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Uber's future could hinge on one key issue

Uber got a nasty PR surprise on the eve of litigation that could fundamentally change its business model.

A California court is set Thursday to decide whether to give class-action status to a lawsuit that claims the ride-hailing company violates labor law in classifying drivers as independent contractors rather than as employees. In defending itself, Uber reportedly recruited 400 of its drivers to say that they prefer to remain independent. On July 23, six of the drivers have changed their minds. The story was broken by Re/Code on August 3.

After speaking with lawyers for the plaintiffs, the drivers claimed that they had not understood the difference between working as an employee of a company and working as a contractor. The law firm representing the plaintiffs told Re/Code that it had spoken with 50 drivers, but that most were afraid to challenge the company in court records out of concern they might be banned from using Uber's technology.

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An Uber spokesperson called the allegations that drivers are actually employees "simply false" and said, "Drivers use Uber on their own time and terms. They control their use of the approximately 400 drivers enthusiastically came forward to provide declarations about exactly how much they value the independence and flexibility of driving with Uber."

Uber also denies the drivers' claims they were unclear on the nature of the suit. The company does not publicly release how many drivers it has in California.

Uber's business model, including its cost structure, depends on employing drivers as independent contractors. That frees the company, which is valued at roughly $50 billion, from being responsible for expenses such as vehicle maintenance, payroll taxes, and workers' compensation insurance.

Uber has been a lightning rod for controversy. It has aggressively pursued expansion and butted heads with regulators and municipal officials around world. But its biggest challenge in the U.S. may hinge on the more prosaic legal question of how the U.S. Labor Department and courts interpret worker classification rules.

For the most part, current regulations and laws encourage companies to treat workers as employees rather than contractors. Not only do officials often want to see workplace protections in place that go missing for contractors, but they also want income taxes collected and remitted through an employer-employee relationship.

In June, the California Labor Commission found that one Uber driver should have been treated as an employee. The company immediately appealed.

A bigger hurdle for Uber may turn out to be guidance issued last month by the Labor Department.

"Misclassified employees are often denied access to the critical benefits and protections they are entitled," wrote Dr. David Weil, administrator of the agency's Wage and Hour Division in a blog post articulating his view of the law. "Misclassification also generates substantial losses to the federal government and state governments in the form of lower tax revenues, as well as to state unemployment insurance and workers' compensation funds. It forces workers to pay the entirety of their payroll (FICA) tax. It also tips the scales against all of the employers who play by the rules and undermines the economy."

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According to Seyfarth Shaw, a law firm that represents corporate employers, the Labor Department's stance on worker classification could have a significant impact on employers, potentially disrupting business models that depend on using contract workers.

That could be a problem not only for Uber, but also for dozens of other "sharing economy" companies that have sprouted up in recent years. Some, such as grocery service Instacart and high-tech product delivery and setup firm Enjoy, have shifted to an employee model, which suggests that companies may be able to absorb the additional costs and still remain viable.

But such a shift would likely affect Uber's profit and change how investors, who have poured $6.9 billion into the company, value it.