For FedEx, much riding on a ruling about drivers

FedEx Corp. tells its ground-service drivers when to work, what to charge customers, and what kinds of socks and shoes to wear, the workers say.

And drivers who have sued the company argue that makes them employees, not independent contractors.

As drivers in a nationwide lawsuit demand the federal pension benefits that are reserved for employees, FedEx founder and chief executive officer Fred Smith has a lot at stake. If a judge in Indiana decides the drivers are employees, they will seek $1 billion in damages. Plus, it may force the company to overhaul or even throw out a business model that gives FedEx Ground a cost advantage over its biggest competitor, United Parcel Service Inc.

"The case does not look good for FedEx," said Michael Harper, a Boston University law professor who is writing the chapter on the definition of

employee

for the Restatement of Employment Law, a reference work to be published by the American Law Institute. "FedEx's legal position is much less appealing because these drivers are at the core of their business."

The dispute has opened FedEx up to a series of related legal responsibilities, including a potential pretax liability from unpaid payroll taxes of as much as $2.5 billion. With $1.1 billion in net income in fiscal 2008, the company declined to say whether it had set aside reserves to cover the possible damages or tax liability. Spokesman Maury Lane said FedEx follows generally accepted accounting principles in disclosing reserves.

The bigger problem for the second-largest U.S. package-delivery company may be how to overhaul the business model to make it compliant. Businesses that use contractors rather than employees enjoy an estimated cost savings of more than 30 percent, according to Marick Masters, a business professor at the University of Pittsburgh.

"It's a critical stage for FedEx Ground," said Richard Reibstein, a New York labor-law partner in the firm WolfBlock who isn't involved in the cases. "The amount at issue is extraordinarily high."

In March, the same Indiana judge ruled that workers in 20 states could sue as 20 individual groups to win employee status. Because those class actions and a nationwide suit involve so many drivers, anticipated rulings by the Indiana judge on whether the workers are misclassified pose the biggest threat to date to Smith's vision.

Smith, who has served as cochair of Republican presidential candidate John McCain's campaign, was suggested in news reports as a potential running mate for McCain - a possibility that the FedEx CEO rejected. Campaign spokesman Brian Rogers said the candidate had no comment on the litigation, which could help define what it means to be a full-time employee.

Treating workers as contractors rather than employees has been gaining popularity among U.S. employers, with the number of contractors in the workforce rising 25 percent to about 10.3 million from 1999 to 2005, according to the Government Accountability Office. The reason for the increase is the cost differential, according to Masters, the business professor.

A Teamsters Union financial model predicts FedEx costs would go up $426 million a year if the company compensated the drivers as it does present employees. The model assumes FedEx would pay Social Security and Medicare taxes, unemployment and worker-compensation insurance, vacations, health insurance, and 15 hours a week of overtime.

FedEx's Lane declined to comment on the Teamsters' model or Masters' 30 percent savings estimate, except to call both "speculative." He declined to say how much FedEx saves by using contractors.

FedEx describes the drivers as small-business owners who invest in their trucks and are free to hire helpers or substitutes.

"We've given that entrepreneurial opportunity to thousands of contractors to own, grow and expand their own business," Smith told investors in a Jan. 10 conference call. "That's what freedom is all about."

The company claims it doesn't prescribe the drivers' work methods or their days or hours of work, allowing them to pick up and deliver packages on their own schedules. Drivers are paid by the job, FedEx says.

"We do not think it's against the law to work for yourself," Lane said.

Pat Becker Jr., chief investment officer for FedEx investor Becker Capital Management Inc., said Smith, before converting the drivers to payroll workers, would revise the model, probably moving toward multi-route drivers as he had when FedEx lost a similar class action in California demanding employee status.

Still, shifting to multi-route may not provide legal sanctuary. Employees of multi-route contractors are suing FedEx in Washington state, arguing that they, too, should be eligible for overtime pay.