Top 10 Employment Compliance Pitfalls for Emerging Companies

Whether you are a founder or a manager, growing a company from scratch is an exciting process. For most companies, this process will involve the hiring and management of employees at a rapid pace. To ensure that a company not only grows, but flourishes, operators and managers must be diligent in their employment compliance efforts. This article discusses some common issues that emerging companies find themselves wrestling with in the early stages of their growth.

1. Independent Contractor Misclassification

One of the most common misconceptions for companies is that they may simply treat a worker as a “1099” consultant or independent contractor, thereby avoiding employment-related obligations such as tax withholding, minimum wage, overtime, and employment benefits. In reality, most workers are legally presumed to be employees under both federal and state laws. A worker may only be classified properly as an independent contractor if the employer can prove that he or she is truly operating his or her own business, economically independent of the putative employer and free from control by the putative employer when it comes to the manner and means of his or her work. 

Some states, such as California, have highly restrictive misclassification laws rendering it essentially impossible to treat individuals as independent contractors if they perform work that is integral to the business of the putative employer. Virginia has enacted independent contractor misclassification statutes that create statutory remedies for employees who are misclassified, placing a heavy burden on companies to overcome the legal presumption that its workers are employees. In Virginia, companies that misclassify employees as independent contractors may be liable for up to three years of unpaid minimum wage, overtime, benefits, liquidated damages, attorney’s fees, and other potential private remedies, as well as government penalties for failing to withhold and pay income and employment taxes. Because the potential exposure is high, this is often a primary focus for employment-related diligence in corporate transactions.

2. FLSA Exemption Misclassification

Another common legal misstep by employers is improperly treating employees as exempt from federal and state minimum wage and overtime laws. Frequently, this happens when employers assume an employee who is paid a set salary is automatically exempt. Instead, employees are presumed to be non-exempt, and thus entitled to minimum wage and overtime, unless they qualify for a specific, enumerated exemption under applicable law. While being paid on a salaried basis of at least the applicable salary minimum is one requirement of most exemptions, an employee’s actual job functions and required qualifications for the position must also meet the requirements of a specific, enumerated exemption (under both federal and state law, if applicable). 

The bar for exemption typically is high. Employers who fail to classify employees properly may be liable for up to three years under federal law (or potentially longer under state law) of unpaid minimum wage and overtime, in addition to liquidated damages and employees’ attorney’s fees. Again, because potential exposure is high, this is often a primary focus for employment-related diligence in corporate transactions.

3. Improper Wage Payments

Employers may also find themselves in hot water with government agencies (and plaintiffs’ attorneys) for failing to pay promised wages, failing to pay wages timely, and/or deducting employee wages improperly. Outside of federal minimum wage and overtime obligations, requirements regarding methods and frequency of wage payment, termination pay obligations, and deductions from wages typically are governed by the law of the state where the employee performs work. These laws vary significantly from state to state. 

Employers must ensure that they are paying employees commissions, bonuses, and even paid time off in accordance with the terms of the employer’s policies and/or plans covering such payments. Employees must be paid final wages (which sometimes must include accrued and unused paid time off) in accordance with state law. For example, in California, involuntarily terminated employees are due their final wages immediately. In other states, including Virginia, they must be paid final wages on the next regularly scheduled payroll date. For the most part, employers also may not deduct any amounts from employees’ earned wages without their express, voluntary, written authorization covering the specific amount deducted.

4. I-9 Compliance

Employers in the United States are required to complete a Form I-9 (and/or the online equivalent through E-Verify) correctly for all employees who perform work for the employer and to maintain these records in accordance with federal law. The I-9 process requires employers to complete Form I-9 or E-Verify within three days after the employee begins work and to confirm the employee’s valid work authorization through the presentation of certain acceptable documents related to the individual’s identity and work authorization. Many states, including North Carolina and South Carolina, require all or most businesses to use E-Verify for I-9 compliance. An employer’s failure to comply with these requirements could expose the employer to federal penalties. Immigration compliance is often a focus of employment-related diligence, especially in the case of equity purchases or when a transaction is covered by representations and warranties insurance (RWI).

5. Noncompete Laws

To protect their confidential information, trade secrets, and customer/employee relationships from unfair competition, employers often require employees to sign restrictive covenant agreements. These types of agreements always have been viewed with scrutiny due to their effect of restraining trade, and employers always must ensure that their agreements are supported by adequate consideration and are tailored narrowly to protect only the employer’s legitimate business interests. In addition, many states have enacted laws in recent years that further limit (or prohibit) these sorts of restrictions. Depending on the state where an employee performs work, public policy or state law may prohibit non-competes and customer non-solicitation restrictions, etc., and may even make the existence of such an agreement unlawful.

(California and Washington, D.C. are some of the most restrictive, and Virginia recently joined the ranks of states that prohibit noncompete agreements with certain so-called “low wage” employees). Other states allow certain restrictive covenants, but only when specific requirements are met. Many of these laws do not allow employers to circumvent state requirements by including a different choice of law in the agreement. Because purchasers and investors often want to see these protections in place, employers must be extremely careful when asking employees to sign restrictive covenant agreements to ensure they are enforceable under the specific laws of the state where the employee is based, even if the agreement has a choice of law provision for another state.

6. Required Employee Handbook Policies

While it is always best practice for an employer to have a well-drafted employee handbook that clearly explains all personnel policies and that is regularly updated, certain policies may actually be required by law and others are necessary for employers to avail themselves of defenses under various employment laws. Policies that provide important safe harbors for employers include EEO/anti-discrimination/anti-harassment policies with complaint procedures, policies for correcting payroll errors, and policies against unlawful payroll deductions. Federal law requires employers with fifty or more employees to have a Family and Medical Leave Act policy, including military caregiver leave. Certain state laws also require additional policies, such as pregnancy accommodation and lactation policies, for example. Employers should ensure that they have implemented a handbook that complies with these requirements for every state in which they have employees.

7. Leave of Absence Laws

Federal and state laws provide various statutory leave rights, both paid and unpaid, depending on employer size and employee work location. Most employers are likely familiar with the Family Medical Leave Act (FMLA), though they may not be counting employees properly for the purpose of determining whether the FMLA applies to their workforce. Employers must also account for state laws that mirror the FMLA but may provide broader rights or cover smaller employers (such as in California). In addition, many states and localities have enacted paid sick leave laws that require employers to provide paid leave for medical reasons, as well as other reasons like domestic abuse or public health crises. These paid leave laws can be difficult for multistate employers to implement across their workforce, as different local laws require different accrual rates, leave uses, carryover allowances, etc.

8. Discrimination, Harassment, and Retaliation

Often employers are aware generally of their obligations not to discriminate against employees, or to allow harassment or retaliation at the worksite. However, these obligations may extend beyond the scope of what is prohibited under federal law (e.g., discrimination based on sex, race, sexual orientation, gender identity, disability, religion, etc.), as some state laws encompass many other protections. For example, Washington, D.C. law includes protections against discrimination for, among other things, personal appearance, family responsibilities, genetic information, educational status, political affiliation, unemployment status, place of residence or business, sources of income, and reproductive health decision-making. 

Employers must also be mindful of their obligations to respond to and promptly remediate employee complaints of harassment or retaliation. The informal, ground-up culture that sometimes forms in new and emerging companies, coupled with the fact that they often lack dedicated human resources departments, may make them uniquely susceptible to harassment and retaliation issues. These companies – particularly those experiencing rapid expansion – need to be especially mindful of preventing harassment and retaliation, ensuring complaint procedures are clearly communicated to staff, and appropriately responding to complaints received.

9. Disability and Pregnancy Accommodation

Employees are protected under federal law and most state laws against discrimination based on a protected disability or their pregnancy and pregnancy-related medical conditions. Generally, disability is defined broadly and encompasses most physical or mental impairments. In addition to prohibiting disability discrimination, the law also requires employers reasonably to accommodate qualified individuals with disabilities or pregnancy-related conditions. This can include on-the-job accommodations (like the ability to take rest breaks or use assistive devices) but can also require employers to provide periods of continuous leave as an accommodation and to consider accommodating alternate schedules and flexible work arrangements.

Employers can therefore face liability for summary discipline or termination of an employee for nonattendance, if the employee’s attendance issues are related to a protected disability. Employers have the right to request certain medical information in connection with an employee’s request for accommodation, but the types of information they can request – and when they can request it – are limited by applicable law.

10. Background Checks

It is common to condition an offer of employment on a successful background check. However, employers’ background check procedures often are not compliant with applicable law. The federal Fair Credit Reporting Act (FCRA) imposes detailed authorization and notice requirements for employers who rely on background checks conducted by third parties. These authorizations and notices must contain certain information, may not contain other information, and must be provided within set time frames. Some states impose similar procedural requirements for background checks. 

In addition to these technical notice requirements, state laws also vary regarding whether and how an employer may rely on criminal convictions or credit history when making employment decisions, and employers must be careful to ensure their onboarding documents and policies comply with these obligations. In addition, employers must make sure that they are not using screening criteria that tends to create a discriminatory disparate impact in hiring based on a certain race, gender, national origin, or other classifications protected by law.

11. Bonus Topic – Multistate Compliance and the Remote Worker

As the above summaries illustrate, employment laws vary widely from state to state and even city to city. Employees are protected by the employment laws of the jurisdiction where they are working. For remote workers, this means they are protected by the laws of their home state. As employers’ workforces become increasingly remote and more and more workers are scattered around the country, employers must be diligent about complying with the specific requirements of each state and locality where they employ staff.

The above are some examples of several of the issues seen as companies grow. By including legal costs in emerging company budgets to ensure processes and policies are in place to help avoid legal pitfalls, companies can prevent molehills from turning into mountains. For more information, you should contact your experienced employment counsel.