UK: California Supreme Court Delivers Blow To Use Of Independent Contractors

On April 30, 2018, the California Supreme Court dramatically changed the legal landscape for California's gig economy, which will have far-reaching consequences for California companies reliant on independent contractors.

On April 30, 2018, the California Supreme Court issued a sweeping decision dramatically changing the legal landscape for California's gig economy. In Dynamex Operations West Inc. v. The Superior Court of Los Angeles County, the Court considered whether the trial court properly certified a class of delivery drivers who claimed they were misclassified as independent contractors rather than employees. In determining that the trial court did not abuse its discretion in certifying the class, the Supreme Court scrapped a more flexible classification test that has been used for decades in California (a multifactor test known as the Borello test) and adopted the "ABC" test,  a standard that has its roots in determination of unemployment tax status in other states and presumes workers are employees instead of independent contractors. This extraordinary decision will have far-reaching consequences for California companies reliant on independent contractors and undoubtedly spur a landslide of litigation for years to come.

Dynamex Operations West Inc. v. The Superior Court of Los Angeles County

Background

Prior to 2004, Dynamex, a nationwide package and document delivery company, classified drivers who performed pickup and delivery work as employees. In 2004, Dynamex adopted a new policy and contractual arrangement under which all drivers were considered independent contractors rather than employees.
In April 2005, a class action complaint was filed alleging that since December 2004, delivery drivers had been misclassified as independent contractors. Plaintiffs argued they continued to perform the same tasks as they had when classified as employees with no substantive changes to the means of performing their work or the degree of control exercised by Dynamex. They claimed the misclassification led to Dynamex's violation of the provisions of Industrial Welfare Commission (IWC) wage order No. 9 – the applicable state wage order governing the transportation industry – as well as various sections of the Labor Code, and, as a result, that Dynamex had engaged in unfair and unlawful business practices under Business and Professions Code section 17200. The case worked its way to the California Supreme Court after Dynamex challenged an appellate court's ruling classifying Dynamex workers as employees based on the IWC's broad definition of "employee" for claims alleging a violation of a wage order.

It is important to note, as it could easily be missed, that the issue before the Court in determining what standard applies under California law in determining whether workers should be classified as employees or as independent contractors is confined to one specific context – application of California's wage orders. California's wage orders are quasi-legislative regulations promulgated by the state IWC that have the force of law. They impose obligations on employers relating to minimum wages, maximum hours and a number of basic working conditions like meal and rest breaks.

Competing Tests: Plaintiffs Argue Martinez and Defendants Espouse Borello

Throughout the litigation, plaintiffs argued that the appropriate standard or test for employment is that as set forth in Martinez v. Combs (2010) 49 Cal.4th 35. Martinez held that "[t]o employ . . . under the [wage order], has three alternative definitions. It means: (a) to exercise control over the wages, hours, or working conditions, or (b) to suffer or permit to work, or (c) to engage, thereby creating a common law employment relationship."

By contrast, Dynamex took the position that the wage order definitions of "employ" relied upon by the trial court, as outlined in Martinez, are relevant only to the distinct question of joint employer status. Dynamex argued that in the wage and hour context, the multifactor test set forth in S.G. Borello & Sons Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 is the only appropriate standard for distinguishing employees and independent contactors.

One of Dynamex's arguments was that a "two-test" approach to the employee or independent contractor distinction would "invariably lead to inconsistent determinations for disparate claims under different labor statutes brought by the same individuals." In other words, an individual worker could potentially be misclassified as an independent contractor under the IWC "suffer or permit to work" standard and entitled to meal and rest periods, overtime, minimum wage, but not to expense reimbursements under Labor Code section 2802 under Borello. The Court dismissed this concern, stating "[a]ny potential inconsistency, however, arises from the IWC's determination that it is appropriate to apply a distinct and particularly expansive definition of employment regarding obligations imposed by a wage order." In other words, the Court prioritized providing broader coverage to workers than with ensuring consistent determinations of employment status.

The New Test: Interpreting "Suffer or Permit to Work" through Application of the "ABC Test"

Dynamex's final argument seemed to have the biggest impact on the Court's reasoning. Dynamex argued that a literal application of the suffer or permit to work standard "would bring within its reach even those individuals hired by a business — including unquestionably independent plumbers, electricians, architects, sole practitioner attorneys, and the like — who provide only occasional services unrelated to a company's primary line of business and who have traditionally been viewed as working in their own independent business."
The Court agreed that the literal language of the suffer or permit to work standard does not itself resolve the question of employee status. Thus, instead of a literal interpretation of the "suffer or permit to work standard," the Court outlined a new way to interpret the standard and adopted the so-called "ABC test" that is utilized in other jurisdictions (for a variety of purposes, but often in the unemployment insurance context), including Connecticut, Delaware, Maine, Massachusetts, New Hampshire, New Jersey, Vermont and Virginia. Under the Dynamex approach:

  • First, there is a presumption that the worker is an employee. The burden is on the hiring entity to establish that the worker is an independent contractor who was not intended to be included within the wage order's coverage.
  • Second, to meet this burden, the hiring entity must establish each of the three factors embodied in the ABC test:
  1. That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;B. That the worker performs work that is outside the usual course of the hiring entity's business;C. That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Failure to satisfy any one of the three parts means that the worker will be treated as an employee for purposes of the wage order.

A Very High Bar For Hiring Entities

Because of the lack of California law to use as precedent, the Court cited cases from other states to illustrate to how each part of the ABC test has been interpreted. The cases may be instructive of just how high the Court is setting the bar for California companies. Here are a few examples:

  • "Free from control" – In a Vermont case, a hiring entity failed to show that work-at-home knitters were not under the control of the entity when they worked from home, at their own pace and on the days and at the times of their own choosing when the entity dictated the pattern and style of knitting. In Washington, a truck driver was deemed not to be free from control when the hiring entity required the driver to keep the truck clean, obtain the entity's permission before taking passengers, to go to the entity's dispatch center to obtain assignments not scheduled in advance and could terminate the driver's service for tardiness or for violating other policies.
  • "Performing work outside the usual course of the hiring entity's business" – The Maine Supreme Court held that the harvesting of timber by individual workers was work performed in the usual course of business of the timber management company whose business operation involved contracting for the purchase and harvesting of trees, even when the timber company did not own any harvesting equipment. A court in New Hampshire found that the performance of live entertainers was within usual course of a business of resort which advertised and regularly provided entertainment. In Connecticut, an art instructor who taught art classes at a museum was deemed to have performed work within the usual course of museum's business where the museum offered art classes on a regular and continuous basis, produced brochures announcing the art classes, class hours, registration fees and instructor's names and discounted the cost of classes for museum members.
  • "Worker is engaged in an independently established trade, occupation, or business of the same nature as the work performed"  – The Court notes that in other states applying the ABC test, the fact that the hiring business permits a worker to engage in similar activities is not sufficient; the appropriate inquiry is whether the worker actually has an independent business or occupation. A Virginia court concluded that a hiring entity failed to prove that siding installers were engaged in an independent business where, although the installers provided their own tools, no evidence was presented that they had their own business cards, licenses, phones or business locations, or that they received income from any party other than the hiring entity.

Immediate Impact on Employers

The ABC test established in Dynamex is now the law of the land in California. In addition to liability for meal and rest break penalties, overtime, minimum wage, waiting time penalties and more, California imposes substantial civil penalties between $5,000 and $25,000 per violation on those that willfully misclassify, or willfully aid in misclassifying, workers as independent contractors.

The 85-page opinion is replete with language suspect of a company's motives in engaging independent contractors ("the risk that workers who should be treated as employees may be improperly misclassified as independent contractors is significant in light of the potentially substantial economic incentives that a business may have in mischaracterizing some workers"), and supportive of the adoption of the "exceptionally broad suffer or permit to work standard." With little recognition of the benefits of flexible, gig work, there is extended discussion of the objective of wage and hour legislation to protect "workers' fundamental need to earn income for their families' survival" and to accord workers "a modicum of dignity and self-respect."

Given the high stakes and sweeping language in the decision, virtually every worker in California who currently is classified as an independent contractor may need reexamination. As such, companies engaging independent contractors in California should work with counsel to revisit classification decisions and undertake a cost/benefit analysis of reclassifying workers in the near term. In addition, given the likely firestorm of litigation, the importance of strong arbitration agreements is front and center, doubling interest in the highly-anticipated US Supreme Court decision on mandatory arbitration agreements due to be published in the next month or so.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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