In California: The End of the Gig Economy?

“Under both California and federal law, the question whether an individual worker should properly be classified as an employee or, instead, as an independent contractor has considerable significance for workers, businesses, and the public generally.” These are the openings words of the newest California Supreme Court decision with respect to independent contractors: Dynamex Operations West, Inc. v. Superior Court of Los Angeles County (Cal. 2018). While the decision in Dynamex may provide clarity for the future, it also ensures that California employers will find independent contractor classifications riskier than ever before.

Briefly, the plaintiffs in Dynamex were a class of document and package delivery drivers. The work performed and working arrangements of these drivers were not dissimilar to those of the many “gig economy” workers who are also generally classified as independent contractors.

As independent contractors, the drivers were not afforded any of the privileges of labor and employment law, simply because such laws do not apply to independent contractors. The contractors were, in other words, not entitled by law to minimum wage, overtime, meal or rest breaks, protections against discrimination, paid medical and family leave benefits, paid sick leave, and more. They were also responsible for a self-employment tax and their employers were consequently not subject to the payroll taxes that apply to virtually all employees.

After hearing oral arguments in February 2018, the California Supreme Court found that there are numerous definitions present in California law that might supply the answer as to whether an individual worker is an “employee.” These tests are well-known in other jurisdictions, such as the “economic realities” test and the “suffer or permit to work” test. In reaching its holding, the Court outright eschewed these tests in favor of the “ABC Test,” a three-factor test that begins with the presumption that an individual is an employee, rather than a contractor.

The presumption is critical to understanding the impact of Dynamex. It means that a labor department or court will assume that any worker whose classification is under scrutiny is an employee and it is the company, also referred to as a hiring entity, that must prove that this is not in fact so; conversely, the hiring entity must prove to the agency or court that the person in question is a contractor rather than an employee.

To prove this, the employer must establish all of the following three items:

  • That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  • That the worker performs work that is outside the usual course of the hiring entity’s business; and
  • That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Let’s review these factors individually.

That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

This first factor borrows from the “suffer or permit to work” test which had been argued by Dynamex as the appropriate standard. It looks to the degree of control exercised by a hiring entity over the worker. If the degree of control is similar to that exercised over employees, then this first part of the test is not met and the contractor classification is erroneous; i.e. the individual in question is an employee, not a contractor.

Companies who wish to review their classification practices should look comparatively to requirements imposed upon workers whom they seek to classify as contractors when evaluating risk under this first factor. Are the requirements similar to those of employees, whether in substance, quantity, or a combination thereof? What is the practical, at-work experience of the contractor, and is it truly dissimilar to that experienced by employees?

Second, companies will be required to prove: That the worker performs work that is outside the usual course of the hiring entity’s business.

This factor in particular will impact the gig economy, where workers may set their own schedules, provide their own resources, and work as they choose, thus satisfying the first factor. But does the worker perform work that is different from the company’s industry? If you are a transportation company, and you classify drivers as contractors, it is unlikely that you will be able to satisfy the second part of the ABC test. Conversely, if you operate an accounting firm and hire document delivery drivers, those drivers may well satisfy the test, as the role of the driver is merely ancillary to the usual business conducted by accounting firms.

The illustrative examples used by the California Supreme Court are the plumber who repairs a leak in a retail store (i.e. a contractor), a clothing manufacturer who hires work-at-home seamstresses (i.e. who are not contractors), and a timber collector for a timber management company (i.e. not a contractor, cited by way of a Maine Supreme Court case).

By implementing this part of the ABC test, the Court indicated that, without it, companies may be able to use superior bargaining power to coerce individuals into relinquishing their labor and employment law rights. In the Court’s view, this is particularly unjust where the work performed is integral to the company’s business.

In the past, savvy companies required their contractors to establish their own businesses, tailored their contracts to allow concurrent work with other companies, and excised the vestiges of “authority and control,” or supervision, from their actual, day-to-day oversight of contractors. However, all of these insulating steps will be for naught under the new decision if the contractor performs work that is within the usual course of the hiring entity’s business.

Companies should review their contractors’ duties to determine whether they are within or outside of the usual scope of business. For any contractors whose duties significantly intersect with usual business functions of the company, the classification is likely to be at risk.

Third, the company must establish: That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Explicitly stated, this part of the test is designed to prevent a company from obtaining “the economic advantages that flow from avoiding the financial obligations that a wage order imposes on employers,” which “unquestionably violates the fundamental purposes of the wage order.” In the Court’s view, this is the case when the worker “has not independently decided to engage in an independently established business.”

Happily, the Court elucidates on those factors that will be critical to future determinations as to whether a worker meets this part of the test. In its opinion, the Court indicates that this “independent decision” may be evidenced when a worker “takes the usual steps to establish and promote his or her independent business.” Examples include “incorporation, licensure, advertisements, routine offerings to provide the services of the independent business to the public or to a number of potential customers, and the like.”

Employers Council attorneys have previously advised companies in California that incorporation of their contractors is a critical step to defending an independent contractor misclassification claim. However, this step alone will likely no longer be sufficient. Companies must look to all the steps that a contractor has taken to establish and promote a business in order to assess risk under this third and final part of the ABC test.

Conclusion

Based on the Dynamex decision, we must absorb the following items:

  • Companies must assess their contractors’ status under the ABC Test as soon as possible.
  • The previous multi-factor, case-by-case standard is dead, and any decisions reached under the old analysis are at risk.
  • There is an open question whether the ABC Test will apply to contractors in industries not covered by one of the many Industrial Wage Commission Orders, referred to by the Court simply as “wage orders.”

For independent contractor questions, Employers Council maintains a staff of California licensed attorneys and certificated human resources professionals. Employers Council also provides for-fee preventative audit services to assist companies in evaluating their contractor/employee classifications in California and legal defense representation for California-based administrative claims in which such classifications are challenged.