A Whole New Paradigm for the Classification of Independent Contractors: The ABC’s of the California Supreme Court’s New Sweeping Dynamex Decision

In one of the most sweeping employment-law decisions from the California Supreme Court in the last few decades, the California Supreme Court just released an unanimous decision in the case of Dynamex Operations West, Inc. v. Superior Court, which will not only have immediate ramifications to businesses statewide but will seriously affect several nascent industries that are projected to come into fruition in the coming decade. By replacing the traditional multi-factor test that primarily focused on the control of the employer over the work completed by the Independent Contractor, employers must now immediately re-evaluate whether its current usage of Independent Contractors is still permissible under the new ABC Test and also whether it makes any sense to use them at all moving forward.

  1. Factual Background

This new case is the result of a class action filed on behalf of independent contractors employed by Dynamex, a same-day courier and delivery service that operates a number of business centers in California. Prior to 2004 Dynamex classified drivers who picked up and delivered the packages from Dynamex customers as employees rather than independent contractors. In 2004, Dynamex adopted a new business structure under which it required all of its drivers to enter into a contractual agreement that specified the driver’s status as an independent contractor.  Like many other employers currently using independent contractors,   Dynamex’s drivers were generally free to choose the sequence in which they will make deliveries and the routes they will take, but were only required to complete all assigned deliveries on the day of assignment.

Among the five causes of action alleged, the class plaintiff sued Dynamex for its failure to pay overtime compensation, to properly provide itemized wage statements, and to compensate the drivers for business expenses as the result of its classification of its drivers as independent contractors. It should be noted that the plaintiff in this case brought a class action on behalf of all similarly situated employees after working only three months as an independent contractor for Dynamex.

  1. Legal Background

In an effort to explain its (r)evolution to the new legal standard, the California Supreme Court’s eight-one (81) page opinion details the history of legal precedents that have long guided employers starting with the previously-seminal case of S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (where the traditional multifactor ‘control’ test had been originally endorsed).  For example, in discussing Borello, the California Supreme Court emphasized that “In no practical sense are the ‘sharefarmers’ entrepreneurs, operating independent businesses for their own accounts; they and their families are obvious members of the broad class to which workers’ compensation protection is intended to apply.”

In an attempt to limit its damages, Dynamex argued that, regardless of whether the misclassified independent contractor should be considered an employee for purpose of wages, any violations of the wage orders should be treated differently. Although the Court agreed that the ‘suffer or permit to work’ language contained in wage orders implied that it should only cover employees, the Court reiterated that the “suffer or permit” language was so broad as to encompass the requirements of the ABC test. In other words, violations of the wage orders equally apply to any worker unless the hiring entity can prove that each of the three factors below has been met.

  1. The Supreme Court’s New ‘ABC’ Test

Under the so-called “ABC” test announced in the Dynamex case, a worker is only properly classified as an independent contractor only if the hiring entity establishes each of the following:

(A) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;

(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 for the hiring entity.

In adopting this test, the Supreme Court adopted this new standard with essentially the presumption that a worker hired by an entity is an employee and that the burden is on the hirer to establish that the worker is an independent contractor.

Putting aside from the first and familiar ‘control’ factor, the real burden now for the employer is to show that, as required by the second factor, the work performed by the independent contractor is outside the course of the hiring entity’s business.  As an example, the California Supreme Court explained that while a plumber could be hired to do work on a regular basis as independent contractor for a bakery, a worker making cakes, even at home, cannot be an independent contractor because baking is at the core of the employer’s business of making cakes.

In explaining the third factor, the Supreme Court equated that factor as to an analysis of whether that independent contractor in reality was its own business. Borrowing from an example from a different case in Vermont involving siding installers, the California Supreme Court reasoned that although those siding workers provided their own tools, no evidence was presented that “the installers had business cards, business licenses, business phones, or business locations” or had “received income from any party other than” the hiring entity.

  1. Court Announces That It Has the Ongoing Mandate To Ensure That The Statutory Purpose Of Any Wage Hour Law Is Being Met At Any Given Moment

Another important aspect of the Dynamex case, a point that is largely missing in the popular news reports of this case, is the Supreme Court’s explicit message that it would review any employment law case from a perspective as to whether the underlying statutory purpose is currently being met (as opposed to whether the employer’s conduct is in compliance with the current legal standard).  Should the Supreme Court determine that any previously-enacted legal standard is not doing enough to achieve its original legislative purpose; the Court is free to judicially update any previously-announced standard to achieve its view of the desired result.

As the Court explained in Dynamex, since “the California Legislature has not exhibited or registered any disagreement with either the statutory purpose standard adopted by the Borello decision” and has continued to “impose substantial civil penalties on those that willfully misclassify,” the Court may now impose a more burdensome standard.   As the California Supreme Court sees it, the new change is justified because, “the misclassification of workers as independent contractors rather than employees is a very serious problem, depriving federal and state governments of billions of dollars in tax revenue and millions of workers of the labor law protections to which they are entitled.”

  1. What Employers Should Do Now

The implications to the adoption of the ABC test are broad and wide-ranging.

All employers must take a serious evaluation as to whether it should continue to employ independent contractors, especially if those independent contractors are performing work that is within the usual course of the hiring entity’s business.  Employers need to decide whether it should continue to use independent contractors because the risks are so high. A legal determination that an employee was improperly classified results in potential violations for unpaid overtime, meal period, rest period, check stub violations, and many other labor code violations and penalties. Improper classification also implicates the non-payment of taxes to the EDD, IRS and other taxing agencies, which can lead to even more potential liability.

The case also threatens to undermine those jobs that constitute a part of ever-growing ‘gig’ economy. As stated by the plaintiff’s attorney in the San Jose Mercury News, this case will have a profound impact on jobs in the gig economy, such as Uber or Lyft.  Over time, it will be interesting to see if this case speeds up the adoption of fully-autonomous solutions and/or the use of artificial intelligence solutions (where little to no human labor is required).

Companies do have several options.  Aside from the option of converting these workers to employees, employers can change their business structures to distinguish themselves from the service-related aspects of the business (say from a taxi service to that of an auto manufacturer) and only selectively employ those independent contractors that truly are independent business operations that services different clients (i.e. John Smith LLC that employs drivers that deliver for Yelp, Lyft, Uber etc.).

There are practical difficulties presented by this case by virtue of the fact that this law was enacted by a court as opposed to the Legislature.  In the two other states where this law had been on the books in the US, there had been a period of adjustment and contemplation before it was placed onto the books.  When the ABC test was adopted in the state of Massachusetts, it was adopted by the legislature in 1990 and amended thereafter. In the New Jersey, that state’s Supreme Court recently affirmed its broader use after it had already been enacted by the legislature and had been enforced by that state’s department of labor as the applicable standard for some time.  No doubt, litigation over the scope of impact of the Dynamex case will be worsened because of the manner of its introduction. If there was ever a decision that should be reviewed by the California legislature, this is one (e.g. AB 1513 and the piece-rate safe harbor).

The bottom line, not only should employers consider whether any of their independent contractors should be converted to regular employees, but also assess how they can mitigate any potential liability from claims from their current or former independent contractors.

For an evaluation of your company’s independent contractor policy or any employment-related matter, please contact Sergio H. Parra (sergio@jrgattorneys.com)