Employment Law Alert: California Dramatically Narrows Which Workers May Be Treated As Contractors

In what we think is the most significant California employment law ruling this decade, Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County (Cal. 4/30/18), the California Supreme Court dramatically narrowed the definition of which workers may be treated as independent contractors (instead of employees) under’s California Wage Orders.

Before Dynamex, California courts generally had relied upon a “multi-factor ‘all circumstances'” test to determine contractor versus employee status.  On April 30, 2018, however, the California Supreme Court ruled in Dynamex that a more simple and broad definition of employment applies under the Wage Orders.  The Wage Orders serve as the primary source of California’s employer wage and hour regulations, establishing requirements with respect to overtime, minimum pay, working hours, meal/rest breaks, work time records, payroll records, and various other matters.

The ABC Test

The Court ruled that California’s Wage Orders require a worker to be treated as an employee if the worker is “suffer[ed] or permit[ted]” to work, and that an “ABC” test (which has been adopted in a few other jurisdictions) governs the determination. Under the ABC test, the hiring entity bears the burden of proving that the worker is an independent contractor. In order to meet this burden, the hiring entity must prove “each of the three factors embodied in the ABC test – namely[:]

The Court highlighted that “it may be easier and clearer” to look at whether B or C can be satisfied first. Indeed, while none of these factors would have been single-handedly determinative under the old “all circumstances test,” now failure of any one of the three standards is fatal to contractor classification.

Outside the Usual Course of the Hiring Entity’s Business (“B”): We believe that standard B will probably have the biggest impact. Under the B prong of the test, if the worker renders services within the usual scope of the company’s business, the worker is automatically deemed an employee-without regard to any other factors. As examples of cases in which prong B was failed, the Court referred to scenarios where “a clothing manufacturer hires work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that will thereafter be sold by the company[,] or where a bakery hires cake decorators to work on a regular basis on its custom-designed cakes[.]” As an example of a case in which prong B is satisfied, the Court referred to “when a retail store hires an outside plumber to repair a leak in a bathroom on its premises or hires an outside electrician to install a new electrical line.” Significantly, the Court held that prong B was sufficient standing alone to warrant its decision to affirm certification of the class action lawsuit against Dynamex. Because Dynamex was a delivery business and the lawsuit was on behalf of drivers making such deliveries, there was sufficient “commonality of interest” to support the case being certified as a class action on behalf of the class of drivers.

Worker is Customarily Engaged in an Independently Established Trade, Occupation or Business (“C”): Likewise, if the worker does not have a bona fide independent business, the worker is automatically deemed an employee. In order for prong C to be satisfied, the company must generally prove that the worker took “the usual steps to establish and promote his or her independent business – for example, through incorporation, licensure, advertisements, routine offerings to provide the services of the independent business to the public or to a potential number of customers, and the like.”

Free from Control or Direction (“A”): While either standard B or C may be dispositive in many cases, standard A should not be ignored. As an example of workers who were not sufficiently free from control under standard A, the Court referred to a case involving a clothing company and “work-at-home knitters and sewers who made the clothing . . . , even though the knitters and sewers worked at home on their own machines at their own pace and on the days and at the times of their own choosing. . . . That the product is knit, not crocheted, and how it is to be knit, is dictated by the pattern provided by [the company]. To reduce part A of the ABC test to a matter of what time of day and whose chair the knitter sits when the product is produced ignores the protective purpose of the [applicable] law.”

What was behind such a dramatic ruling by the California Supreme Court? Several things actually. The Court emphasized the “very serious problem” of “depriving federal and state governments of billions of dollars in tax revenue and millions of workers of the labor law protections to which they are entitled.” The Court also expressed concern that “the public may be required under applicable laws to assume additional financial burdens with respect to [misclassified] workers and their families” because they are not receiving the rights and benefits of an employee. The Court reasoned that the “suffer or permit to work” standard in the Wage Orders is purposefully broad, having been drafted originally into early 1900’s laws regulating and prohibiting child labor. The standard was intended to impose liability “even when no common law employment relationship existed between the minor and the defendant, based on the defendant’s failure to exercise reasonable care to prevent child labor from occurring.” The Court explained that it had not had occasion to consider whether and how the “suffer or permit to work” standard should be applied to independent contractor classification, until this case. Importantly, the Court also emphasized the benefits of having a more simple and clear test (suggesting that the “all circumstances test” created too much ambiguity, resulting in non-compliance, contrary to the broad protective purposes of California employment laws).

The Court’s ruling applied only to cases brought under California’s Wage Orders (i.e., not other employment laws) because the specific appeal only related to Wage Order claims. This does not mean, however, that it would be lawful or practical for employers to classify workers as employees for Wage Order compliance purposes, and contractors for other purposes. In all likelihood, California courts will rule that Dynamex’s rationales for applying the ABC test to California Wage Orders also apply to other California employment laws. Moreover, it is difficult (if not impossible) to conceive of a scenario when it would be administratively practical (and not fraught with risk) to treat a worker as an employee for wage and hour law purposes, and a contractor for other purposes. If a California worker is an employee under the ABC test, the practical answer in virtually every case now is that the worker will need to be treated as an employee for all purposes.

Recommendations

We have long recommended that clients review their contractor classifications with legal counsel to ensure compliance. With Dynamex’s dramatic change in the law, it is imperative that companies work promptly with legal counsel to review their contractor classifications, even if they were already reviewed under the law as it existed before Dynamex. Potential legal liabilities for contractor misclassification are enormous, because one misclassification results in the simultaneous violation of a wide range of employment and tax laws, many of which impose substantial penalties.

We also strongly recommend reviewing and updating independent contractor agreement forms. Generally, those forms should be drafted to support the legitimacy of the contractor classification under applicable law. Contractor agreements should be reviewed and updated to account for the dramatic shift in the law by Dynamex.