[Revised July 27, 2019]
In California, questions regarding the validity of a worker’s classification as an independent contractor often arise when the worker files a complaint alleging that he or she was misclassified for the purpose of wage payments under the Department of Industrial Relations Wage Orders. On April 30, 2018, the California Supreme Court considered the criteria that courts should utilize to distinguish independent contractors from employees under the California Wage Orders and substantially changed state law by adopting the restrictive standard commonly known as the “ABC test.”
In Dynamex Operations West, Inc. v. Superior Court, delivery drivers claimed in a class action lawsuit that Dynamex misclassified them as independent contractors rather than employees. Dynamex is a courier and delivery service whose customers include the general public and a number of large companies for whom it delivers purchased goods and picks up returns. In 2004, Dynamex converted all of its drivers from employees to independent contractors to save money. Dynamex continued to obtain its own customers and set the prices it charged for its services. Although drivers were required to provide their own vehicles and pay for all of their transportation expenses, they had to wear Dynamex shirts and badges. The drivers were free to set their own schedule, but deliveries were assigned by Dynamex dispatchers at Dynamex’s sole discretion, and drivers had no guarantee of the number of deliveries offered.
In a far-reaching decision, the California Supreme Court revised the standard used to distinguish contractors from employees when a worker alleges a violation of the Wage Orders. Under the so-called “ABC test” adopted by the California Supreme Court, a company that wishes to classify a worker as an independent contractor bears the burden of proving that:
- the worker is free from control and direction in the performance of the work, both under the terms of the contract and in fact;
- the worker performs work that is outside the usual course of the hiring entity’s business; and
- the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
The hiring party must satisfy all three criteria in order for a valid independent contractor relationship to exist.
To explain its decision, the court offered the example of a plumber hired by a retail store to repair a bathroom leak. In such a situation, the plumber is performing work that is not part of the store’s usual business and therefore is not reasonably viewed as working in the hiring business. In contrast, when a bakery hires a cake decorator to assist in creating custom-designed cakes, the cake decorator is part of the hiring entity’s usual business operations and would be viewed as an employee.
Application of the “ABC” criteria will undoubtedly permit fewer workers to qualify as independent contractors than prior law, and calls the validity of many existing contractor classifications into question. The Dynamex opinion left various questions regarding the scope of the "ABC test” unanswered. The Court limited its ruling to wage and hour claims based on a Wage Order adopted by California’s Industrial Welfare Commission, for example, so the extent to which the "ABC test” will apply in other contexts (such as disputes before the Employment Development Department regarding a worker’s eligibility for unemployment insurance benefits, or in disputes over workers’ compensation benefits) remained uncertain, together with the question of whether the Dynamex opinion itself is applicable retroactively.
Classification Under California Law for Other Purposes
While the Dynamex decision left some questions regarding the scope of its ruling unanswered, subsequent decisions from California appellate courts have started to resolve some of those questions.
In Curry v. Equilon Enterprises, LLC, a California appellate court offered some relief to employers by holding that the "ABC test” does not apply in a “joint employment” scenario in which a worker is officially employed by a business entity such as a corporation or limited liability company, but provides service as a “leased employee” or contractor to a different party. The Curry decision represents a substantial victory for businesses that contract with other companies to fill their staffing needs, as do a substantial number of large companies throughout California. The Curry decision suggests that a company that contracts with another for labor will not be deemed the employer of the leased employees under Dynamex as long as the employees are treated as employees and paid on a W-2 basis by the staffing company.
Garcia v. Border Transportation Group, LLC represents another favorable outcome for employers. In Garcia, a California court of appeal held that the "ABC test” does not apply to claims that do not arise under a Wage Order. Instead, the widely-used Borello standard (emphasizing control and other common law factors) applies when differentiating employees from independent contractors under claims not based on alleged violation of a Wage Order, such as claims for expense reimbursement under Labor Code Section 2802, claims for wage statement violations under Labor Code Section 226, and claims for waiting time penalties under Labor Code Section 203.
Classification Under Federal Law
When analyzing the classification of a worker under federal law, courts and the Department of Labor consider the totality of the circumstances and evaluate a multitude of factors, with no single factor controlling the outcome of the analysis. Among the factors considered under federal law are:
- Integration – the extent to which the services rendered are an integral part of the hiring party's business;
- Continuing relationship – independent contractors generally do not have continuing relationships with the hiring party, while employees do;
- Investment – bona fide independent contractors generally make a financial investment in their business, while employees do not;
- Business expenses – independent contractors generally bear their own business expenses, while employees are reimbursed by their employers;
- Opportunity for profit or loss – true independent contractors may experience profit or loss on a project, while employees work for wages only;
- Work for multiple firms – independent contractors are generally free to work for more than one firm at once, while employees often are not;
- Services available to the public – independent contractors generally offer their services to the general public, while employees do not;
- Operation as a bona fide business – genuine independent contractors often operate through a business entity (corporation or limited liability company), maintain their own insurance, maintain a website to attract business, and utilize their own business cards, while employees typically do none of these things;
- Limited right to discharge / liability for non-performance – independent contractors are generally subject to discharge only for breach of contract, while employees may be terminable at will; and independent contractors are generally subject to liability for failing to complete their work properly, while employees are not; and
- Control – employers have the right to exercise strong control over their employees, while they generally cannot hold contractors accountable for anything more than the ultimate result of their work.
What Should Employers Do Now?
As a result of the Dynamex decision, California employers can anticipate a significant rise in misclassification claims brought by independent contractors. Employers may best prepare themselves by taking these steps:
- Be especially alert to “B” in the "ABC test” – Do not classify persons you hire and pay directly (in contrast with persons you pay through a business entity) as independent contractors if they perform work that is integral to your business.
- Take advantage of the protection offered by the Curry decision – Whenever possible, contract with a corporation or a limited liability company for necessary labor, rather than with individuals.
- Audit existing classifications with the protection of attorney-client privilege – Employers should review the validity of their existing contractor classifications under the new Dynamex standard. Prudent employers will conduct any assessment of their contractors under the guidance of counsel to assure that the outcome of the assessment is protected by the attorney-client privilege and cannot be used against the company in the event of a later dispute.
- Address re-classifications strategically and carefully – If an independent contractor classification is identified as potentially vulnerable to a challenge, confer with counsel and consider the potential options strategically. Employers should remember that re-classification can serve as a double-edged sword – it can eliminate potential future liability, but can also increase the risk of liability for the period during which the contractor classification was in effect. Clumsy or poorly conceived re-classifications may serve only to exacerbate an employer’s liability. In deciding how to address a misclassification, employers should consider factors such as the number of misclassified contractors involved, whether misclassified contractors are still providing service to the company, whether misclassified contractors should have been treated as exempt or non-exempt employees, and the extent to which misclassified contractors who should have been treated as non-exempt employees may have worked overtime.
- Review and update independent contractor agreement templates – Employers that utilize the services of independent contractors should review their contract forms with the Dynamex, Curry and Garcia decisions in mind, and update their agreements as appropriate.
- Watch for legislative and legal updates – Employers should expect the impact of the Dynamex decision to evolve in the coming months, and should closely follow legislative and other legal updates. California state legislators have introduced a series of bills following the Dynamex decision that highlight the competing interests of business and individuals when it comes to application of the new test. Some, including Assembly Bill 71 and Senate Bill 238, seek to preserve the individual’s ability to operate as an independent contractor or reverse Dynamex altogether. Another, Assembly Bill 5, seeks to codify the court’s decision, expand its application beyond the Wage Orders, but exempt certain professions from its reaches.
If you have any questions about the proper classification of your contractors, or any other issue relating to employment law, please contact one of our attorneys: