach, however, seems to disincentivize brokers from being more proactive in ensuring compliance with existing state rules and laws because it could potentially punish them for taking steps that go beyond what the law requires.

In a letter drafted to the DOL by the “N.A.R.”, the NAR noted the control factor of the New Rule is unpredictable as currently drafted because, “[t]he supervision that brokers generally must provide includes details such as the allocation of earned fees, management of incurred business expenses, and details on licensure requirements […] are different from control that would define an employment relationship where any employee produces work in a manner controlled by the employer.” Until more guidance is provided by the DOL, it is not clear how the control factor would result in our scenario.

Factor 5: DOL wants courts and agencies to consider the extent to which the work performed is an integral part of the potential employer's business when making determinations under the FLSA. What does “integral” even mean? Further, ask any broker about their best agents and they will tell you they are linchpins to the success of the business. Good agents—by definition—make themselves integral pieces of a brokerage’s culture, team, and performance. If you read the guidance released by DOL discussing this factor, no clarity or confidence is provided to help articulate and fill in the details of this factor. In fact, an initial reading of the DOLs guidance seems to imply that all individuals who either produce goods or perform services are “integral” to their potential employer’s business. For example, the DOL says, “if a potential employer’s primary business is to make a product or provide a service, then the workers who are involved in making the product or providing the services are performing work that is integral to the potential employer’s business.” (DOLs Rule Commentary, section V.C.5.) Doesn’t it seem like this is not so much a factor, as it is an assumption?

A BRIEF ASIDE FOR AGENTS WHO ARE READING THIS

Agents, admittedly, this article is drafted from a perspective that focuses on the impact of these changes for brokerages and brokers. A second article where these changes are discussed from an agent’s perspective is undoubtedly due, but is not discussed here for brevity’s sake. One of the more obvious potential consequences of these changes that comes to mind for agents is that an agent’s ability to set up their employment as an independent contractor may become more difficult. For example, if the New Rule results in more and more agents being determined to be employees and not independent contractors, it is likely that brokers will adjust their employment models to prioritize employees. As a matter of efficiency, it will no longer make sense for brokers to employ independent contractors if the law prioritizes treating individuals as employees. Why risk the extra cost of litigating whether someone was an employee or independent contractor if it is more likely the New Rule will treat them as an employee in the end?

Conclusion: Embracing Change and Staying Informed

There is only one predictable thing happening in the real estate industry today, and that is, change. It seems everywhere you look, decades-old industry practices or standards are being turned on their head. When it comes to the New Rule, the lack of clarity may seem overwhelming. So, what can you do? Be flexible and stay informed.

If the independent contractor model best suits your business and your agents’ wants and needs, continue to abide by the relevant California laws and regulations that define independent contractors. Be aware, however, that such compliance with the California Rule is not guaranteed to satisfy the New Rule. Until further guidance is given by the DOL, or decision precedent is handed down through the courts and applicable agencies, the onus will be on brokers and agents to be diligent in their practices. Additionally, you can read the 106 pages worth of the DOL Rule Commentary yourself, so you can better understand the DOLs rationale for the change. Warning: reading guidance on the Federal Register is not exactly like reading your favorite fiction novel, but developing even a cursory understanding of the DOLs rationale may help you anticipate where the industry is headed in the midst of these changes. As always, if you have questions related to how all of this impacts your specific business or strategy, it is always a good step to consult with a qualified attorney on these matters.

[1] “The clause in Article VI of the U.S. Constitution declaring that the Constitution, all laws made in furtherance of the Constitution, and all treaties made under the authority of the United States are the “supreme law of the land” and enjoy legal superiority over any conflicting provision of a state constitution or law. (SUPREMACY CLAUSE, Black's Law Dictionary (11th ed. 2019) (emphasis added).)

[2] “The principle (derived from the Supremacy Clause) that a federal law can supersede or supplant any inconsistent state law or regulation.” (PREEMPTION, Black's Law Dictionary (11th ed. 2019).)

[3] “The legal relationship and distribution of power between the national and regional governments within a federal system of government, and in the United States particularly, between the federal government and the state governments.” (FEDERALISM, Black's Law Dictionary (11th ed. 2019).)

[4] For further information and discussion about how Federal agency rules and regulations interact with existing state law, see Executive Order 131320. (Federal Register, Presidential Documents, Executive Order 13132 of August 4, 1999.)