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California employers face tougher rules on how to classify workers

Golden state employers have tightened their classification of employees and independent contractors after a California Supreme Court ruling last year, but that may be too late to escape liability dating back years for not offering various benefits, experts say.

The 2018 state high court ruling added a stringent test on whether employers can classify workers — often working in the gig economy — as contractors rather than employees, and avoid paying minimum wage and other benefits, but another recent court decision and guidance from the state’s Division of Labor Standards Enforcement may expand the scope of the ruling to include past years. In addition, pending legislation would add workers comp obligations, experts say.

At the federal level, however, a memo from the National Labor Relations Board on Tuesday favored gig economy employers. 

On May 2, the 9th U.S. Circuit Court of Appeals held in Vazquez v. Jan-Pro Franchising Intl. that the 2018 holding by the California Supreme Court in Dynamex Ops. W. Inc. v. Superior Court — which established a new test for determining whether workers were independent contractors or employees under state law — could be retroactively applied. And the May 3 letter from the California DLSE confirmed that the Dynamex decision extends to obligations imposed by the Industrial Welfare Commission wage order, making employers who misclassify workers responsible for California Labor Code obligations such as overtime, minimum wage, reporting time pay, record-keeping, business expense reimbursement and meal and rest periods.

“(The Jan-Pro) decision puts a spotlight on proper classification and the tremendous amount of risk that an organization carries with improper classification,” said Justine Phillips, a partner in the San Diego office of Sheppard, Mullin, Richter & Hampton LLP. She said employers who misclassify employees can face “a whole wheel of terribles” including liability for failure to pay minimum wage, offer sick leave, proper withholding, lack of disability and workers compensation and more. With the look-back period established by Jan-Pro, employers could potentially face claims from workers misclassified as far back as four years ago, she said.

Ms. Phillips said audit activity by the state’s Employment Development Department has also drawn more attention to misclassification. Claims filed with the state by independent contractors seeking disability for a workplace injury or unemployment will trigger an automatic and immediate audit, and she said she believes “the EED is considering Dynamex and its progeny to determine proper classification.”

For insurers, the uncertainty surrounding independent workers in the gig economy, where workers often work for several companies, may give some pause and make the job of assessing risk more difficult, said Liz Carabas, Portland, Oregon-based managing principal at insurance brokerage and specialty risk management firm Integro Group Holdings LP.

“With bigger gig economy companies, some of the insurance companies might take a wait-and-see approach … until they see how the laws pan out around it,” said Ms. Carabas. With the look-back period and the uncertain landscape, given the decisions are being appealed, workers comp insurers may be forced to “pick up some of that burden,” she said.

While an October 2018 California Workers Compensation Appeals Board decision held the more stringent Dynamex standard was not applicable for determining independent contractor status for the purposes of workers compensation, the case was remanded, and pending legislation including A.B. 5, which is currently in the California Assembly Committee on Appropriations, would extend the reach of Dynamex’s ABC independent contractor assessment for the purposes of unemployment and disability insurance and workers compensation.

Under Dynamex, an employer must establish each of the following to show a worker is an independent contractor: (A) The worker is free from the control and direction of the hiring entity in connection with performance and in fact; (B) the worker performs work that is outside the usual course of the hiring entity’s business; and (C) the worker is engaged in an independently established trade, occupation or business of the same nature as the work performed.

A spokesperson for the State Compensation Insurance Fund in San Francisco said that although the decision will not affect its handling of employment status for workers comp purposes in the state, the insurer will be keeping “a close eye on any proposed legislation and all relevant California judicial decisions that may extend Dynamex, Jan-Pro, or any variation of these, to workers compensation.”

Jan-Pro could appeal the decision, though Katherine Sandberg, associate attorney in the San Francisco office of Hunton Andrews Kurth LLP, said any appeals would likely yield the same result, and that the heavily democratic California Legislature is unlikely to take any measures to roll back the 9th Circuit’s decision.

“The implications are pretty far reaching,” said Ms. Sandberg, noting that industries including construction, real estate, professional services and fitness often have many workers classified as independent contractors.

“California is a trailblazer when it comes to employment laws,” Ms. Sandberg said. “When California starts applying a stricter standard, other states who also have a more employee-friendly stance … tend to adopt what California is doing. I would not be surprised if other states adopt a similar practice when it comes to independent contractor classification.”

At the federal level, however, employers in the gig economy may have received some additional protection from a National Labor Relations Board decision, which said in a memorandum released on Tuesday that drivers for ride-share app Uber Technologies Inc. are independent contractors, not employees.

The retroactive nature of Jan-Pro also creates a big exposure that employers have not been able to budget for, said Ms. Phillips.

“To go back, it seems punitive to those organizations that have changed their practices,” she said. “It’s sort of the perfect storm for companies.”

She suggests that employers “immediately assess” 1099 payments made to individual social security numbers, divide them into types of services provided and begin analyzing them under the ABC test to decide whether they are employees.

“Even where there’s a close call, where you really believe that these people are independent contractors … it may be less risky to classify them as employees,” she said.

As for insurers, Ms. Carabas said she’s talked to workers compensation insurers who have clients in the gig economy and are concerned about how to underwrite the risks.

“(Insurers) want to make sure they’re accurately capturing the exposure up front and to the extent they can,” said Ms. Carabas. It’s one thing to have a one-time audit, but it’s “another thing to go back a few years and potentially have to pick up claims retroactively … it’s not what they underwrote.”