Seismic Shift in Determining Contractor Status: Unanimous California Supreme Court Adopts New Test for Evaluating Independent Contractor Classification

Companies and individuals have long used independent contractor relationships to provide workers greater flexibility and to lower costs. The California Supreme Court’s decision Monday in Dynamex rewrites the test for evaluating those relationships. Unfortunately, now, companies in California need to rethink those relationships, and may need to reclassify such workers as employees subject to overtime, meal periods, rest breaks, and other protections under California’s Wage Orders. And companies in the “gig” or sharing economy, as well as others that rely heavily on the use of independent contractors, may need to rethink their overall business model in California.

What Did Dynamex Decide?

For nearly 30 years, California courts have used the multi-factor test in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal. 3d 341 (the “Borello test”) to determine whether an individual is an employee for purposes of California’s Wage Orders. The Borello test primarily focuses on control over the means and manner of performing contracted work, and additional secondary factors, such as who provides work tools and the individual’s opportunity for profit or loss, to determine contractor status. The Court in Dynamex was asked to revisit whether Borello was the only appropriate test for determining overtime, meal periods, rest breaks, and other issues covered by the Wage Orders.

The controversy in Dynamex arose from three possible alternative definitions of an “employee” in the Wage Orders: (1) “to engage,” thereby creating a common law employment relationship; (2) “to suffer or permit to work”; or (3) “to exercise control over wages, hours or working conditions.” Dynamex held that the Borello test did not adequately assess whether entity “suffers or permits” an individual to work. The Court then adopted a new test - the so-called ABC test - to analyze this issue. The ABC test has previously been adopted by the New Jersey Supreme Court in a 2014 decision, and codified in other states, including Massachusetts.

What Is the “ABC Test” and How Did the Court Apply It?

Under the “ABC Test”, an individual is an employee for purposes of the California Wage Orders unless the company proves each of the following elements:

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 (i.e. that the worker is free from the hirer’s control in performing work both practically, and in contract);

B. That the worker performs work that is outside the usual course of the hiring entity’s business (i.e. that what the worker does is different from what the hirer’s business does); 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 (i.e. that what the worker does for the hirer is what the worker typically does for work).

After articulating this new test, the Court went on to determine whether the independent contractor misclassification claims alleged could be certified for resolution as a class.

Dynamex is a delivery service offering same-day pickup and delivery to the public, including high-volume retailers. Before 2004, Dynamex classified its deliver drivers as employees. In 2004, Dynamex reclassified its delivery drivers as independent contractors. Drivers provided their own vehicles and covered all transportation expenses. They could set their own schedules and only needed to tell Dynamex what days they wished to work. Drivers also could generally determine their own routes, so long as they completed all assigned deliveries for a given day. Drivers also could “subcontract” work to other drivers, and could work for other delivery companies. Delivery drivers performed nearly identical work, both while they were classified as employees and once classified as independent contractors.

The Court concluded that the drivers’ misclassification claims were properly subject to class certification because common facts existed on at least one of the B or C elements.  Regarding the B element, the Court found that common proof existed as to whether the drivers’ work was within Dynamex’s usual course of business because Dynamex obtained customers for its deliveries, set the rates customers would be charged, notified drivers where to pick up and deliver packages, tracked packages, and required drivers to utilize its tracking and recording system. Regarding the C factor, the Court also held that common proof existed because the drivers in the class the trial court certified only worked for Dynamex and who did not have employees of their own.

What Does This Mean For California Employers and What Should They Do Now?

Dynamex requires companies in California with independent contractors to immediately re-evaluate independent contractor status for at least four reasons.

First, Dynamex introduces not only a new test, but that new test includes two factors—the B and C factors—that were never part of California’s independent contractor analysis.  Worse yet, the decision provides little guidance to courts regarding how to define a hirer’s business under factor B, or how much time an individual must spend on a certain type of work to be “customarily engaged” in it under factor C. If courts narrowly interpret the scope of an entity’s business, few positions may qualify for independent contractor status. And the “customarily engaged” requirement may eliminate workers who perform side jobs—like those in the gig economy—that are relatively minor compared to their main day-to-day work. Employers can expect California courts to look to decisions from other ABC jurisdictions, including Massachusetts and New Jersey, for guidance as suggested by the Court’s extensive citations to cases from those states.

Second, Dynamex places the burden on the business to prove each of the A, B, and C elements. That is, if the employer fails to prove any one element, an individual is an employee.

Third, Dynamex emphasizes that its new test is designed to narrow independent contractor status to only “traditional” independent contractors like plumbers and electricians. In fact, the decision uses “traditional” or “traditionally” over 10 times. Plaintiffs’ counsel will use that language and other passages from the decision to argue for a narrow application of an already onerous test for employers, perhaps tipping the balance in close cases to the individual.

Fourth, the Court intimated that the B and C factors are governed by common facts, and that the commonality among those factors predominates over any individualized inquiries on factor A, concerning control. That (thinly-reasoned) class certification analysis magnifies the risk of independent contractor claims.

Dynamex places employers in an unenviable spot. If they do not reclassify employees, they risk liability for various Wage Order violations—such as overtime and meal period violations—and for various other violations and penalties if the courts decide to extend the Dynamex test to claims under the California Labor Code (which is a question Dynamex left open, and is discussed further below). If, on the other hand, the employer reclassifies an individual in response to the Dynamex decision to ensure compliance with the Wage Orders, this reclassification will likely trigger various obligations under other employment laws—even if those other laws would use a different test for employee status. Those obligations include provisions of the California Labor Code and federal wage/hour laws, OSHA rules, anti-discrimination obligations, vicarious liability for torts, benefits obligations, and tax withholdings (among many others).

Employers can also expect plaintiffs’ counsel will seek to apply Dynamex retroactively, prompting a wave of independent contractor class actions and PAGA representative actions. Employers may wish to consider arbitration agreements and proactive individual settlement offers to potentially mitigate risk. The considerations behind those options are complex, and employers should seek experienced counsel if they wish to explore them.

What Does Dynamex Leave Unresolved?

Dynamex leaves a host of unanswered questions in its wake. We mention just three.

First, Dynamex did not decide whether the third potential definition for an employee under the Wage Orders—whether an entity exercises control over “wages, hours, or working conditions” of an individual—determines independent contractor status. To the extent that independent contractor relationships survive under the ABC test, employers can expect plaintiffs’ attorneys will argue that this third, broader test renders such individuals employees—even though the California Supreme Court was careful to say in Dynamex that it did not intend to render every independent contractor an employee.

Second, Dynamex does not address whether its new independent contractor test applies beyond the Wage Orders. For example, the Court did not address whether the test applies to the employment obligations established in the California Labor Code, such as requirements regarding reimbursement of business expenses, and the potential recovery of PAGA penalties by “employees.”

Third, Dynamex does not provide any examples of how the ABC test may apply to non-traditional workers in the gig or sharing economy. That leaves those businesses with significant uncertainty. However, gig economy companies can anticipate that plaintiffs’ attorneys will argue that their workers are performing work within the company’s usual course of business, because gig economy employers could not exist without their workers; that the often part-time workers are not “customarily engaged” in gig economy work; and that gig economy work is not an “independently established trade, occupation, or business.”