New graduates in a tough economy are often looking for ways to network and enhance their résumé. Businesses are always looking for ways to get the job done and save money too. It’s no surprise that the internship seems like a win-win. But it isn’t that simple. If an intern should have been classified under the Fair Labor Standards Act (FLSA) as an employee, businesses must provide proper compensation or face significant penalties.

In the past decade, plaintiffs’ lawyers have become more aggressive in pursuing the opportunities presented by improper internship programs and the courts have come down hard on businesses that fail to comply. From NBCUniversal paying $6.4 million to settle an internship lawsuit in 2014, to Viacom paying out $7.2 million, to Warner Music paying out $4.2 million, and SiriusXM paying $1.3 million in 2015--the list goes on.

While some corporations have learned their lesson, misclassification of interns remain a common and costly legal issue, particularly in a down economy when businesses are looking for ways to cut costs. A small business may be unable to bounce back from a multi-million-dollar judgment or the bad PR that comes with it. So, it is particularly important that entrepreneurs understand how to run legal internship programs that benefit their companies and the participants, while mitigating risk.

Quantifying the internship risk

People may be willing to work for no pay to build their résumé, but that doesn’t mean it is legal.

The FLSA makes no exception to requirements for minimum wage and overtime payments simply because someone is willing to work for free. The prevailing test among courts and the Department of Labor (DOL) is the primary benefit test. In 2018, the DOL updated its criteria for internship misclassification and issued guidance on it in Fact Sheet #71: Internship Programs Under The Fair Labor Standards Act. Although the test is nuanced (read ahead for more details) it depends in large part on whether the intern understands the terms and conditions of the arrangement and receives appropriate academic credit.

“The only way to have a legitimate unpaid intern program is to create a legitimate educational opportunity. Too many ‘interns’ are simply unpaid employees. Internships involving coffee runs and copy jobs are bound to result in big trouble for corporations,” explains Kate Bally, director of labor & employment service at Thomson Reuters Practical Law, an online tool business owners can use to access up-to-date legal resources.

To get a sense of the financial risks, we can look to similar legal pitfalls. Another common liability that threatens small businesses is misclassification of independent contractors. Savvy plaintiffs’ lawyers are mindful that often independent contractors are actually employees and that catching mistakes like these can result in significant financial judgments or settlements. Some estimates value misclassification cases at as much as $80,000 per worker in IRS back taxes, penalties, and legal fees, Bally explains. Unfair internship programs could result in even higher losses since companies likely paid at least something to contractors, but often nothing at all to those misclassified as interns.

How to run a legal internship program

Again, interns are only interns if they meet specific requirements of the FLSA. Under this law, anyone who is required to do work must be compensated properly, with very few exceptions. If interns are receiving school credit from an accredited college or university and the programs meet other requirements, they may be part of a legitimate unpaid internship program. (More information is available at Practical Law and accessible by signing up for a free trial.) Bally recommends reviewing Practical Law know-how content and consulting with an employment lawyer to be sure your program complies.

It isn’t enough that you’re a scrappy startup without a lot of funding. That is not a recognized FLSA exception. “I think startups and small businesses are often eager to say, ‘Well, there must be some exception because I’m just starting out.’ But there isn’t. There really isn’t,” Bally explains. “If you are not going through a formal process with an accredited program, you are likely to get yourself in hot water.”

Most issues arise when an intern complains to the DOL. That may result in an investigation or a lawsuit, either of which can be enormously costly. To mitigate these risks, it is best practice to pay interns at least minimum wage and to ensure they work fewer than 40 hours a week. If they are working more, they are likely to be entitled to overtime. Entrepreneurs may also want to consider hiring a third party to manage their interns and lower-wage employees to steer clear of violations.

Before retaining any unpaid interns, businesses should consider the factors outlined by the U.S.Court of Appeals for the Second Circuit in Fox Searchlight Pictures in 2016 (Glatt v. Fox Searchlight Pictures, Inc.), a test also adopted by the DOL in 2018 (rejecting its prior six-factor test). Under the new test, called the primary beneficiary test, the following elements must be considered: 

  • Whether both the intern and the company share the expectation that there would be no compensation paid.
  • Whether the program provides the equivalent of educational training.
  • Whether the internship program is tied to a formal education program through coursework or academic credit.
  • Whether the internship program fits with the individual’s academic calendar.
  • Whether the program lasts only as long as it offers educational benefits.
  • Whether the intern’s tasks compliment or displace work otherwise done by employees, while also benefitting the intern.
  • Whether both the intern and the company share the understanding that there will be no entitlement to employment after the internship ends. 

Bottom line? There is no such thing as free labor. The risk of getting it wrong is too great for most small companies to absorb easily. To mitigate risk, pay your interns, and seek expert guidance if attempting an unpaid internship program.

Practical Law provides easy-to-navigate access to legal resources so you can keep up with small business labor law and more. To access a free trial, visit https://legal.thomsonreuters.com/en/products/practical-law today.