News

September 13, 2018

COMPANIES WITH CONTRACTORS: HAVE YOU LEARNED YOUR DYNAMEX A, B, C’S? 

Executive Summary

On April 30, 2018, the California Supreme Court issued a groundbreaking decision in Dynamex Operations West, Inc. v. Superior Court (Los Angeles), 4 Cal. 5th 903 (2018), regarding the standard by which employers may classify California workers as employees or independent contractors for purposes of the California wage orders.  Since then, employers have scrambled to scrutinize their relationships with contract workers and potential obligations relating to minimum wages, overtime, and basic working conditions such as required meal and rest breaks.

The new “ABC test” announced in Dynamex places the burden on employers to show that a worker is an independent contractor rather than an employee for purposes of the California wage orders.  To satisfy the ABC test, the employer must establish all three of the following:

  1. 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
  2. the worker performs work that is outside the usual course of the hiring entity’s business; and
  3. the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The case generated more questions perhaps than answers:    How will this impact the gig economy?    Will the decision reverberate into the franchise business model?    Does the new test apply retroactively and will it open the door to a flood of litigation?   The ensuing months have done little to clarify the murky waters.

Background of the Dynamex case

Dynamex is a nationwide package and document delivery company.  Prior to 2004, it classified its truck drivers as employees subject to the California state wage and hour laws governing minimum wage, overtime, and rest and meal breaks for non-exempt employees.  In 2004, however, Dynamex “converted” all of its truck drivers to independent contractors in an effort to “generate economic savings for the company.”

With the new classification, the drivers’ duties effectively did not change but their financial obligations did.  They became responsible to provide their own vehicles and pay for expenses, including fuel, tolls, maintenance expenses, and auto liability insurance, as well as workers’ compensation insurance and all taxes.  The drivers still had to wear Dynamex shirts and occasionally place Dynamex decals (which they had to pay for themselves) on their vehicles.  Dynamex continued to obtain the customers and set the rates for its delivery services.  It also negotiated the amount to be paid to drivers.  The drivers were free to set their own schedules and were generally free to choose the sequence in which they would make deliveries and the routes they would take, but were required to complete all assigned deliveries on the day of assignment.  The drivers were ordinarily hired for an indefinite period of time but Dynamex retained the authority to terminate its agreement with any driver without cause, on three days’ notice.

In 2005, Dynamex was sued by two delivery drivers on their own behalf and seeking to represent all other similarly situated drivers, claiming that Dynamex had misclassified drivers as independent contractors.  The lawsuit contended that, since the December 2004 conversion, Dynamex drivers had performed essentially the same tasks, in the same manner, as when they were classified as employees, but that Dynamex had failed to pay overtime compensation, to properly provide itemized wage statements, and to compensate the drivers for business expenses.

Dynamex appealed a court order certifying a class of drivers who did not themselves employ other drivers or do delivery work for anyone but Dynamex.  The matter ultimately reached the California Supreme Court on the issue of whether the wage order’s definitions of “employ” and “employer” were the appropriate standard for determining whether a worker is an employee or an independent contractor for purposes of the obligations imposed by California law.

The Plaintiffs argued that Martinez v. Combs, 49 Cal. 35 (2010), set forth the proper standard for determining whether an individual was an employee or independent contractor.  In Martinez, the California Supreme Court set forth three alternative definitions of “employ” in the context of examining whether a business other than the primary employer was a joint employer:

  1. To exercise control over wages, hours or working conditions, or
  2. To suffer or permit to work, or
  3. To engage, thereby creating a common law employment relationship.

Dynamex argued that the “exercise of control” and the “suffer or permit to work” standards in Martinez only applied to situations when the worker is acknowledged to be an employee and the question is one of potential joint employment, while the proper standard for distinguishing employees from independent contractors was the multifactor test used in S.G. Borello & Sons, Inc. v. Dep’t of Indus. Rel., 48 Cal. 3d 341 (1989).

Result

The California Supreme Court, after extensive analysis of the state’s historical treatment of the employee/independent contractor distinction, and in particular the Borello case, concluded that the “suffer or permit to work” definition applies even outside the joint employment context.  The Court stated the definition:

must be interpreted broadly to treat as “employees,” and thereby provide the wage order’s protection to, all workers who would ordinarily be viewed as working in the hiring business.  At the same time, we conclude that the suffer or permit to work definition is a term of art that cannot be interpreted literally in a manner that would encompass within the employee category the type of individual workers, like independent plumbers or electricians, who have traditionally been viewed as genuine independent contractors who are working only in their own independent business.

Thus, the Court concluded that the correct way to determine whether a worker is properly classified as an employee or independent contractor under the “suffer or permit to work” definition was to apply a standard known as the “ABC” test by:

  1. placing the burden on the hiring entity to establish that the worker is an independent contractor who was not intended to be included within the wage order’s coverage; and
  2. requiring the hiring entity, in order to meet this burden, to establish each of the three factors embodied in the ABC test — namely:
  3. 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
  4. that the worker performs work that is outside the usual course of the hiring entity’s business; and
  5. that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Applying the Dynamex ABC Test

The first (“A”) prong of the Dynamex ABC test closely mimics the old common law control test.  The Court cautioned that “a business need not control the precise manner or details of the work in order to be found to have maintained the necessary control that an employer ordinarily possesses over its employees.”

The second prong (“B”), which will often pose the biggest hurdle, requires proof that the worker performs work outside the usual course of a company’s business.  For example, an outside plumber hired to fix a leak at a retail store performs work outside the store’s usual course of business.  However, a work-at-home seamstress contracted to make dresses for a dress company using cloth and patterns supplied by that company works as part of the dress company’s usual business operation.

Prong C essentially requires a business to prove that the worker has chosen to go into business for himself or herself, rather than having the label of independent contractor unilaterally assigned by the hiring entity.  This typically involves taking steps by the worker to promote the independent business, “for example, through incorporation, licensure, advertisements, routine offerings to provide the service of the independent business to the public or to a number of potential customers, and the like.”

Scope of the Dynamex ABC Test

The California Supreme Court declined to extend the ABC test to worker classification for all purposes, instead explicitly limiting the ABC test to the classification of a worker under the “suffer or permit” standard in the California wage orders.  The Borello factors, consequently, may still apply for other purposes such as workers’ compensation coverage, wrongful termination and discrimination claims, unemployment benefits, and certain provisions of the California Labor Code.

Additionally, unless its reach is extended to other statutes, the ABC test will likely have little or no impact on workers who would be classified as “exempt” if deemed employees of the employer, such as those who qualify for the professional, executive, and administrative exemptions, as well as the outside sales exemption.

Illustrative Application of the ABC Test

The ABC test is not nearly as simple as its name implies.  The following are some hypothetical case studies to demonstrate the steps in the analysis and the difficulty companies may face in attempting to satisfy the test.

Each of the following hypotheticals assumes the company engaged the worker as an independent contractor, as written in an independent contractor agreement.  We then consider two key questions:  (1) Does the ABC test apply?  (2) If the ABC test does apply, can the hiring entity satisfy the test?

Case Study 1:  An accounting firm hires a certified public accountant (“CPA”) to advise a particular client about regulatory compliance for a specific jurisdiction in which the hired accountant has specialized knowledge.

Does the ABC test apply?  Probably not.  As explained above, the ABC test currently applies only to determine independent contractor or employee status under the California wage orders.  A CPA, in this scenario, likely qualifies for the professional exemption, and therefore is exempt from application of the wage orders.  If, however, the accountant is non-exempt, the ABC test will apply to determine whether the individual is properly classified as an independent contractor, but the conclusion will depend on the existence of individualized relevant facts[1] that support either independent contractor or employee status.

Case Study 2:  An accounting firm hires a student for the summer as an independent contractor to accumulate and list all expenses for a particular client from the previous quarter.

Does the ABC test apply?  Yes, the test likely applies for purposes of the California wage orders because the type of work the student is performing will likely not qualify as exempt.

Can the accounting firm satisfy the ABC test?  Doubtful.  The student is performing work in the usual course of business of the accounting firm, thus failing prong B.  Prongs A and C would also be difficult to establish for a summer student hire.

Case Study 3:  A software company hires an accountant to manage its own financial accounting books for the next year as needed.

Does the ABC test apply?  It depends on whether or not the accountant qualifies as an exempt employee, as in Case Study 1.  But assuming the accountant would be nonexempt, the Dynamex case leaves open the question of how the ABC test would view this type of service.

In its examples of work performed in and out of the ordinary course of business, the court made clear connections between the product or service the company provides to end-users.  That is, does the individual’s work directly contribute to the product or service of the company?  However, the court seemingly failed to consider a business’ administrative work.  Every business requires some form of accounting.  It is a crucial administrative function of a business, yet remains separate from the products or services the company creates and sells.  The degree of connection required to satisfy Prong B has yet to be developed.

The Gig Economy

The reach of the Dynamex decision is likely to be felt well beyond the traditional business models envisioned by the wage orders to include companies that provide service based apps and online platforms.  To the extent such companies classify workers as contract workers, they may well be especially vulnerable to claims of misclassification.  In applying the Dynamex ABC test, such companies will urge that their “ordinary course of business” is the technology itself – the application, platform, or code.  However, to the extent such companies engage workers to carry out the services the app or online platform exists to provide, they can expect to be challenged to demonstrate the workers’ services are outside the companies’ end product or service.

Franchises

Franchisors have also been watching for developments following Dynamex that could impact them, in light of the traditional classification of franchisees as independent contractors, which is a key component of the franchise model.  Separate laws typically govern the franchise relationship, which is a unique business arrangement that should not be viewed through the lens of an employer-employee relationship.  According to the California Chamber of Commerce, California has more than 76,000 franchise locations that support nearly 730,000 jobs.  Therefore, the Dynamex case should be of significant interest to franchisors in the State of California.

Retroactive Application and Final Thoughts

Another concern is the potential retroactive application of the ABC test.  To the extent that the ABC test applies retroactively to workers retained before the date of the Dynamex decision, companies that relied on prior case law in classifying workers will be at risk.  In an effort to stem a potential flood of litigation, business groups have filed amici briefs with the California Supreme Court requesting clarification and urging against the retroactive application of the ABC test.  The briefs contend that companies have relied for decades in good faith on the Borello standard and that it would therefore be unfair to retroactively apply a new standard.

Additionally, on August 6, several companies sent a letter urging the California State Legislature to actively suspend application of the ABC test imposed by the Dynamex decision while the companies try to implement complying policies.  The companies argue that their existing policies relied on the previous test (the Borello test) in classifying workers as independent contractors.  Applying the ABC test now without any adjustment period, the companies argue, would undermine the companies’ prior efforts to operate in full compliance with existing law.

Also in August, a group of independent contractors held a rally at the state capitol to urge policymakers to suspend application of the Dynamex test until the Legislature has time to address it during its next session.  A coalition website has also been established at https://imindependent.co/.  Meanwhile, organized labor is placing pressure on the Legislature not to cut back on Dynamex.

Given that it will likely be some time until the various consequences of Dynamex play out and more answers are known, companies should examine their worker classifications now to reduce their potential exposure.  To minimize risk going forward, businesses are advised to review existing independent contractor relationships to assess whether the ABC test may apply and, if so, whether the business can satisfy the test.  In some cases, a business may be able to gather more information, or modify the relationship or contract in some aspects to better position itself to satisfy the ABC test.

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[1] Naturally, many factors will go into the analysis of whether the ABC test can be satisfied in any particular case, and companies must do their best to weigh the individualized factors on a case by case basis.

 

For further information, please contact one of our employment attorneys.

Hope Case
(650) 494-4098
hcase@srclaw.com

Merrili Escue
(858) 381-5458
mescue@srclaw.com

Nancy Kawano
(858) 381-4890
nkawano@srclaw.com

 

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