California Supreme Court’s new Dynamex test may throw a wrench into business models that rely on independent contractors.

  • The California Supreme Court has imposed a new test for determining who is an independent contractor or an employee subject to protection of the California Wage Orders.
  • The new three-part test, which requires employers to satisfy each element of the test, will make it harder for companies to classify workers as independent contractors.
  • Workers who do not engage in an independent business and who do not provide services outside the usual course of the hiring entity’s business will be deemed employees, even if they are free from the direction and control of the hiring entity.

On April 30, 2017, the California Supreme Court made it much more difficult for employers to prove that a worker is an independent contractor with respect to certain California wage and hour laws. In its unanimous decision in Dynamex Operations West Inc. v. Superior Court of Los Angeles, Case No. S222732, the Court held that all workers are employees governed by the California Wage Orders unless they meet a three-part test to prove that they are independent contractors. Under the “ABC Test,” a worker is presumed to be an employee for purposes of the California Wage Orders unless all of the following conditions are met:

A. The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for performance of such work and in fact;

B. The worker performs work that is outside the usual course of the hiring entity’s business; and

C. 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 test adopted by the Court tracks a version already used in Massachusetts for determining independent contractor status. Delaware and New Jersey also use the ABC test, and several other states use variations of it or apply it to certain industries or workers.

Prior to the decision, the standard for determining whether a worker was an employee or independent contractor was set forth in S.G. Borello & Sons Inc. v. Dept. of Indus. Relations, 48 Cal.3d 341 (1989). Under Borello, the Court used a multifactor test to determine whether farmworkers were independent contractors or employees for purposes of California workers’ compensation statutes. The Borello test, which still applies to other California statutory protections, looks primarily at whether the business had the right to control the work details. In addition, it looks at secondary indicia such as (1) whether the business had the right to discharge the worker; (2) whether the worker had a distinct occupation or business; (3) the kind of occupation with reference to whether in the locality the work was usually done under direction or by a specialist without supervision; (4) the skill required; (5) whether the business or worker supplied the instrumentalities, tools, and place of work; (6) the length of time the services were performed; (7) whether the worker was paid by time or job; (8) whether the work was part of the regular business; and (9) whether the parties believed they were creating an employer-employee relationship. None of these other factors were controlling, and they were not applied mechanically as separate tests; rather, their weight depended on particular combinations. The Dynamex Court determined that the multi-factor Borello test made it difficult for business and workers to determine in advance how the worker would be classified, and it afforded the hiring business a greater opportunity “to evade its fundamental responsibilities under the wage and hour law.”

The Specifics of the ABC Test

The Court provided further clarification as to each factor of the three-part test:

Part A of the new test is similar to the control standard set forth in Borello. A worker is an employee if the business exercises the same type and degree of control over the worker that it would typically exercise over its employees, either as a matter of contractual right or in actual practice. As under Borello, a business need not control the precise manner or details of the work in order to be found to have maintained the necessary control that an employer ordinarily possesses over its employees, but does not possess over a genuine independent contractor.

Part B requires that the work be outside the usual course of the hiring entity’s business. Workers whose roles are most clearly comparable to those of employees include individuals whose services are provided within the usual course of the business of the entity for which the work is performed and thus would ordinarily be viewed by others as working in the hiring entity’s business and not as working, instead, in the worker’s own independent business. The Court gave some specific examples: A plumber hired to repair a leak in a bathroom or an electrician hired to install a new electrical line by retail store is an independent contractor because the services provided are not part of the store’s usual course of business and the store would not be seen as having the services provided by an employee. However, a work-at-home seamstress who makes dresses for a clothing manufacturer from materials supplied by the hiring company and that the hiring company will thereafter sell, or a cake decorator who regularly works on a bakery’s custom-designed cakes, is an employee. These services are within the usual course of the entity’s business and the entity can reasonably be viewed as having those services provided by employees. The Court reasoned that treating all workers whose services are provided within the usual course of the hiring entity’s business as employees is important to ensure that those workers who need and want labor law protections do not lose them. If employer obligations under the labor laws could be avoided for workers who provide services in a role comparable to employees but who are willing to forego those protections, other workers who provide similar services would be displaced by those willing to decline the protections. In addition, the rule protects companies who comply with labor law protections against competitors in the same industry who classify similarly situated workers as independent contractors and thus benefit from the cost savings of such classification.

Part C of the new test requires that the worker be customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity. Evidence of an independent business includes incorporation, licensure, advertisements, and routine offerings to provide the services of the independent business to the public or a number of potential customers. It is not sufficient that the hiring entity has not prohibited or prevented the worker from engaging in his or her own business.

The Court made clear that the new test applies only for purposes of determining application of the California Wage Orders, which protect workers by imposing obligations on employers relating to minimum wages, maximum hours, and working conditions such as meal and rest periods. The case does not change the standard for other areas of law that may be concerned with employee/independent contractor classification such as state tax withholdings, unemployment insurance and workers’ compensation insurance. However, California agencies and courts may adopt the ABC test in these areas, so businesses should use caution when applying the multifactor Borello standard.

Threat to the Gig Economy

The ABC test threatens numerous independent contractor relationships in California in a variety of industries—most notably in the growing gig economy, which relies on independent contractors almost exclusively to carry out its work. These companies hire independent contractors paid by the “gig” to provide services to consumers who arrange for those services through the companies’ app or technological platform. Such services include driving, delivery, cleaning, shopping and other services. If these companies are required to reclassify their independent contractors as employees, they will face significantly higher costs. The law will require that they pay minimum wage, overtime, payroll taxes, workers compensation, unemployment benefits, and business expenses for each and every employee, which, for some companies, could number in the tens and hundreds of thousands.

Although the California Supreme Court’s opinion in Dynamex states that the ABC test should provide clarity as to who is an independent contractor under the California wage and hour laws, commentators believe that that there will still be disputes as to the application of the components of the test, especially Part B. The examples provided by the Court are relatively straightforward applications of this test; challenges are likely to come from attempts to reclassify workers whose duties do not so squarely fall within (or outside) the scope of the hiring entity’s business. Similarly, some of the gig economy companies have successfully argued that the services provided are outside their usual course of business because their business is to provide the technological platform that facilitates the provision of services and payment by customers, as opposed to providing the actual services. It remains to be seen whether this argument will succeed under Part B of the new ABC test.

We can anticipate that businesses will also argue that they satisfy Part C by demonstrating that their independent contractors perform services for multiple technological platforms.

Advice for Businesses that Rely on Independent Contractors

  1. All businesses that rely on independent contractors in California should reevaluate their current classifications to ensure that they are compliant under the ABC Test. This is particularly true for businesses that hire low-level contractors who, if classified as employees, would likely be performing work and earning pay that would require they be classified as non-exempt from wage and hour laws.
  2. Businesses should also reevaluate their independent contractor and consultant agreements, even if those agreements were negotiated, and they should determine whether any independent contractors are performing work that is part of the usual course of business.
  3. Businesses should require that their independent contractors take steps to actively run and promote an independent business. This includes incorporation, licensure, advertisements, and routine offerings to provide the services of the independent business to the public.
  4. Businesses with large numbers of independent contractors should consider utilizing arbitration agreements that include class actions waivers consistent with the Federal Arbitration Act.

Many businesses are likely to have independent contractors that do not meet the new test, and that noncompliance exposes these businesses to costly and time-consuming audits, liability for back wages, penalties, and assessment of back taxes in the event state and/or federal agencies determine that workers were misclassified. Businesses who make the effort to implement changes now to comply with the ABC standard may be able to avoid imposition of penalties based on past good-faith compliance with the Borello standard. However, failure do so will put businesses at a much greater risk for such penalties.

Businesses who rely on independent contractors, and especially those that rely exclusively on independent contractors, must consider whether their business model exposes them to expensive litigation, and whether it is more cost-effective to reclassify their independent contractors as employees.