Independent Contractor Versus Employee

It’s been nearly six months since the California Supreme Court announced that employers and government agencies were using the wrong test to determine who’s an independent contractor. In Dynamex Operations West, Inc. v. Superior Court, the court declared that employers must meet the three-prong ABC test to overcome the presumption of employment status. But Dynamex left a number of questions unanswered. A decision filed this week,  Garcia v. Border Transportation Group, LLC, takes a tentative initial step to address those open questions.

There, the trial court granted summary judgment for the employer on the basis that Garcia was an independent contractor. Some of those claims (but not all) were based on the IWC Wage Orders, which guarantee employees a minimum wage, maximum hours, overtime compensation, meal and rest breaks, and more. The employee appealed and, while the appeal was pending, the CA Supreme Court issued its opinion in Dynamex.

Since the employer could not show that the plaintiff had an independently established business (part C of the ABC test), the court of appeal reversed the summary judgment on the claims based on the Wage Orders. These included claims for unpaid wages, minimum wage violations, failure to provide meal and rest periods, failure to furnish itemized wage statements, and a claim that the foregoing constituted unfair competition.

The court upheld summary judgment on claims for wrongful termination, waiting time penalties, and an unfair competition claim based on those violations. The court reasoned that, while Dynamex applied to claims based on the Wage Orders, the test for the remaining claims still involved the extent of control the employer exercised over the worker.

In a footnote, the court also questioned whether the Dynamex decision applies retroactively. The parties had not raised the issue and the court therefore said it would not address it. But in declining to address it, the court noted: (1) the general rule that judicial decisions have retroactive effect; (2) that there could be exceptions where the parties reasonably relied on the previously existing law; (3) that the Dynamex court declined a request to apply its ruling only prospectively; and (4) that Dynamex came as no greater surprise than a number of decisions that routinely apply retroactively. That’s quite a bit for an issue the court said it would not address.

While this decision doesn’t hold out much hope for Dynamex not applying retroactively, it at least says that it may be an open question. The greater value for employers comes in the decision’s reinforcement that (at least in this appellate court on this day), Dynamex is limited to claims under the Wage Orders. As to when we’ll have greater clarity on those issues, that remains to be seen.

Determining whether a California worker is an independent contractor or an employee has always been difficult. Judges deciding the issue have complained that the test used by California courts “provides nothing remotely close to a clear answer.” Then there was the nail salon that was told by one state agency that its workers were employees and by another that they were independent contractors. So there’s no question that the law in this area has been messy.

On Monday, it got considerably messier. That’s when the California Supreme Court issued its decision in Dynamex Operations West, Inc. v. Superior Court. For years — even decades — judges, government agencies, and lawyers have interpreted the law to say that the key to distinguishing between employees and independent contractors was whether the company had the right to control the manner and means by which the worker accomplished the desired result. So if drivers for a gig-economy car service decided what days to work, when to start work on a particular day, where to work, what to wear, when to take breaks and for how long, and when to quit for the day, there was an excellent chance that they’d be considered independent contractors,

Under the California Wage Orders, which guarantee employees a minimum wage, maximum hours, overtime compensation, meal and rest breaks, and more, that is no longer the case. Now, according to the California Supreme Court, companies must meet a three-prong test to establish independent contractor status (“the ABC test”).

  • A) The company must not be able to control or direct what the worker does, either by contract or in actual practice. This is similar to the test used in the past.
  • B) The worker must perform tasks outside of the hiring entity’s usual course of business. So if you’re a driver for a ride service, a delivery person for a delivery service, or a seamstress for a clothing company, you can’t be an independent contractor no matter how little control the company has over you.
  • C) The worker must be engaged in an independently established trade, occupation, or business. It’s not enough that the company doesn’t prohibit the worker from having his own business or working for others. Instead, the court will look at factors such as whether the business is incorporated or licensed, whether it’s advertised, and whether it offers services to the public or other potential customers.

It is the employers burden to satisfy all three prongs to establish that the worker is an independent contractor. If it fails to establish one, the worker is entitled to be treated as an employee under the Wage Orders. (The Wage Orders themselves are not particularly helpful in this regard. For example, they circularly define “employee” as ” any person employed by an employer.”)

The Court spent 80+ pages explaining its rationale. Nowhere in that lengthy analysis was any recognition of the upheaval this opinion will cause. Millions of workers in the state that were considered independent contractors will now be deemed employees. This will require employers who have done everything they could to follow the law as it was then understood to reevaluate the nature of the relationship with many of their workers and either modify the relationship or provide them the pay and treatment required by the Wage Orders. They also face litigation, including potential class actions, from workers complaining that they were misclassified. And since this case only addresses the wage order definition, they need to apply different standards (which can lead to different conclusions) in deciding how to characterize workers for purposes such as workers compensation and payroll taxes. As I said, a messy situation just got messier.

In recent years, California and federal agencies have highly scrutinized independent contractor status.  While that scrutiny may be abating somewhat on the federal level, it is still alive and well in our golden state.  In fact, the issue has been popping up quite a bit lately in the context of audits by the Employment Development Department (EDD).

Copyright conceptOne issue that trips up many employers involves a standard provision many companies include in their independent contractor agreements to protect their intellectual property rights.  The standard language involves a statement that any work product developed by the contractor is deemed a “work made for hire“ under the meaning of the US Copyright Act, and is therefore owned exclusively by the company.  In lay terms that means that the company retains the intellectual property rights to works developed under contract.

Unfortunately, under California Unemployment Insurance Code Section 686, that language also means that the contractor is presumed to be an employee.  Yes, that’s right.  Even if the contractor meets none of the common law factors of an employee (i.e. works independently, the company doesn’t control how they do the work, they are paid by project, etc.), and wants or even requests to be a contractor, California’s EDD requires that the contractor be deemed an employee for purposes of unemployment and state disability taxes.

When and if the company is audited, the EDD will ask for copies of all independent contractor agreements, and if those four words are in there, “work made for hire,” the EDD will find the contractor (or group of contractors) should be taxed as employees.  That translates into back taxes, penalties and interest, as well as the potential of a pretty unhelpful precedent for related legal claims.

There is a possible work-around for this language — to use very specific assignment language instead; although this could have serious copyright implications under the “termination of transfer” provisions of the Copyright Act, so please consult a copyright lawyer before going forward with such a work-around.  Companies can also be proactive and remind departing contractors that they are not entitled to unemployment, which might dissuade a contractor from inadvertently triggering an audit.

For companies that rely on independent contractors, including consulting and entertainment businesses, it is especially important to review your contractor agreements for those four “work made for hire” words.  Oh, and if you use independent contractors and don’t have a signed contractor agreement on file, well you have much more risk than just an EDD audit on this one four-word technicality!

 

Guest blog post by Mikella Wickham:

They say location is everything in business.  How about classification of workers?

In certain industries, workers have a unique combination of specified skills and

Fit people working out
Copyright: wavebreakmediamicro / 123RF Stock Photo.

relative freedom to do their job.  As a result, small businesses are stuck between a rock and a hard place when deciding whether their workers are employees or independent contractors.  Of the many small businesses that want to pay their workers fairly and legally, it is becoming harder to do so without going out of business altogether.

Take fitness companies, for example.

Fitness instructors are not the average employees.  They may have input on their schedules (because they only want to work mornings or weekends).  They may work at several different studios, or work more than one job.  Often they teach in their own style, and even impact how many customers attend the classes.  Very often customers are loyal to a studio based on their rapport with a particular instructor.  Does the fitness company pay that person as an employee or as an independent contractor?

Let’s say the employer pays the instructor as an employee, on an hourly basis.  That worker becomes much more expensive for the business because she is covered by workers’ compensation insurance, gets paid sick leave, is paid at least the minimum wage (which keeps going up), and gets overtime, meal breaks and paid rest breaks.  Given all of that, how does the employer incentivize the instructor to bring more customers in the door to offset the additional costs incurred?

Alternatively, if a company pays a fitness instructor as an independent contractor (as many do), but still controls aspects of what the instructor does (such as what she wears, the music she plays, or the moves she teaches), it risks a misclassification claim.  Defending such lawsuits can mean death to a small business.

With no law designating a “dependent contractor” middle ground category, businesses are left to choose from a pick-your-poison set of options.

Standing next to larger brand name fitness companies, smaller fitness companies who can afford to pay employees well, or eat losses at smaller studios for the larger corporate good, can find themselves disadvantaged in a David and Goliath battle to simply have a place in the market.

As we have suggested, perhaps the law will carve out an exception for businesses in this category.  The future will tell.  In the meantime, small businesses have a tough decision to make: pay up now, or, perhaps, pay more later.


Mikella P. Wickham is a summer associate, based in the firm’s Los Angeles office.

Labor laws are not keeping pace with the new economy.  Right now there are only two options for employers.

Option one is to hire employees, and comply with the myriad complicated wage-and-hour laws, including very strict rules about monitoring an employee’s work hours.  In California, an employer must ensure a non-exempt employee works no more than 8 hours per day (even if the employee wants to stay late one or two days and leave early another) or pay overtime.  Any time over 8 hours in one day must be paid at an overtime rate that must be calculated to include extra non-discretionary pay (such as commissions, service charges, and shift premium pay).  An employer must ensure meal breaks are taken (even if the employee prefers not to take them), and make sure they are taken before the end of the 5th hour of work.  Any lack of proof of compliant meal breaks (typically punch records) requires the employer to pay an extra hour of “premium” pay.  Both daily overtime and meal premium pay can blow up a business’ labor costs and put a large dent in what are often already slim profit margins.

Option two is to retain workers as independent contractors and have them agree (preferably in writing), that they are contractors and not employees.  Independent contractors are not entitled to overtime or meal premium pay.  They also aren’t covered by workers’ compensation and don’t get employee benefits (such as paid sick leave or employer-sponsored health care or unemployment benefits).  But independent contractors have freedom.  They can work hours as needed to achieve the scope of work agreed upon.  They have the opportunity for profit (by working efficiently) or loss (by working less efficiently).  And they can work for more than one employer and have a more fluid work/life balance.

The problem is that many jobs in the new economy do not fit neatly into either option.  The new rideshare technology is a prime example, but there are many others (including many types of semi-professional services, such as movers, tech/HR consultants, fitness instructors, hair stylists, etc.).  And with the DOL’s new guidance the federal government is now joining the California trend in going after both businesses who engage contractors, as well as individuals who work as contractors.  The goal?  Some might say to protect workers.  Others might say to ensure payroll tax revenue streams are intact.  Whatever the goal, retaining contractors to run an integral part of your business is just plain risky.

So what we need is an option three – dependent contractors.  A dependent contractor would be a worker who works exclusively (or semi-exclusively) for one business, but still retains the freedom to work flexible hours, to take a meal break when hungry, to accept or reject assignments, and to take time off when desired.  A dependent contractor would still be self-employed, but could avoid the rigid lifestyle that regulations require employers to impose on employees, and could work at their own pace without feeling the pressure to perform in an outdated 8 hour workday / five day workweek model.

As the cases about rideshare technology work their way through our state agencies and court systems, expect to hear more about this idea of dependent contractors.  Maybe the law will eventually catch up with the needs of businesses and the new generation of workers who want some freedom to redefine the work experience.  One can only hope.

 

Companies have a lot to lose if they misclassify employees as independent contractors. The affected workers can sue (individually or as a class) for any number of wage and hour violations. Employers can also get in trouble with the Internal Revenue Service, the Employment Development Department, the US Department of Labor, the Division of Labor Standards Enforcement, the Franchise Tax Board, and others.

So it would be nice if there was a clear test that could be applied in a straightforward manner. But there isn’t. The Employment Development Department, for example, uses a test that includes three “significant questions,” three additional questions, and seven questions that address “additional factors.”

Now, as noted by Kat Greene at Law360 (subscription required) a federal judge here in San Francisco is chiming in on the unfortunate state of the law. The Honorable Vince Chhabria of the US District Court, in addressing whether certain drivers qualify as independent contractors, issued a decision saying that the test applied by California courts “provides nothing remotely close to a clear answer.” So the issue will go to a jury that, according to Judge Chhabria, “will be handed a square peg and asked to choose between two round holes.”

Welcome to California employment law in 2015: potentially disastrous penalties for violating laws that are vague and hard to apply.

Copyright:  / 123RF Stock Photo
Copyright: / 123RF Stock Photo

Takeaways:

  • Pay close attention to these independent contractor determinations. Recognize that different agencies use different tests.
  • Get legal help if you need to.
  • Consider moving your operations elsewhere. Qatar maybe. Please turn out the lights if you’re the last to leave.

 

From the employer’s perspective, the only way to truly “win” an employment case is to avoid it in the first place. We litigators love the thrill of gettting a judge, arbitrator, or jury to decide in our client’s favor. But it can be awfully expensive to get to that point. So without further ado, here are ten commandments for avoiding employment litigation in California.

I. Thou shalt pay employees for all hours worked and provide them their breaks. It’s hard to think of a large employer in California that hasn’t spent gobs of time and money litigating this issue.

II. Thou shalt not treat nonexempt employees as exempt. This is another wage and hour issue that has given rise to thousands of class action claims.

III. Thou shalt not treat employees as independent contractors. Multiple government agencies are reviewing this issue in an effort to collect unpaid taxes.

IV. Thou shalt engage disabled employees in the interactive process. This is one of the hot areas in employment litigation. Failure to comply is, by itself, a violation of the Fair Employment and Housing Act.

V. Thou shalt pay attention to the unique legal requirements of the localities thou operates in. Following federal law isn’t enough. Even following California law isn’t enough if you’re operating in a locality, like San Francisco, with its own requirements.

Moses with the Ten Commandments VI. Thou shalt train thy managers to comply with applicable laws. Having the best policies in the world won’t protect a company if its managers don’t know how to implement them or whom to turn to with issues. This is especially true for harassment training (which is mandatory in California for employers with 50 or more employees).

VII. Thou shalt properly document the steps thou takes. I completed an arbitration last week that, because an issue went up on appeal, took place four years after the decisions in question. Notes of key conversations are critical in these situations.

VIII. Thou shalt require employees to waive class actions and arbitrate disputes. The law is now clear in California that, with an appropriate arbitration agreement, you can require employees to waive their right to class-wide relief. There are still open issues regarding collective actions under California’s Private Attorney Generals Act, but protection against class actions can still be of great value.

IX. Thou shalt provide employees an up-to-date employee handbook.

X. Thou shalt stay up to date regarding ever-changing legal requirements. One way to do that is to subscribe to this blog.

Another way to avoid litigation is to consult an employment lawyer (like me or my colleagues) before making decisions that may result in litigation. It’s frustrating to see companies spend years and hundreds of thousands of dollars litigating issues that could have been avoided with a phone call. So next time you confront these issues, make the call!

Many employers in California feel like the deck is stacked against them. But as I’ve written before, some have a stronger basis for that conclusion than others. Consider the plight of poor Happy Nails, a chain of nail salons. In 2001, they hired a consultant to help them structure their business so that the cosmetologists working there were independent contractors, not employees.

Not so fast, said the Employment Development Department. In 2004, the EDD assessed penalties against Happy Nails for not making unemployment insurance contributions on behalf its cosmetologists (which would only be owed if they were employees). Happy Nails challenged the assessment and, after years of administrative wrangling and hearings and an appeal, it got a determination that the cosmetologists were, in fact, contractors.

Then in 2008, along comes the Division of Labor Standards Enforcement. It assesses a penalty against Happy Nails for not giving its employees itemized wage statements. Hold on, said Happy Nails. Another state agency determined that these aren’t employees. They’re independent contractors. So they don’t get wages or itemized wages statements. The DLSE responded, We don’t care what that other agency said. We say they’re employees.

Happy Nails requested a hearing to challenge the penalties and submitted a brief saying that it had

already spent hundreds of thousands of dollars, and borne the burden of years of administrative proceedings, to determine that [its] [c]osmetologists are not employees.

At the hearing, Happy Nails submitted the same evidence that persuaded the EDD that the workers were contractors. But this time the hearing officer ruled the workers were employees. What did the hearing officer say about the prior contrary ruling from the EDD? Nothing at all.

Happy Nails asked the superior court to review the decision and, after another hearing, the court sided with the DLSE. Happy Nails next asked court of appeal to review the issue and, finally, got a 3-justice panel to tell the State that it can’t have it both ways. The appeals court pointed out that the same issue had already been litigated between essentially the same parties and that, based on the legal doctrine of collateral estoppel, there was no reason to relitigate it.

This decision (pdf) came out today, so there’s no word yet about whether the DLSE intends to take this all the way to the Supreme Court (exceedingly unlikely). And it probably isn’t even worth pointing out that every employer in California is expected to make these independent contractor/employee distinctions that the enforcing agencies and courts can’t even agree on.

iStock_000002879611XSmall

We’ve written quite a bit about the new penalties for mischaracterizing employees as independent contractors. But we haven’t talked as much about how to draw the distinction. Partly that’s because different government agencies use different approaches. And some of it’s due to the fact that these can be very fact-specific determinations and it’s hard to discuss them in generalities.

In California, the Employment Development Department administers unemployment, state disability, and workers’ comp claims and collects employment-related taxes. They’ve put together this questionnaire (pdf) that includes three "significant questions," three additional questions, seven questions that address "additional factors," and a discussion of how to interpret the answers. While it’s not a perfect tool, it at least provides some insight on how one agency approaches the issue.

If you want to see other agencies’ approaches, here are the links for the Division of Labor Standards Enforcement (which enforces wage and hour laws) and the IRS (pdf) (which California’s Franchise Tax Board follows).