A year and a half ago, the U.S. Court of Appeals for the Third Circuit, in a class action independent contractor misclassification case, asked the New Jersey Supreme Court to articulate the test that federal judges should apply in state law wage and hour claims being heard in federal court. The case involved drivers that delivered mattresses for Sleepy’s.  After extensive briefing by the parties and submissions by “friends of the court” organizations, the New Jersey Supreme Court issued its decision yesterday. The ruling: New Jersey will now apply the most challenging test for companies seeking to establish independent contractor status – the so-called “ABC” test found in New Jersey’s unemployment compensation law.  Hargrove v. Sleepy’s, LLC (N.J. Sup. Ct. A-70-12) (072742)

While some commentators already have begun to suggest that companies operating on a nationwide basis may have to conduct business differently in New Jersey, the decision by the New Jersey Supreme Court imparts a standard no different than is currently used in New Jersey and many other states for unemployment purposes and in states that use the “ABC” test for unemployment and wage and hour claims, such as Illinois.

What is the ABC Test?

The ABC test is the statutory definition of employee under the New Jersey Unemployment Compensation Act. It presumes an individual is an employee unless the employer can show that:

  1. Such individual has been and will continue to be free from control or direction over the performance of such service, both under his contract of service and in fact; and
  2. Such service is either outside the usual course of the business for which such service is performed, or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and
  3. Such individual is customarily engaged in an independently established trade, occupation, profession or business.

Under the ABC test, the New Jersey Supreme Court noted, “[T]he failure to satisfy any one of the three criteria results in an ‘employment’ classification.”

The ABC and other statutory tests for independent contractor status exist in one form or another in over 20 states in the U.S.  Most of these statutes only govern unemployment and workers’ compensation laws, but (as noted above) some states, including Illinois, uses an ABC test for wage and hour laws as well.  (Massachusetts has a form of ABC test, but the “B” prong substitutes “and” for “or”, which dramatically changes the results in many situations.)

What Tests Were Not Accepted by the New Jersey Supreme Court?

The federal district court judge in the lower court decision used the common law test that the U.S. Supreme Court applies in ERISA and tax cases. That decision, which awarded summary judgment to Sleepy’s, was appealed to the U.S. Court of Appeals for the Third Circuit. The Third Circuit, however, referred the federal court case to the state’s highest court because it concluded that “there are at least four distinct employment tests that have been applied under New Jersey law in other contexts (including unemployment, whistleblowing and tort claims) to determine independent contractor/employee status.”

Those tests included the so-called “common law” or “right to control” test; the “economic realities” test used in wage and hour cases arising under the federal Fair Labor Standards Act (FLSA); and the so-called “hybrid” test, also referred to as the “relative nature of the work” test, which was used in a New Jersey Supreme Court case arising under the state’s whistleblower law.

Why Did the New Jersey Supreme Court Choose the ABC Test?

The New Jersey Supreme Court first noted that the wage and hour laws in that state are remedial statutes and should be liberally construed. Critically, the New Jersey Supreme Court noted that the New Jersey Wage and Hour Law’s implementing regulations, adopted by the New Jersey Department of Labor, provide that the criteria identified in the ABC test found in the New Jersey Unemployment Compensation Act is to be used to determine whether an individual is an employee or independent contractor.

The Court stated that since no good reason was advanced to depart from the standard adopted by the New Jersey Department of Labor to guide employment status determinations or to disregard the long-standing practice of treating both statutory schemes in tandem, the Court holds that any employment-status dispute arising under the state’s wage and hour laws should be resolved by utilizing the ABC test set forth in the Unemployment Compensation Act.

The Court noted that although the FLSA also uses similar language in its relevant definitions, the Court discerned no reason to depart from the test adopted by the New Jersey Department of Labor in its implementing regulations. The Court also found that the ABC test provided more predictability and may cast a wider net than the FLSA “economic realities” test. This, the Court noted, fosters the provision of greater income security for workers, which is the express purpose of both the wage and hours laws in New Jersey. For the same reasons, the Court rejected the common law “right to control” test, which it found originally arose in different contexts unrelated to wage and hour protections.

Analysis

As noted above, the test that now governs New Jersey wage and hour claims is by no means a new standard.  Companies that operate in New Jersey using independent contractors have, for a long time, needed to comply with the New Jersey unemployment law, which has historically used an ABC test for most employees covered by that law.  (There are a number of exceptions in the law for specialized occupations, such as certified court reporters.)

Some early commentators on the decision yesterday by the New Jersey Supreme Court already have begun to suggest that companies operating on a nationwide basis may need to conduct business differently in New Jersey than anywhere else in the nation.  However, the decision by the New Jersey Supreme Court imparts a standard that is not the least bit more challenging than it is in other states currently.  Many states already use an ABC test for their unemployment laws as well as their workers’ compensation laws. Illinois, as mentioned earlier, has also used its ABC law for independent contractor status for years in both the unemployment and wage and hour arenas. Thus, the test now being applied in New Jersey for wage and hour laws is no different than the current test under the state’s unemployment statute, and similar to the laws in many other states for workers being paid on a 1099 basis as independent contractors.

Takeaways

The decision by the New Jersey Supreme Court is not the “game-changer” many commentators have begun to suggest.  New Jersey does not prohibit companies from using independent contractors, nor do any states, although a few states make is extremely challenging.  Instead of shying away from using independent contractors, businesses that rely on independent contractors to supplement their workforce or that use an independent contractor business model need only to structure, document, and implement their independent contractor relationships in a manner that is compliant with the laws in each state in which they operate as well as federal law.

While such efforts to enhance compliance are by no means self-evident and requires commitment and rigorous adherence to the laws governing the company’s operations, independent contractor compliance is readily attainable in most instances.

Companies seeking to enhance their independent contractor compliance can use IC Diagnostics™ to determine if their independent contractor/1099 relationships in New Jersey and other states are likely to satisfy the applicable federal and state tests for independent contractor status – either as presently structured, documented, and implemented, or as restructured, re-documented, and/or re-implemented going forward.