By Terry O’Connor

An increasingly unloved category of working persons, the Independent Contractor, has been moved to the endangered species list by a recent California Supreme Court decision.

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. When this test is applied, expect a breath-taking expansion of the number of California workers covered by the wage and hour regulations of California’s Industrial Welfare Commission (IWC) Wage Orders. There will be a concomitant decrease in the number of independent contractors. Many businesses and individuals will painfully learn that the independent contractors they engaged are actually employees with all of the considerable rights and obligations attached thereto.

In Dynamex Operations West, Inc. v. Superior Court of Los Angeles, the California Supreme Court rejected the long-standing “right to control” standard, which weighed various indicia of the principal’s control over the worker to determine if a worker was properly classified as an independent contractor or employee. Dynamex had originally engaged its drivers and couriers as employees. It later reclassified them as independent contractors. When challenged in court, the company argued that its contract and practices did not show the requisite control over the workers to characterize them as employees.

The court rejected the “right to control” standard and adopted an “ABC” test to determine whether a worker falls under the broad “suffer or permit to work” standard. “Suffer or permit to work” is part of the definition of employer contained in all Wage Orders. Under this test, an entity which knowingly allows another individual to provide services, regardless of a lack of control over the worker, is nevertheless the employer of that individual. The ABC test is used by many state unemployment insurance agencies and more broadly in certain other jurisdictions, including Massachusetts and Vermont. It appears that California has now joined these other liberal Blue States to limit the use of independent contractors.

The ABC test begins with the presumption that individual service providers are employees of the hiring entity, unless all of the following are present:

A. 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; and

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.

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 whether control is exercised in practice. Like the traditional 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. Hiring entities and individuals should scour their contractor agreements to remove any language that would give them implied control over a contractor. Independent contractor agreements should scrupulously avoid any employment-like provisions. For example, at-will employment status, overly restrictive prohibitions on working for others or other policies drafted for the entity’s true employees.

Part B looks to the services provided and whether they are the same services provided in the ordinary course of the hiring entity’s core business. It requires an analysis of 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 will be challenging for gig economy providers. Indeed, the District Attorney in San Francisco, inspired by the Dynamex decision, has subpoenaed all of Lyft and Uber’s records to determine if their drivers are properly being treated as employees. Even if the hiring entity does not control or direct the work, the nature of work performed must also be differentiated from the company’s core business and processes.

The Part B test will likely be the most difficult for a hiring entity to establish, because it requires showing that the worker is truly providing a unique and isolated service for a business. As an example of this, the Supreme Court described a plumber hired by a retail store to repair a bathroom leak. Because the plumber is performing work that is not part of the store’s usual business of selling clothing, it would not be reasonably viewed as working within the scope of the hiring entity’s business. On the other hand, a seamstress working from home for a clothing manufacturing company to make dresses from company-supplied cloth patterns likely would not pass muster under Part B and would be viewed as part of the hiring entity’s usual business operations.

Part C focuses on the provider to determine whether he/she is providing services as 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 can be evidenced by such things as incorporation, licensure, advertisements or routine offerings to provide services to the public or a number of potential customers. A worker solely dependent on a single principal for his entire livelihood is unlikely to be regarded as independent. Lengthy relationships over many years will be suspect. Hiring entities should confirm that the contractor has other sources of business and holds herself out to the general public as a separate business. As in Part A, it will not be enough that the contract allows the contractor to work for others, the worker must actually perform work for others.

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. Dynamex is also silent on whether the ABC test applies retroactively or prospectively.

The decision leaves no doubt that there are significant risks for businesses in California who use independent contractors without careful analysis. While a legislative fix would be helpful, powerful forces in government, unions and plaintiff lobbyists have been urging the elimination of independent contractors for many years.

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.

Individuals and businesses using independent contractors should carefully analyze their independent contractor relationships to make sure they comply with the ABC test. If an independent contractor’s services are not clearly beyond the range of ordinary business operations, the hiring entity should consider whether those workers should be reclassified as employees. Obviously reclassifying an employee as an independent contractor, even if the employee’s role or duties may be different, would be foolhardy.

If a company uses labor contractors or other temp agencies to provide services, it should ensure that the relationship between the labor provider and any independent contractor also passes the ABC test. Labor Code section 2810.3 holds companies using labor contractors jointly liable for the wages of labor contractor employees. This section would presumably hold the “client employer” liable for the wages of employees misclassified as independent contractors.

(Terry O’Connor is an attorney with Noland, Hamerly, Etienne & Hoss. His expertise involves counseling and representing business owners in employment practices.)