On April 30, 2018, the California Supreme Court adopted a new test for determining whether a worker should be classified as an independent contractor or an employee. Application of this test is expected to expand the universe of California workers covered by the wage-and-hour regulations of California's Industrial Welfare Commission (IWC) Wage Orders and to constrain the use of independent contractors.
In Dynamex Operations West, Inc. v. Superior Court of Los Angeles, the California Supreme Court rejected the long-standing "right to control" standard, which balanced numerous indicators of control – none of which were dispositive – to determine if a worker was properly classified as an independent contractor or employee.
Instead, the court adopted the "ABC" test to determine where a worker fits under what it described as "the exceptionally broad suffer or permit to work" standard. The term "suffer or permit" is contained in the Wage Order definition of employer, and essentially means one who allows another to provide services. The ABC test is used in connection with many state unemployment insurance laws and more broadly in certain other jurisdictions, including Massachusetts and New Jersey.
The ABC test starts with a rebuttable presumption that individual service providers are employed by the hiring entity, unless:
- the worker is free from the control and direction of the hiring entity, both under the contract for the performance of the work and in fact
- the worker performs work that is outside the usual course of the hiring entity’s business and
- the worker is customarily engaged in an independently established trade, occupation, or business.
The ABC test is not a balancing test – if the hiring entity cannot prove all three prongs in an administrative or judicial proceeding, the presumption of employment applies and the worker will be classified as an employee
Part A of the ABC test looks to both the right to exercise control and the application of control in practice. Like the multi-factor "right to control" test, Part A looks to the nature of the work and the relationship between the business and the person performing the work. A business need not control every detail of the work in order to have maintained enough control to fail this test. It is important for hiring entities to review contractor agreements and ensure that they are not retaining the right to control. It is also important not to inadvertently impose employment-like conditions (at-will employment status, recitation of "work for hire" with respect to inventions, or overly restrictive prohibitions on working for others) through incorporation of an Employee Proprietary Invention and Assignment Agreement or other policies drafted for the entity's employees.
Part B looks to the services provided and whether they are provided in the ordinary course of the hiring entity's core business. The analysis looks at whether the worker is providing services that are not routine in the hiring business, but rather need to be performed by a traditional independent contractor like a plumber or electrician or one who otherwise has expertise not required in the hiring entity's day to day operations. Part B can be challenging for gig economy providers. Even if the hiring entity does not control or direct over the work, the nature of work performed must also be differentiated from the company's core business. This can be a complex analysis for operators of technology platforms and counsel should be consulted to address platform-specific issues.
Part C looks to whether the worker is providing services through an independent business or is providing services as a de facto employee. Freedom to provide services to others and the actual exercise of that right are important considerations; this case was based on a class limited to drivers who did not perform delivery services for other delivery companies or for their own independent delivery businesses. The concept of economic dependency – making a living from the hiring entity's business and not from the worker's own independent business – will weigh against finding independence for Part C. Long-term relationships can also be problematic. Hiring entities may consider requiring certification of a contractor's other sources of business, limiting business with sole proprietors or restricting hours or duration of service to satisfy the independence requirement.
This decision leaves many unanswered questions, including how courts will reconcile the ABC test for claims under the IWC Wage Orders with the "right to control" standard used for Labor Code claims. The Labor Code imposes other remedies for wage violations and provides a right to bring representative actions for penalties under the Private Attorneys General Act. Plaintiffs frequently bring claims subject to both standards. Applying two different tests to classify a single worker will lead to bizarre jury instructions, but that challenge remains for the courts to address, along with other questions involving preemption.
The decision leaves no doubt that there are significant risks for businesses in California who use independent contractors indiscriminately. The situation cries for a legislative remedy, but legislative remedies face numerous hurdles and take time.
Meanwhile, the consequences of misclassification liability continue to be significant, including assessments for unpaid payroll taxes and penalties, worker claims for back pay and penalties for unpaid overtime, meal and rest breaks, attorneys' fees and interest, along with workers compensation coverage issues. Businesses may also be exposed to vicarious liability when former independent contractors are reclassified as employees with an accompanying agency relationship to the employer.
Businesses with California workers (and would-be acquirors) should work with counsel to carefully review their practices for retaining, using, compensating and terminating contractors; review benefit plans as needed to address risk of retroactive coverage obligations for misclassified employees; update contractor agreements and related documentation; review contracts and practices for use of leased and other contingent workers; and evaluate arbitration strategies to mitigate the classification challenges presented by the ABC test.