Will California Employment Law Change How Contractors Are Classified?

Photo by Thought Catalog on Unsplash

If you work in the gig economy as a contractor or freelancer, own a business that employs contractors, or serve as an independent consultant, you may have heard rumblings about the Dynamex case ruling issued by the California Supreme Court, and might be wondering what it actually means for you.

In this article, Kevin and I wanted to try to demystify the legal developments that have occurred around contractor classification, and cut through what they may mean for the key stakeholders involved. Here, we join our perspectives — Kevin’s, as a Deputy Attorney at the New Business Practicum at Berkeley Law, which provides free legal advice and support to businesses in the Bay Area, and mine, as the founder of a consulting firm helping businesses and startups launch and scale their operations — to provide you with information that helps you better navigate an ambiguous environment. Our goal is to provide an overview of what’s happened to date from a legal perspective, what it may mean for you, and what you should be aware of in terms of managing risk going forward.

Below, we cover some of the questions you may have, as well as a few profiles of people who are trying to navigate the aftermath of the Dynamex case. Our advice is to stay informed and plan to manage risk, but never let fear prevent you from moving forward in making decisions for your business. We hope the following conversation helps you move forward on your path.

Yaya: Kevin, a lot of people reading this may not have a law background, but have heard that changes coming down the pipe might affect a broad range of people, from contractors in the gig economy to self-employed independent contractors and the businesses that employ them. Can you give us a layman’s overview of what’s happening in the legal landscape around the gig economy and the classification of employees and contractors?

Kevin: Sure thing. In short: when it comes to minimum wage and overtime laws, California’s test for determining whether a worker is an employee or independent contractor used to involve analyzing 12 different factors, none of which were absolutely required for an independent contractor relationship. However, Dynamex changed that, and many companies in the gig economy might have trouble satisfying the new test.

Yaya: What actually came out of the Dynamex case? What does the ruling mean and what, if any, changes does it dictate?

Kevin: Well, instead of the old multi-factor test that looked at 12 different aspects of the worker-employer dynamic, Dynamex says that in order to set up an independent contractor relationship, the hiring entity must satisfy a three-factor “ABC test.” There are variations of this test in other states, but the rule that the California Supreme Court adopted says that the hiring entity must establish:

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

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.

In terms of changes to expect out of this ruling, I’d say that the most immediate consequence would be that companies, which have the burden of proof in demonstrating the ABC criteria, will request more information about prospective service providers than they have in the past. Since the previous multi-factor test didn’t set out any hard requirements, companies that hire independent contractors probably haven’t been collecting documentation related to the ABC test.

Another thing to note is that Dynamex only focuses on one context: the definition of an employee for purposes of California wage orders. These orders cover issues like minimum wage, overtime, and rest periods, but not other benefits such as health insurance, unemployment, and workers’ compensation. As a result, it’s possible that an employer would provide minimum wage and overtime to workers, but not health insurance, since that’s not required under the applicable wage order. However, over the next few years, I’m sure we’ll see more caselaw developing on whether the ABC test would be adopted in other contexts.

Yaya: What states does this kind of case precedent currently affect? For people who don’t live in these states, do they need to worry about these cases?

Kevin: While Dynamex only acts as binding precedent in California, the case could be persuasive to other states looking to adopt or apply the ABC test. In fact, in writing the Dynamex opinion, the California Supreme Court cited cases from Connecticut, Maine, Massachusetts, New Jersey, and Vermont, each of which have already adopted some form of the ABC test for purposes of employment law.

For people outside of these states, Dynamex just adds California to the growing list of states that have adopted the ABC test. It’s certainly possible that companies that have a national presence will modify their hiring arrangements nation-wide in order to simplify the logistics of managing workers.

Yaya: How does the “ABC” rule work? Do all three clauses need to be met for someone to be classified as a contractor? For example, many consultants might have incorporated their own business (meeting the third requirement) however also be performing responsibilities core to the central business. How does the “ABC” rule apply to them?

Kevin: Yes, the hiring entity has the burden of satisfying all three factors of the ABC test. Furthermore, the Court specifically mentioned that it’s often easier to analyze the B and C prongs of the test, and that courts are free to consider the factors in any order. As a result, a court could rule in a case that part B was not satisfied, and just end the analysis there.

In the example you laid out, it sounds like the hiring entity would have a hard time arguing that they’ve satisfied part B of the ABC test. If the consultant is performing work that would reasonably be viewed as being within the usual course of business of the hiring entity, then the consultant is an employee for the purpose of wage orders in California — even if the consultant has formed their own separate legal entity. If their services are core to the central business, it sounds like an outside observer would reasonably believe that the contractor is working in the hiring entity’s business, and not in the contractor’s own independent business.

The classic example of an independent contractor is a plumber who visits a brick‑and‑mortar retail store to fix a leak in the restroom. While a leak-free restroom is a crucial component of the customer experience, a reasonable outside observer would not believe that the plumber works as an employee of the retail store. The plumber doesn’t come to the retail store every weekday from 9:00AM to 5:00PM. The plumber doesn’t wear the store uniform. The plumber doesn’t ask the manager about the steps for replacing the P-trap underneath the restroom sink. But the plumber does perform services for other clients who also have leaky pipes, the plumber has a professional license to perform their services, and the plumber has their own legal entity for which they advertise and market their plumbing services.

The further away you get from this example, the more likely the relationship would be viewed as that of an employee.

Yaya: Can you walk us through how this will affect each group? Let’s start with employers that have hired independent contractors and are weighing whether they will need to convert them to full or part-time employees.

Kevin: Employers that have hired independent contractors in California will want to document that they have satisfied the ABC test with respect to each contractor. For prong A, this might come in the form of a written services agreement with a statement of work that stipulates that the contractor retains control over the performance of the work. Additionally, the employer should actually follow the contract and refrain from controlling or directing the contractor in performing the work. For prong B, this could be a document that describes the specialized expertise required to perform the work, which would be unreasonable for the hiring entity to develop in-house, as the work is not needed on a regular or continuous basis. Furthermore, the employer should not hold itself out as a provider of those services in its advertisements. For prong C, this might entail collecting business cards or other marketing materials from the contractor that demonstrate that the contractor has sought out other clients. Showing that the contractor has a professional license to perform the work (e.g., plumbing, electrical, accounting, etc.) would also bolster this prong.

Yaya: How about people working as contractors and freelancers in the gig economy?

Kevin: As you can tell from the previous question, documenting each of the prongs of the ABC test is going to take a lot of work. With this recent significant development in case law, contractors and freelancers might want to take a moment to do some introspection regarding their status, and decide whether they want to either: (1) reinforce their status as independent contractors; or (2) negotiate to be reclassified as employees. This would, however, be more of a business decision rather than a legal one.

Yaya: In my mind, the key questions for contractors and freelancers are:

(1) What kind of status do I want? Do I want to remain outside of the organization as an independent contractor, or would I prefer to be an employee?

(2) Should I approach my employer to discuss what my options are?

(3) What is the best way for me to lay out the facts for consideration?

Kevin: I think those are certainly the right questions to keep in mind. After weighing those questions, it’d be a good idea to speak with an attorney to discuss the situation with their specific facts in mind.

Yaya: How about companies that want to provide a platform, that essentially matches independent contractors with projects and short-term work arrangements sourced from companies and individuals?

Kevin: In my view, the main focus would be to ensure that users of the platform maintain a clear separation in their minds between the platform business and the vendors setting up shop on the platform. In other words, be more like craigslist, Etsy, or Patreon, and less like some of the higher profile ride‑hailing apps. This way, there’s a stronger argument that the platform just provides a logistics backbone for independent merchants to run their own businesses, rather than a system where the platform business hires workers to perform services for the platform.

Yaya: How about consultants that are doing work as independent advisors/consultants, and who wish to stay independent rather than becoming employees?

Kevin: The major prong to worry about here would probably be part B, which requires the services performed to be outside of the hiring entity’s usual course of business. As such, consultants who would prefer to maintain their independent contractor status should perform and market some kind of specialized expertise that the hiring entity otherwise wouldn’t have in-house. This might require some contractors to pick up additional skillsets and may involve pivoting their value proposition to highlight those specialized services.

Yaya: Given how uncertain the environment is and the lawsuits that may emerge, how should these groups think about moving forward with how they conduct their business? What risks should they think about managing?

Kevin: Employers should reach out to legal counsel to analyze the facts of their specific hiring arrangements, and make adjustments, if necessary. Before Dynamex, the question of worker classification in California mostly involved examining the degree of control the employer has over the worker. Now, though, more of the analysis will turn on what services can be reasonably viewed as “outside” of the hiring business, and what facts indicate that the worker has an independently established business. As more lawsuits go through the court system, we’ll have a better idea of each of those prongs. Based on the cases that Dynamex cited, however, we do have some data points on how a court would rule in certain scenarios:

Yaya: Much of case law is obscure to the average person, at the same time the legal precedents being set are likely to have an impact on a growing number of people in California who classify themselves as contractors. What are some of the key precedents to be aware of?

Kevin: Good question. So far, there haven’t been any additional opinions that would act as binding precedent in California for purposes of applying the ABC test. I would expect that moving forward, parties would cite cases from other states that have had a longer history with the ABC test, starting with the cases mentioned in Dynamex (see above for summary tables).

Yaya: From a macro perspective, much of the case law you cited seems to be aimed at protecting the rights of workers in industries where employers might have disproportionate control over wages, the nature of the work, and working environment, so that people who should be classified as employees receive the appropriate wage protections. Is that a correct interpretation? At the same time, what does this mean for the group of people who may be in a professional services industry where they want to set up their own business entity and who desire to retain an independent status from the hiring entity?

Kevin: There’s certainly much more caselaw on the books that involve workers who provide manual labor than workers who provide professional services. After all, it’s pretty rare to find, for example, accountants, attorneys, and architects whose hourly billing rates wouldn’t satisfy a state’s minimum wage requirements, whose clients have the power to control or direct the performance of the work, or who don’t have an independently established business serving other clients in that capacity. However, it is possible that a court would classify this type of worker as an employee under the ABC test. In Gerber Dental Ctr. v. Unemp. Ins. Com’n, 531 A.2d 1262, (Me. 1987), the Maine Supreme Court held that dentists working within a dental office were misclassified as independent contractors, stating that the hiring entity didn’t satisfy prong B of the ABC test. It’s possible that California courts would come to a different conclusion, but the Maine case illustrates at least one line of reasoning that would lead to a provider of professional services to be deemed an employee.

In our work, we regularly speak with clients who are navigating the increasingly blurry and confusing line emerging as more people opt for non-traditional career paths, pursue starting their own business, and pick up work in the gig and self-employment economy.

We wanted to highlight a few profiles/stories in case you are in one of these boats and wondering, “Where does this leave me, and what should I be considering at this moment?”

Profile 1: Full-time worker in the gig economy

Lucas is a driver for a ride-hailing app. This is his primary source of income, and he drives full-time. If he had the choice, he would prefer to be classified as a full-time employee and receive the associated benefits, such as healthcare. What should Lucas be aware of in the legal landscape that could affect his future status?

There are a number of ways this could go for Lucas, and it’s unclear which way would be more likely, as it’ll depend highly on the business judgment of the ride-hailing app company. The company’s process will involve the following three questions:

(1) Does the current driver employment relationship satisfy the ABC test?

(2) If not, is there a way to re-design the relationship such that it does satisfy the ABC test?

(3) If there is no way to satisfy the ABC test, would converting the drivers into employees maximize the long-term profits of the company?

In the best case (for Lucas), the ride-hailing company would analyze the ABC test, find that it couldn’t re-design the driver relationship, and decide that converting its drivers into employees would maximize its profits in the long-term. If this happens, Lucas should get ready to accept a job offer as an employee at the ride-hailing app, at least for purposes of minimum wage and overtime. As mentioned above, it’s still possible that the company would use an alternative test for purposes of benefits like health insurance, workers’ compensation, and the like.

In the worst case (again, for Lucas), the company would shut down operations in California and other states that have adopted the ABC test, deciding against modifying the driver relationship and concluding that hiring drivers as employees would not maximize long-term profits.

Between those two extremes would be efforts to change certain aspects of the driver‑company relationship in order to satisfy the ABC test, like allowing users to choose drivers directly, rather than being assigned to drivers, and insisting that all drivers demonstrate that they are each independently in business to perform driving services. Alternatively, the company could bring on some drivers as employees, while signing others on as contractors, due to the need for specialized skills or equipment for some rides.

Profile 2: Freelancer with existing full-time job

Claudia is a designer employed as a full-time employee at an ad agency. On nights and weekends, she does freelance work for one of the freelancing apps that matches freelancers with projects. She also drives for a ride-sharing app, but has no desire to be an employee, as she has health benefits and wants to be able to control her own hours. What should she be aware of in her part-time work, especially if the classifications for contractors in the gig economy were to change?

If Claudia wants to remain as an independent contractor (and assuming whoever hires her wants to avoid the risk of a worker misclassification lawsuit), she’ll want to prepare documentation that will demonstrate to her employer that her position satisfies the ABC test. The trickiest part will likely be part B, where she would need some insight on the inner workings of the hiring entity to make the case that her work is outside of that entity’s usual course of business. Additionally, the requirements of part C might make it more difficult for Claudia to moonlight quietly, as she would need to generate materials that indicate that she is seeking other clients (e.g., business cards, flyers/advertisements, service contracts, etc.).

Profile 3: Independent consultant

Alex is an independent consultant that incorporated his own LLC to provide advisory and consulting services to clients. He works sometimes on a full-time basis and other times juggles several projects concurrently. His desire is to build his own brand and consulting business, and does not wish to be classified as a full-time employee at any single organization. How does he retain his status, so he can keep the autonomy and independence of being an independent consultant?

It sounds like Alex would satisfy parts A and C pretty easily, since he would actively push for autonomy and independence, and performs work for multiple clients at any given time. However, just like with Claudia, Alex should tailor his services such that he would satisfy part B of the ABC test. Because Alex offers advisory and consulting services, I would think that clients engage with him due to his specialized expertise. As long as this expertise is outside of the usual course of business of his clients, there shouldn’t be an issue.

Profile 4: Newly designated consultant working for former employer

Jennifer recently left her employer to start her own business. She has decided to continue to perform work for her employer on an hourly basis, as a contractor. She has incorporated her new business, however concurrently is still performing work for her old employer as a 1099-contractor. What precautions should Jennifer take in negotiating terms and setting boundaries for how she performs work for her former employer?

In this case, it sounds like Jennifer’s former employer would be taking a risk in hiring her as an independent contractor to perform work that she used to do as an employee. I suppose it’s possible for the former employer to make the case that it was no longer commercially viable to offer certain specialized services after Jennifer left, so the company pivoted to a reduced set of services as part of their usual course of business. The company would need to make clear in their advertising and marketing materials that their business is focused on the reduced set of services. In the rare case that a client requests the more specialized skill, though, it might be okay to bring Jennifer on as a subcontractor — so long as the frequency of Jennifer’s work falls short of “regular and continuous.” Additionally, the dynamic of the working relationship would need to change, as compared to when Jennifer was an employee. Jennifer would need to be free from the control and direction of the former employer, both under the contract and in practice. Furthermore, Jennifer would need to show that she is independently in business to perform those specialized services. If the new business she incorporated is focused on providing those specialized services, that might suffice. On the other hand, if the new business is unrelated to the specialized services, Jennifer would need documentation showing that she is also in the business of performing those specialized services by seeking or contracting with other clients.

Closing Takeaways:

Employers, independent contractors, and freelancers in California need to assess the impact of the newly adopted ABC test on their businesses. While this test is currently limited to determining whether a worker is an employee for purposes of minimum wage, overtime, rest periods, and other protections covered by California wage orders, it’s possible that it will be applied to other benefits in the coming months and years.

Kevin Xu is a Deputy Attorney at the New Business Practicum at Berkeley Law, which has been offering free legal advice and services to businesses and startups in the Bay Area since 2007. Kevin is a graduate of Berkeley Law School.The free resources the New Business Program provides can be found at https://www.ollielegal.com

Yaya Zhang is the Founder of Renegade Ventures, a boutique consulting firm helping independent-minded founders and leaders develop compelling brand narratives for their products and services, launch and scale new initiatives, and grow their business through effective sales and partnership strategies. She received her MBA from the University of California, Berkeley.

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