DO YOU KNOW YOUR ABCS? CALIFORNIA’S NEW INDEPENDENT CONTRACTOR TEST

Distinguishing between an independent contractor and an employee has been an important analysis conducted by courts and state agencies throughout California for decades, and after a recent Supreme Court landmark decision, classifying workers as independent contractors as opposed to employees just got riskier (Dynamex Operations West, Inc. v. Superior Court of Los Angeles, No. S222732 (April 30, 2018)).

In Dynamex Operations West, Inc. v. Superior Court of Los Angeles (Dynamex), the California Supreme Court abandoned the long-standing “right to control” test based on the Court’s 1989 decision in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello). It instead adopted a new three-factor test known as the “ABC” test for distinguishing between an independent contractor and an employee under California’s Wage Orders, which govern items like overtime, meal and rest breaks, and other basic working conditions of California employees. While new to California, the ABC test has long been used in other parts of the country.

Delivery Drivers’ Class Action Lawsuit

Dynamex involved a group of delivery drivers that filed a class action lawsuit against nationwide package and delivery company Dynamex Operations West, Inc.; the drivers alleged that they were misclassified as independent contractors and unlawfully denied overtime, among other wage and hour violations. In addition to asserting that Dynamex violated the California Industrial Welfare Commission (IWC) Wage Order that covers the transportation industry, the drivers also alleged that they weren’t reimbursed for business expenses under Labor Code section 2802, among other employment claims.

Dynamex initially classified its drivers and couriers as employees. In 2004, however, the company changed its policies and contractual agreements, and reclassified its drivers as independent contractors — but no apparent changes were made to the drivers’ actual duties.

Charles Lee — the sole named plaintiff in the original complaint — entered into a written contract agreement with Dynamex in January 2005, which was shortly after the new policy and classification was adopted. He filed the underlying misclassification lawsuit on his own behalf and on behalf of other similarly situated Dynamex drivers approximately three months after leaving Dynamex; Lee had only worked for Dynamex for a total of 15 days.

After several years of litigation, the California Supreme Court was faced with which test should apply when analyzing independent contractor classification. Specifically, the Court looked at whether it should continue to apply the long-standing Borello test or apply the wage order’s “suffer or permit to work” standard, which the Supreme Court interpreted as:

• Placing the burden on the hiring entity to establish that the worker is an independent contractor not intended to be protected by the wage orders; and
• Requiring the hiring entity to establish the three factors of the ABC test that has been used in other states.

In its unanimous decision, the high Court ultimately embraced the more rigid ABC test.

Borello Test vs. ABC Test

For decades, California courts and state agencies have applied a multi-factor, common-law test — also referred to as the “right to control” test — established by Borello. Until now, it has been the leading test applied when distinguishing between an independent contractor and an employee. Borello’s multi-factor test primarily focuses on an employer’s right to control its workers, but it also considers several secondary factors, including the right to discharge at will, whether the worker was engaged in a different occupation or business, and the type of occupation, among others. The application of the Borello test is a flexible one that balances the various factors based upon a particular case’s facts and circumstances.

But in Dynamex, the California Supreme Court disregarded the Borello test and instead adopted the ABC test — a much more rigid standard that has long been applied in such states as Massachusetts, Vermont and New Jersey.

The ABC test presumes a worker is an employee and places the burden on the hiring entity to demonstrate otherwise. To establish that a worker is an independent contractor, a hiring entity must prove all of following three elements:

• Part A:The worker is free from the hiring entity’s control and direction in connection with his/her performance of the work, both under the contract for performance of the work and in actually performing the work;
• Part B:The worker performs work that is outside the usual course of the hiring entity’s business; and
• Part C:The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

If the hiring entity fails to show that the worker satisfies each of the three elements, the worker is treated as an employee, not as an independent contractor.

More specifically, Part A is similar to the primary factor applied in Borello’s common-law test, which asks whether the worker is free from the “type and degree of control a business typically exercises over employees.” It is noteworthy that this element looks at both the independent contractor agreement and the work that is actually performed.

Part B will likely be the most difficult for a hiring entity to establish, because it requires showing that the worker is truly providing a unique and isolated service for a business. As an example of this, the Supreme Court described a plumber hired by a retail store to repair a bathroom leak. Because the plumber is performing work that is not part of the store’s usual business of selling clothing, it would not be reasonably viewed as working within the scope of the hiring entity’s business. On the other hand, a seamstress working from home for a clothing manufacturing company to make dresses from company-supplied cloth patterns likely would not pass muster under Part B and would be viewed as part of the hiring entity’s usual business operations.

Part C looks at whether the worker has independently made the decision to go into business for himself/herself. This can be evidenced by such things as incorporation, licensure, advertisements or routine offerings to provide services to the public or a number of potential customers. For purposes of proving Part C, the Court made clear that a hiring entity not prohibiting or preventing a worker from engaging in such business is not sufficient; there must be some affirmative showing that the worker has chosen to go into business for himself/herself as opposed to simply being labeled as such.

The Court pointed out that because all three elements must be met, courts will be free to address them in any particular order. For example, many courts may choose to start with Part B or Part C, which may be easier and clearer for a court to determine than Part A. In applying the ABC test to Dynamex, the Court found that the class of delivery drivers could be certified under Part B because the question of whether the drivers were performing work outside Dynamex’s usual course of business could clearly be resolved on a class-wide basis. The Court also held that the drivers could defeat Part C, and therefore did not need to address Part A of the test.

The Court’s Reasoning

In its 82-page decision, the Court detailed at length the policy reasons behind the various tests that historically have been applied in determining independent contractor status. Ultimately, the Court reasoned that the ABC test provides more clarity for employers; it is in line with California wage orders’ history and fundamental purpose of providing workers fair wages and basic protections; and it will provide less opportunity for manipulation. The Court also recognized that the consequences of misclassification are severe, as misclassification impacts not only workers, but also honest competitors and the public as a whole.

Although the test does provide increased clarity regarding the elements that a hiring entity must meet to establish that a worker is an independent contractor, there is still a degree of uncertainty surrounding practical application of the ABC test.

Ultimately, there is no doubt that the ABC test will be a more difficult standard to meet than the previously applied Borello test. But it remains to be seen how the lower courts and state agencies will interpret and apply the ABC test to various industries. Additionally, because Dynamex is limited to the context of wage orders (or California Labor Code protections that are addressed in wage orders), it is unclear if or how it will impact other employment contexts, such as workers’ compensation or Labor Code protections not addressed in wage orders. For example, the California Supreme Court specifically did not address the drivers’ claims for reimbursement for business expenses under Labor Code section 2802, which is not governed by a wage order.

Another unanswered question is whether the Dynamex decision will apply retroactively to claims predating the April 30, 2018, ruling. Amicus requests have been filed, asking the California Supreme Court to clarify that the test adopted in Dynamex be prospective only — which may result in the Court amending its ruling.

Employers should remember that if a worker is determined to be an employee but has been misclassified as an independent contractor, claims for wage and hour violations — including under the Private Attorneys General Act (PAGA) — can be made, resulting in costly litigation.

Best Practices

• Companies that use independent contractors should consult with legal counsel, and carefully review and analyze their independent contractor relationships to make sure they comply with the ABC test. If an independent contractor’s services are not clearly outside the scope of your business operations, you should carefully consider whether those workers should be reclassified as employees.
• Avoid any temptation to reclassify a worker from employee to independent contractor (which is what the defendant in Dynamex did). This practice is now even riskier in light of the newly adopted ABC test.
• When contracting with vendors, make sure your vendor is using employees or independent contractors that can meet all ABC test requirements.