California Supreme Court Alters Legal Landscape for Employers That Work with Independent Contractors

Last week, the California Supreme Court issued a sweeping decision adopting a new test that will make it much harder for companies to show that workers qualify as independent contractors instead of employees.  The ruling affects all companies in California that work with independent contractors, which includes freelance workers and outside consultants. The Court’s decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles may end up requiring companies that work with independent contractors to follow wage and hour laws that apply in the typical employer-employee relationship.

The Court scrapped the existing test for determining employee status that focused on various factors with an emphasis on who has the right to control the contractor’s work.  The Court adopted a standard known as the “ABC test” that presumes workers are employees instead of independent contractors for purposes of California’s Wage Orders – which govern matters such as overtime and meal and rest breaks – and places the burden on employers to prove workers aren’t employees.

Under the ABC test, a person will be considered an independent contractor only if the hiring entity can prove all three of the following:

(A) 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; and

(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The only way to satisfy part B – and, thus, the only way to be an independent contractor – is for one’s work to fall outside the usual course of the hiring entity’s business.  As a practical matter, for most companies, this prong will prevent the use of independent contractors except where the person’s work has no tangible connection to the hiring entity’s business.

The Court gave the following examples of workers who satisfy part B of the test, explaining that when a retail store hires an outside plumber to repair a leak in a bathroom on its premises, or hires an outside electrician to install a new electrical line, the services of the plumber or electrician are not part of the store’s usual course of business. On the other hand, the Court said that when a clothing manufacturing company hires work-from-home seamstresses to make dresses that will thereafter be sold by the company, or when a bakery hires cake decorators to work on a regular basis on its custom-designed cakes, the workers are part of the hiring entity’s usual business operation.

As for part C, the Court was clear that the fact a company has not prohibited or prevented a worker from engaging in an independent business or providing similar services to others is not sufficient to establish that the worker has in fact independently made the decision to go into business for himself or herself.  The Court did not provide instructions on how companies may meet this prong, but cited to cases in other states that use the ABC test that held the prong may be met by showing the worker has his or her own clientele, business cards, business phones, business locations, and seeks and obtains work from other companies.

What Does This Mean for Employers?

The Court was careful to limit the ABC test to the California Wage Orders, meaning that this test is now applicable to issues of overtime pay, and meal and rest breaks.  At least for now, this test should not apply in other instances, such as to determine if the hiring company bears the responsibility of paying payroll taxes and unemployment insurance taxes, providing worker’s compensation insurance, or determining liability under employment discrimination laws.  However, other courts may end up adopting the ABC test to apply it in these other situations.

The biggest impact may be that an employer can now be on the hook for complying with California’s wage and hour laws for its independent contractors’ work.  Liability for these violations can add up quickly.  There will now be many instances in which companies have no choice but to comply with California’s Wage Order protections applicable to employees because under the ABC test their independent contractors are now in fact employees.

The Court left open a host of questions that will have to be sorted out in the subsequent case law that applies the new test.  For example, under part B of the test, the Court provided no guidance as to how to assess what is “the usual course of the hiring entity’s business.”  The Court’s example of a retail store hiring an electrician and plumber is a pretty clear-cut example of a worker who would likely be an independent contractor even under the state’s previous factor test.  However, most cases litigated in this area of the law are likely to exist in a “gray area” as to whether the worker is providing services in the usual course of the hiring entity’s business.  Courts in other states that have a version of the ABC test have interpreted prong B in vastly different ways from one state to another.

It may take years until the lower courts in California develop a comprehensive body of law to provide sufficient guidance so that businesses and workers can conform their actions to the contours of the new decision.

Employer Action Items

• If your business works with independent contractors (including freelance workers or outside consultants), carefully evaluate the relationship to determine if the individuals should be properly classified as employees. If you have hired someone to perform work that clearly falls within the usual course of your business, or they do not actually provide services for anyone else, they are likely now employees, and you may therefore be liable for paying overtime and providing meal and rest breaks.
• If your independent contractors are likely employees under the ABC test, you will have to decide whether to convert them to employee status, sever your ties with the worker, or maintain the status quo and hope for the best while this gets sorted out by the courts.