The new ABCs of worker classification in California

In a groundbreaking decision on April 30, the California Supreme Court adopted a new legal standard that makes it much more difficult for businesses to classify California workers as independent contractors.

The decision in Dynamex Operations West, Inc. v. Superior Court will directly affect the trucking and transportation industry because the workers involved in the case were delivery drivers, but it will also likely affect nearly every other industry that has relied to some degree on independent contractors – including hospitals and physicians.

New Test for an Old Problem
The dichotomy between employees and independent contractors is well known. For example, if a worker is an employee, the law imposes specified obligations on the business employing the worker, such as providing workers’ compensation insurance, withholding taxes from wages and complying with wage-and-hour laws. Independent contractors, on the other hand, are effectively treated as separate business entities, and companies utilizing their services are relieved of most of these kinds of obligations.

In Dynamex, the state’s highest court adopted a new standard for determining whether a company “employs” or is the “employer” of a worker for purposes of the California Wage Orders, which govern minimum wage, overtime, days of rest, meal and rest periods, and similar employment obligations. Casting aside the balancing test that had governed the independent contractor versus employee analysis in California for over 30 years, the court announced a stricter standard in which a worker is considered to be an employee under the Wage Orders unless the hiring entity establishes all of the following:

(A) 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) The worker performs work that is outside the usual course of the hiring entity’s business; and

(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Importantly, it is the hiring entity classifying an individual as an independent contractor that now bears the burden of establishing that such a classification is proper under the “ABC test,” by proving each of these three factors.

Over 20 states use the ABC test in some form, although for most of them, the test has been used for only a particular inquiry, most commonly determination of eligibility for unemployment benefits. In California, the court specifically stated that the ABC test was being applied broadly for inquiries under the California Wage Orders as to whether a worker is an employee or independent contractor. The Wage Orders regulate the terms and conditions of employees in all industries and occupations. Thus, the test has far reaching consequences, although some areas remain unsettled, such as whether the ABC test could be applied to Labor Code claims not arising under a Wage Order (e.g., section 2802 (reimbursement of expenses)) or to what extent state or local federal courts could find that an element of the test is preempted by federal law.

ABC Test: Easy as 1-2-3?
The California Supreme Court seems to think so. The test is indeed simple to apply. But it’s difficult to “win” if the goal is proper classification of a worker as independent contractor. Prong A of the new test is akin to the common law control standard that employers are likely familiar with. Due to the prevalence of decisions finding “control” under the old test, it is foreseeable that many businesses will suffer losses due to misclassification under factor A. The fact that some workers request, or require, a 1099 arrangement generally will not help much if the other facts do not support independent contractor status. And one issue impacting this factor is whether the worker treated as an independent contractor is also the same individual doing the work, a circumstance that the Dynamex court cautioned is an example of where control is implicit.

Prong B examines whether workers can reasonably be viewed as providing services in a role comparable to that of an employee, rather than in a role comparable to that of an independent contractor. The court used the example of a retailer that hires a plumber or electrician to perform maintenance at its establishment; such a worker would not be employed in the usual course of the retailer’s business, indicating independent contractor status. Conversely, a clothing manufacturer that hires a work-at-home seamstress, or a bakery hiring a cake decorator, typically would not meet the standard. This prong expands those within the definition of employee to include almost any worker who is engaged in the same business as the hiring entity. Many employers will face serious challenges with this factor, and succeeding on this factor will not guarantee success on the other factors.

Finally, Prong C seeks to identify those workers who have taken steps to create their own independent business. The good news: the court stated that a business does not necessarily have to prove that the workers in question took steps such as incorporation, licensure, advertising, and the like. The bad news: the court also stated that the simple fact that a company does not prohibit or prevent a worker from engaging in such an independent business is, by itself, insufficient to establish that a worker has independently made the decision to go into business for himself or herself.

Re-evaluating Hospitals’ Use of Physicians as Independent Contractors
Just as many businesses have service workers who request to be paid as 1099 independent contractors, hospitals commonly engage physicians as independent contractors. Among the reasons that such physicians request or accept independent contractor status are avoiding income taxes, enjoying other tax relief benefits, having schedule flexibility, and wanting “to be their own boss.” But these preferences may seemingly be irrelevant if the ABC test is not met. In Dynamex, the court maintained that the public interest in social welfare does not always jive with the personal interests of workers and that, in the end, the intent of public policy in protecting workers is a central consideration in determining employee versus independent contractor status. So, a worker’s request to be an independent contractor, standing alone, will not tip the scales in an employer’s favor.

The most challenging obstacle for a hospital’s ability to use a physician as an independent contractor will likely be Prong B – Does the doctor perform work that is outside the usual course of the hospital’s business? Stated broadly, hospitals provide medical services. If the physician provides medical services on behalf of the hospital, it appears that Prong B is not met. But what if a doctor provides a kind of medical service that the hospital does not commonly provide? It’s not clear whether that fact makes a difference.

An easier analysis applies to a doctor who provides non-medical services to a hospital, perhaps some kind of administrative or peer review services. The stronger argument there is that Prong B is satisfied.

What options does a hospital have? It can make the physician a part-time or full-time W-2 employee. That decision, of course, brings numerous burdens and responsibilities: complying with timekeeping requirements; deducting state and federal payroll taxes; providing worker’s compensation insurance; protecting against unlawful discrimination, harassment, and retaliation; paying minimum wage and, when applicable, overtime wages; ensuring opportunities, when applicable, for meal and rest breaks; giving notice of various workplace rights; and providing paid sick leave benefits.

Another option is to proceed with classifying the physician as an independent contractor. Obviously, the ABC test creates a greater risk that the classification decision was wrong if it’s ever challenged. But isn’t that an issue to consider? How likely is it that a certain physician will contact a state agency, or file a lawsuit, based on the contention that the hospital misclassified them? A hospital may consider that likelihood to be extremely small, if not remote. In light of the difficult-to-win ABC test, however, rolling the dice may be too risky. That risk is especially sharp if the hospital uses a large number of similarly situated physicians as independent contractors. For many California employers, a damaging wage-and-hour class action is only one misclassified worker away.

Does Dynamex Apply Retroactively?
There is yet another reason for employers’ concern: the issue of whether the Dynamex decision applies retroactively. This issue could mean the difference between catastrophic liability and merely a correction going forward, as needed. Employers maintain that the decision -- with its new mandatory test replacing older tests that balanced multiple elements -- should not apply to employers retroactively because doing so would violate due process. On the other hand, employee advocates contend that the decision merely clarified existing law and therefore should apply retroactively. This issue is before the California Supreme Court, which hopefully will soon provide guidance.

Act Now
Regardless of the outcome on the retroactivity question, employers would be wise to carefully evaluate their independent contractor relationships with legal counsel to avoid liability going forward. The Dynamex decision imposes an affirmative, substantial burden on companies to prove that independent contractors are being properly classified. If that burden cannot be met, substantial exposure might result. As a result of this decision, all hospitals and other medical-services businesses utilizing independent contractors in California should conduct a thorough evaluation of such workers to determine whether they are properly classified. Employers will need to discuss these factors as they relate to their business, and there is good reason to be very careful with regard to engaging any independent contractors going forward, especially workers who are working as single individuals rather than companies that have retained a force of workers in an independent business.

David B. Monks is a partner in the San Diego, Calif. office of employment law firm Fisher Phillips. He has substantial experience defending and counseling employers on a wide variety of lawsuits and administrative claims. He can be reached at dmonks@fisherphillips.com.

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