Death of the Independent Contractor: The Dynamex Decision and Beyond

Filed under: Business Law

On Thursday, May 2, 2019, the 2018 California Supreme Court ruling that created a strict standard for determining who is an employee, and making it almost impossible for companies to classify workers as independent contractors, was upheld by the U.S. Court of Appeals for the Ninth Circuit. Further, the ruling which creates a new test for determining whether a worker is an independent contractor or an employee will be applied retroactively. It is an understatement to say that the Ninth Circuit opinion has major implications for California workers and employers.

BACKGROUND
The original case, Dynamex Operations West v. Superior Court of Los Angeles (“Dynamex”), stems from a claim made by Plaintiff Charles Lee who in 2005 entered into a written independent contractor agreement with Dynamex to provide delivery services for the Company. As many may know, Dynamex is a nationwide same-day courier and delivery service. Prior to 2004 the Company classified all its delivery drivers as employees. However, beginning in 2004, Dynamex converted all its drivers to independent contractors in order to cut costs.

Mr. Lee’s complaint alleged that Dynamex misclassified its drivers as independent contractors in violation of various sections of the California Labor Code and Industrial Welfare Commission (“IWC”) wage order No. 9, which is the applicable wage order governing the transportation industry. The complaint further alleged that as a result of the claimed violations, Dynamex also engaged in unfair and unlawful business practices pursuant to California Business and Professional Code section 17200.

After an early round of litigation regarding class certification, the Court of Appeals rejected Dynamex’s argument that asserted that the traditional multi-factor “common law” classification analysis, outlined in S.G. Borello & Sons, Inc., v. Department of Industrial Relations (“Borello”), should be applied where there was an employer obligation imposed by an IWC wage order.

As a result, the California Supreme Court granted review in order to clarify the correct standard for determining employee or contractor status where there is a governing wage order.

Consequently, the Court created a new and substantially more restrictive test known as the “ABC test.” Under the ABC test, a worker will be deemed to be an employee for wage order purposes, unless the putative employer proves:

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 it fact;

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

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

It is important to understand that each of these requirements needs to be met in order for the putative employer to rebut the presumption that a worker is an employee. In addition, the May 2 ruling will be applied retroactively, which means that the ABC test will be applied to cases going forward, as well as to disputes dating back to before the new test was articulated.

UNINTENDED OR INTENDED CONSQUENCES – THE EFFECT OF DYNAMEX

The determination regarding whether a particular worker should be classified as an employee or independent contractor is of great importance to workers, businesses and the general public. Workers classified as employees create significant employer obligations with regard to Social Security and payroll taxes, worker compensation insurance, unemployment insurance and state employment taxes, not to mention the complicated framework of federal and state statutes governing wages, hours and working conditions.

Additionally, the Dynamex ruling has considerable implications for employers and workers participating in the “gig” economy like Uber, Lyft, GrubHub and Postmates. The decision could compel some employers to reclassify contractors as employees and change pay and benefit schemes, a cost that will no doubt be passed along to the consumer.

The ruling has already prompted new litigation against “gig” employers. Also, it has far reaching implications for existing Ninth Circuit cases, including the worker classification case against Grub Hub, which is considered to be a test case for the gig economy’s current business model. It is widely believed that these employers face an uphill battle in asserting that their businesses are their apps rather than the service provided to the customer.

Further, the ruling also has an effect on major franchises because the Dynamex decision retroactively subjects employers (franchisors and franchisees) to liability for misclassifying workers as independent contractors going back four years before the 2018 decision based on California’s statute of limitation. Because the Court held that the ABC test applies to both a franchisee and the parent franchisor when deciding whether workers are employees, it naturally creates increased liability exposure for the franchisor. Matthew Haller, a senior vice president at the International Franchise Association believes that unless there is legislative relief or intervention from the U.S. Supreme Court, which is unlikely, “California’s 76,000 franchise hotels, gyms, restaurants and retail stores will live in legal uncertainty for the foreseeable future.”

In addition to gig employers and franchises, the Dynamex decision effects an array of California workers by creating a presumption that a worker is an employee unless they meet the difficult criteria that would make them independent contractors. Therefore, the ruling will certainly effect hair stylists, barber, beauticians, exotic dancers, contract lawyers, outside sales agents, insurance agents, and maybe even real estate professionals.

CODIFYING DYNAMEX – A DIFFICULT CERTAINTY

In December of 2018, Assemblywoman Lorena Gonzalez introduced Assembly Bill No. 5 (“AB 5”) which is designed to codify the decision in Dynamex and clarify its application. In May of 2019 the California Assembly voted to pass AB 5 by a vote of 55 to 11, and the bill is now headed to the California Senate for a vote at the end of the summer.

The controversial law would set forth the intent of the Legislature to codify the decision in the Dynamex case and clarify its application. The bill would provide that the factors of the ABC test be applied in order to determine the status of a worker as an employee or independent contractor for all provisions of the Labor Code and the Unemployment Insurance Code, except if a statutory exemption exists. AB 5 currently exempts a number of occupations from the new statutory scheme, including doctors, securities broker-dealers, direct sales agents, licensed real estate professionals, and hairstylists. The exempted workers’ classification will be determined using the multi-factored Borello test.

Of course, major gig employers like Uber and Lyft have launched aggressive public campaigns to defeat the bill. If passed, gig workers would get labor protections and benefits that all employees get, like unemployment insurance, health care subsidies, paid parental leave, overtime pay, worker’s compensation and a guaranteed $12 and hour minimum wage. Moreover, California stands to benefit by taking in as much as an additional $7 billion in tax revenue each year that the state currently loses because of employee misclassification.

Currently, California Democrats have a veto-proof supermajority in the State Senate and Assembly. Therefore, there is a pretty good chance that AB 5 will become law.

Also, in December of 2018 Assemblywoman Melissa Melendez introduced Assembly Bill No. 71 (“AB 71”) which is designed to protect the independent contractor by rolling back the precedent set by the Dynamex decision. Melendez believes that Dynamex will have a chilling and harmful effect on the business community and hurt the almost 2 million California workers that choose to work flexible schedules as independent contractors.

AB 71 would effectively overrule Dynamex by removing the ABC test as the method for determining worker classification and replacing it by codifying the almost 30-year old common law factors outlined in Borello. Certainly, the eight-factor test outlined in Borello is a more flexible test emphasizing the extent of the employers control over the worker. Both the California Chamber of Commerce as well as the state’s business and tech communities support AB 71. However, AB 71 has so far lacked the momentum of AB 5 and it failed to make it to an Assembly vote. Currently, AB 71 is again awaiting approval from the Assembly Committee on Labor and Employment.

CONCLUSION

No matter where you stand on the issue of business use of independent contractors, it is clear that there is a new legal standard in California for determining whether workers should be classified as employees or independent contractors. Employers and workers should take note and contact an attorney to discuss their particular situation. Further employers need to reevaluate any workers currently classified as independent contractors. Below are some specific things to remember about the new case law.

An employer must satisfy all three factors outlined in the Dynamex decision to correctly classify a worker as an independent contractor. Beware of factors B and C. In Dynamex the Court recommended that the analysis begin with factors B and C. This is a departure from previous law because the analysis previously focused on the amount of employer “control” which is now addressed in factor A. Employers should be prepared to make their case on factors B and C before they address questions of control.

Employers have the burden of proof. The Dynamex’s ruling makes it abundantly clear that the burden of proving a worker is an independent contractor rest entirely with the employer. The Court found that it was “appropriate, and most consistent” to require the hiring entity [employer] to establish not just one or a majority of the factors in the standard, but instead must stratify each of the three factors outlined in the ABC test.

Adding to the burden and difficulty of the new standard, the Dynamex decision applies retroactively and the federal courts agree. The Ninth Circuit provided that “retroactive application is neither arbitrary nor irrational” in violation of the due process and that the ABC test remains “faithful… to the fundamental purpose of [California’s] wage orders.”

For employers, the Dynamex decision will have a major impact. Retroactive application of a new standard that puts the burden squarely on the employer will most certainly open the door to potential employer liability going back several years. The Dynamex decision coupled with new legislation has the effect of forever changing the way we classify workers. In California we may be in the beginning stages of the death of the independent contractor.

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