California payroll companies are breathing a sigh of relief after the state's Supreme Court unanimously decided in Goonewardene v. ADP, LLC that employees may not sue their employers’ payroll companies for wage and hour claims related to their employment under contract, tort, or joint-employer liability theories.
In Goonewardene, the plaintiff filed a lawsuit against her former employer, Travel Agency Altour International Inc., for discrimination, missed overtime and breaks, wrongful termination, breach of contract, violations of the Labor Code, and related claims. The plaintiff subsequently filed numerous amended complaints naming her employer’s independent payroll service provider, ADP, as an additional defendant based on the theory of joint-employer liability. The amended complaint included claims against ADP for breach of contract, professional negligence, and negligent misrepresentation on the grounds that ADP performed payroll services in an inaccurate and negligent manner. The trial court, however, disagreed with the plaintiff’s theory of liability and granted ADP’s demurrer without leave to amend.
On appeal, the California Court of Appeal agreed that ADP was not the plaintiff’s employer under the California Labor Code, yet found that the plaintiff has standing to sue ADP for breach of contract for unpaid wages as a third-party beneficiary of the contract between ADP and her former employer. The Court of Appeal also allowed the plaintiff to pursue her tort claims against ADP as a third-party beneficiary for negligence and negligent misrepresentation. As expected, the Court of Appeal’s decision sent waves throughout the legal community because it opened the door to third-party beneficiary wage and hour claims against not only the employer but also the employer’s independent payroll companies.
Welcome relief came to payroll companies throughout California on February 7, 2019, when the Supreme Court of California issued a unanimous opinion that an employee is not a third-party beneficiary to an employer’s payroll company. Under California’s third-party beneficiary doctrine, a third party may bring a breach of contract action against a party to a contract only if the third party establishes: (1) that it is likely to benefit from the contract; (2) that a motivating purpose of the contracting parties is to provide a benefit to the third party; and (3) that permitting the third party to bring its own breach of contract action against a contracting party is consistent with the objectives of the contract and the reasonable expectations of the contracting parties.
The California Supreme Court concluded that even though an employee may benefit from the contractual relationship between the employer and payroll company (e.g., received wages), distribution of wages is not the motivating purpose of the contracting parties. Instead, the court found that the relevant motivating purpose is “to provide a benefit to the employer” in the form of “cost and efficiency of the tasks performed and the avoidance of potential penalties.” Indeed, payroll companies would see an influx in defense costs, which translates to higher rates to the employer if it could sue as a third party-beneficiary. Consequently, imposing liability on the payroll company would be contrary to the employer’s and payroll company’s expectations when they entered the contract.
Second, the California Supreme Court determined that the Court of Appeal also erred in determining that an employee may maintain tort causes of action for negligence and negligent misrepresentation against a payroll company. The court reasoned: (1) California law provides employees with a full and complete remedy to recover any wage loss against the employer in civil action; (2) imposing tort liability on a payroll company is an unnecessary deterrent since the payroll company will be liable to the employer for negligent conduct; (3) the payroll company has no special relationship with the employer’s employees to warrant such a duty of care; (4) imposing a duty of care on a payroll company could adversely affect its performance of contractual obligations to the employer; and (5) public policy dictates that imposing a tort duty of care on a payroll company will unnecessarily add to California’s volume of wage and hour litigation. Notably, the California Supreme Court did not reverse the Court of Appeal’s holding that ADP is not the plaintiff’s joint-employer, which also bodes well for payroll companies.
This ruling certainly eased the tension felt by payroll companies throughout California who were undoubtedly bracing for the tidal wave of wage and hour claims that would have followed under contract, tort, and joint-employer liability theories. Employers can also breathe a sigh of relief because the increase in defense costs for payroll companies would have certainly translated into higher fees to the employer to offset costs and potential liability.