Startups are faced with a myriad of choices on how to allocate limited capital to their needs. Some startups consider hiring interns as a free or low-cost work option. However, management must be wary of the pitfalls of hiring free trainee (or student) labour. Generally, a for-profit company must pay its employees for their work. However, in these circumstances, an intern may not be considered an employee under the federal Fair Labor Standards Act (“LSF”).
In 2018, the Department of Labor replaced its six-factor test for determining whether or not a trainee is an employee under the FLSA and adopted the seven-factor primary beneficiary test used by the Second Circuit Court of Appeals. to determine the economic reality of the relationship between the intern and the for-profit enterprise. The seven-factor test has also been adopted by the Ninth and Eleventh Circuits, but unfortunately it has not been adopted by all circuit courts.
Unlike the previous Department of Labor six-factor test, where all six factors had to be met for a worker to be classified as an unpaid intern and not an employee, in the new test adopted by the Department of Labor, the factors are weighed in all the circumstances. This new standard makes it easier for a for-profit company to assess whether an unpaid worker can be hired as an unpaid intern without violating the FLSA.
If an intern is the primary beneficiary of the relationship (which, in practice, is when the intern is at least the beneficiary of at least 51% of the benefits of the relationship), then the intern is likely considered a non-employee under the FLSA and will not be required to receive compensation for their work. The following seven factors make up the test:
1.) Both parties understand that there is no expectation of compensation.
2.) The practicum provides training that would be given or is similar to school-based training.
3.) The intern’s successful completion of the program qualifies for academic credit in a formal student intern education program.
4.) The internship adapts to the intern’s academic calendar and other academic commitments.
5.) The duration of the internship is limited to the period during which the internship provides training or an apprenticeship to the intern.
6.) The internship provides significant educational benefits to the intern, and the intern’s work complements, rather than replaces, the work of paid employees while providing significant educational benefits to the intern.
7.) The intern understands that there is no promise of employment after the end of the internship and that the for-profit company cannot make any such promise or assurance. (See https://www.dol.gov/agencies/whd/fact-sheets/71-flsa-internships).
To avoid running up against the seven-factor test, a for-profit company that recruits or engages an unpaid intern must align any solicitation, advertising, or promotional materials used to recruit unpaid interns and any other documentation or guidance provided to an intern potential or committed. intern, as well as the employment agreement for an unpaid intern with the seven-factor test.
For example, in Xuedan Wang vs. Hearst Corp.., 877 F.3d 69 (2d Cir. 2017) in upholding the district court’s ruling that Hearst interns were not employees, the Second Circuit noted that the employer, Hearst, required applicants obtain pre-approval for credit from their educational institution prior to their participation in the internship and that it was clear to the interns that there was no promise of employment and that the internship was unpaid.
While this is a helpful illustration, management should be clear to check with an experienced attorney in their own state to determine if your jurisdiction applies the Department of Labor’s seven-factor test or for any requirements additional under state law. But, at a minimum, a for-profit business must ensure that the expectations of both parties follow the guidance provided by the seven-factor test.