Rolling the Dice with Independent Contractors

Authored by Steve Holden. Published in the Sacramento Business Journal September 2018.

To reduce expenses and obtain particular skills sets, employers often look to use independent contractors instead of employees.  While the strategy is logical, misclassification could create a very expensive nightmare and, in many instances the continued use of contractors, is simply a dicey gamble.

The combination of a series of newer statutes, a dramatic Supreme Court opinion and increased enforcement have changed the landscape. Employers that are careless or too aggressive with the use of independent contractors may end up paying significantly more than if they had used employees.  Labor Code section 226.8 creates hefty penalties for “willfully” misclassification of employees as contractors and those who advise employers to classify employees as contractors.  The penalties can be as high as $15,000 for a single violation and up to $25,000 for “pattern or practice” violations.  In addition, employers who misclassify are often liable for (1) unpaid income taxes and the associated penalties; (2) unpaid employment taxes and the associated penalties; (3) unpaid overtime wages and associated penalties; (4) unpaid employee benefits and associated penalties; (5) the plaintiff’s attorneys’ fees; and (6) the multiplying effect of class action claims. In short, the cost of misclassification can be extremely high.

Previously, proper classification of workers was not always easy. Confusion arose because the law requires employers to weigh various factors, but without clear guidance on the amount of weight to assign to each factor. Moreover, the courts and various government agencies involved do not use the same set of factors. That confusion remains with respect to certain laws that touch the employment relationship such as workers’ compensation, unemployment and equal employment opportunity. It does not, however, when the question relates to the wage and hour rules found in the California Wage Orders. Earlier this year, the California Supreme Court created a dramatically different, and arguably very simple, test for independent contractor status under the Wage Orders; the ABC test.

Under the ABC test, “a worker is properly considered an independent contractor to whom a wage order does not apply only if the hiring entity establishes: (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; (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 for the hiring entity.” It is the highlighted “B” factor that makes the new test dramatically different. Under the other tests for contractor status, a contractor could perform work that was within the hiring entity’s usual course of business. The new test appears on its face to exclude all instances where the contractor’s work is an integral part of the employer’s operations.

Too often employers believe that a contractor classification is legal when the worker desires the classification and agrees with it.  Not the case.  The parties’ intentions and desire are irrelevant.  The nature of the work performed and how it is performed dictates whether the contractor classification is proper and passes the required tests.

Employers can dramatically reduce the risk of misclassification liability by following a few fundamental guidelines.

Self-Audit. Conduct a comprehensive self-audit of worker classifications. Do it before the government comes to audit or a worker files a claim.

Written Agreement.  In all cases where an independent contractor relationship is desired and deemed proper, ensure that a carefully drafted agreement is signed by both parties.

Work with Qualified Counsel.  While the audit could be accomplished by internal staff, it is highly recommended that the audit be conducted in coordination with qualified legal counsel.  Not only can qualified counsel provide guidance on application of the various legal tests, they can help the employer decide how aggressively to make classifications and can help to ensure that the employer does not create unfavorable evidence that could be used against the employer in a government audit or worker’s claim.  Counsel can also assist the employer with the necessary written agreements and avoid the pitfalls commonly encountered where “template” agreements are used.