May 1, 2018 California Supreme Court Tightens Up Test to Determine Whether Workers are Independent Contractors

Summary

In a major decision with wide-ranging implications, the California Supreme Court handed down a decision on April 30, 2018, substantially restricting the ability of California businesses to lawfully use independent contractors in their core business operations.  Dynamex Operations, Inc. v. Superior Court (Lee), Case No. S22732.

Under pressure from government tax and employment law enforcement agencies, as well as labor representatives, the Court announced a new independent contractor test.  The decision is widely viewed as a potential blow to the gig economy, and a significant restriction on employer flexibility in determining the most cost-effective configurations between contractors and employees.

Facts and Analysis

Dynamex is a nationwide package and documents delivery service.  In recent years it classified its drivers and delivery personnel as independent contractors.  The Supreme Court, citing arguments that such classification denied workers various employment benefits and resulted in significant loss of tax revenue, held these contractors were improperly classified, and must be treated as employees.  The determination of class-wide damages awaits.

Under prior law, the test for determining contractor status relied upon a number of factors, and thus allowed employers some flexibility in classifying certain workers as contractors, especially if they could demonstrate that one, but not all, of the definitions were met.  No more.  Now to establish an exemption the employer must prove that all factors point to independent contractor status under a new test.  Here’s how it works:

First, the courts will presume that anyone whom the employer “suffers or permits” to work for them is presumed to be an employee.  This definition presumes that “all workers who would ordinarily be viewed as working in the hiring business” are employees.  (Emphasis is the Court’s.)  The only examples of exclusions given by the Court would be workers – like plumbers or electricians – who the Court called “genuine independent contractors” – who do not perform services that are part of the employer’s scope of operations or line(s) of business.

Second, the Court adopted what in other states has been called the “ABC” test.  Under this test, a worker is properly considered an independent contractor only if the employer establishes all of the following:

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

B.  The worker performs tasks that are outside the usual course of the hiring party’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 business.  This normally means the worker will have established and promotes his or her own business; is licensed; does advertising; has other clients or potential customers; and the like.

What This Means

Although this test is new, the Court ruled that its decision was merely explaining existing law, which means it can and will be applied retroactively.  In light of this, all California employers are well-advised to conduct a prompt audit of their use of contractors in light of the new standards.  The expectation and intention of the decision is that large numbers of current contractors may not qualify for that status under the new test.

It remains to be seen how this ruling will affect joint employer or subcontractor relationships, in which a true contractor entity (such as a staffing company) is engaged but whose employees are subject to detailed direction by the retaining company.  It is clear, however, that this ruling is intended to expand the populations of persons for whom tax deduction, statutory employee benefits, leave and discrimination benefits, and the like, are available, and that hiring companies could be exposed to statutory liability to the subcontractor’s employee, since it “suffered or permitted” them to work on its premises.  It is not clear whether the rules on indemnification and reimbursement of expenses will be interpreted in the same fashion as the new rules on classification and taxation, but caution suggests these practices, and subcontractor indemnities, be examined as well.