March 11 was a tough day for ride-sharing start-ups Uber and Lyft as federal court judges in the U.S. District Court for the Northern District of California issued separate decisions in class action lawsuits brought by drivers from both companies. Those drivers allege that Uber and Lyft misclassified them as independent contractors (ICs) instead of employees — thereby depriving the drivers of many employee benefits. Both Uber and Lyft had filed motions with the court seeking summary judgment on the grounds that they had properly classified the drivers as ICs. The courts in both cases denied the motions and ruled that juries would have to decide whether the drivers are employees or ICs. O’Connor v. Uber Technologies, Inc., No. 3:13-cv-03826-EMC (N.D. Cal. Mar. 11, 2015); Cotter v. Lyft, Inc., No. 3:13-cv-04065-VC (N.D. Cal. Mar. 11, 2015).

These cases will likely have far-reaching implications for Uber, Lyft and other companies in the “on demand” economy. Companies that use a 1099 business model or that have failed to properly structure, document and implement their IC relationships in a manner that complies with applicable laws should take steps such as those discussed below in the "Takeaways" to avoid being the next Uber or Lyft in an IC misclassification lawsuit.

Analysis

The Uber case was decided by Judge Edward M. Chen and the Lyft case by Judge Vince Chhabria. The decisions are very similar, with both judges concluding that some of the facts favored employee status and some favored IC status. Although both judges identified more factors favoring employee status, Judge Chhabria put it best when he wrote that “Lyft drivers don’t seem much like employees . . . [b]ut Lyft drivers don’t seem much like independent contractors either.” In these circumstances, both judges concluded that, because neither of the defendant companies could establish that their drivers were ICs as a matter of law, a decision could only be made by a jury after weighing all of the facts and circumstances. (In the Lyft case, Judge Chhabria also denied the drivers’ cross-motion for summary judgment that they were employees as a matter of law.)

The facts in both cases have a number of similarities. Both Uber and Lyft allow drivers to make themselves available for work whenever they want and allow them to accept or reject rides once they have been selected — both factors that favor IC status. On the other hand, both companies expressly reserve the right to either terminate a driver’s relationship or to terminate use of the company app if a driver’s customer ratings are deemed unacceptably low or for any reason at all. Both courts noted that this factor is a key one favoring employee status.

Both judges stated that, while there are numerous factors that bear on whether a worker is an employee or an IC, the “principal” test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired. To that end, the court in the Uber case identified other factors favoring employee status, including Uber’s “Driver Handbook.” The handbook provides instructions for drivers on dress codes, communication with clients, use of a car radio and availability of an umbrella in their cars.

Similarly, the court in the Lyft case pointed to the Lyft Rules of the Road, which give drivers a list of “rules to live by.” Those rules provide direction on greeting passengers, requests for tips, customer service and use of cell phones. Judge Chhabria noted that Lyft replaced the Rules of the Road with FAQs in July 2013, but they still instructed drivers about such things as the cleanliness of their vehicles, the use of GPS navigation while driving, smoking in their vehicles and asking passengers for their telephone numbers.

The judges also found that Uber and Lyft monitored their drivers’ performance. Judge Chen noted that there is evidence that Uber monitors its drivers to ensure compliance with Uber’s many quality control standards. Uber passengers give drivers a star rating on a scale from one to five after each completed trip based on the driver’s performance, and Uber uses these ratings “to monitor drivers and to discipline or terminate them.” Uber’s contract with drivers provides that it may terminate any driver whose star rating “falls below the applicable minimum star-rating.”

Similarly, Judge Chhabria found that Lyft reserved the right to penalize or even terminate drivers who did not follow the instructions in its Rules of the Road or FAQs. He also noted that Lyft solicited ratings from passengers about the drivers, and, pursuant to its contract with the drivers, Lyft reserved the right to investigate and terminate drivers who have “behaved in a way which could be regarded as inappropriate” or whose passenger ratings fall below a certain threshold.

Although both Uber and Lyft maintained that their respective Driver Handbook and Rules of the Road/ FAQs were “suggestions,” both judges dismissed that argument by referring to the mandatory language of the documents that the “suggestions” could be enforced by disciplinary action or termination.

In our September 18, 2014 blog post titled “Silicon Valley Misclassification,” we observed that technology companies that use the 1099 “on demand” business model were at risk if they do not take care to structure, document and implement their IC relationships in a manner consistent with federal and state IC laws. Based on the two decisions issued in California, it appears that Uber and Lyft may not have structured and documented their IC relationships in compliance with California’s legal test for IC status — which is similar to prevailing federal law and the law followed by most states in employment-related lawsuits.

This does not mean, however, that companies cannot prevail on IC misclassification claims. In fact, the decision inUber pointed to two recent cases where courts in California found workers to be ICs as a matter of law. As the court noted, even though some factors may have “cut in favor of employee status,” courts will still find IC status when “all of the factors weighed and considered as a whole establish that [an individual] was an independent contractor and not an employee.”

So, how does a company avoid class action IC misclassification cases or, if ever sued, prevail in the lawsuit and secure a judgment that its 1099 contractors are legitimate ICs? Is it too late to restructure and redocument a company’s IC relationships in order to maximize its IC compliance and minimize the risk of IC misclassification liability?

Takeaways

Many new and existing companies have resorted to IC Diagnostics™ to enhance their level of IC compliance and to determine whether a group of 1099 contractors would pass the applicable tests for IC status under governing state and federal law. That proprietary process also offers a number of practical, alternative solutions to enhance compliance with those laws, including restructuring, redocumenting and reimplementing the IC relationship; reclassifying 1099 contractors as W-2 employees; and redistributing 1099 contractors as more fully described in ourWhite Paper on the subject.

Companies that wish to retain an IC business model generally opt for restructuring, redocumenting and reimplementing their IC relationships. Although not all companies can eliminate most control and direction over workers treated as 1099 contractors, an overwhelming number can effectively restructure their IC relationships to comply with federal and most state IC laws. The IC Diagnostics™ process provides the means to stress-test the IC relationship. If it can be effectively restructured to comply with IC laws, the next step in the process is redocumentation. What seems like a simple act, however, is anything but. Indeed, many IC statutes and most judicial and administrative decisions in this area are often counter-intuitive.

As we discussed in our August 29, 2014 blog post titled “Earthquake in the Independent Contractor Misclassification Field,” FedEx Ground lost a key case because of its misplaced reliance on an IC agreement and its policies and procedures that were good, but not good enough. Plainly, FedEx is a savvy company, but close scrutiny by a court found one fallacy after another in the very documents FedEx created — sufficient in degree to lead the court to rule against FedEx. As we noted, “IC agreements and policies and procedures that are not drafted in a state-of-the-art manner, free from language that can be used against the company, can cause businesses that use ICs to face class action litigation or regulatory audits or enforcement proceedings they may be able to otherwise avoid.”

Lastly, the implementation of a legitimate IC relationship is essential. As shown in the Uber and Lyft cases, even when those companies’ contractual provisions were drafted in a manner intended to be consistent with IC laws, Uber and Lyft failed to strictly follow the contractual limitations on direction and control when they put their IC relationships into effect. There is no reason, however, why a company committed to complying with IC laws cannot, when exercising both rigor and restraint, implement and carry out in practice an enhanced IC relationship.