Historically, California has applied a multi-factor test for evaluating whether a worker is an employee or independent contractor.  These factors – all of which must be considered with no single controlling factor – were developed almost 30 years ago by the California Supreme Court in S.G. Borello & Sons v. Department of Indus. Relations (Borello).  Under this test, consideration was given to the business’ right of control over the manner and means of completing the work, the method of payment, duration of the relationship, and the kind of work being performed, among other factors.  Although Borello examined these factors in the context of workers’ compensation laws, its multi-factor test has been applied to other types of legal claims.

In the new economy, businesses have considered arrangements outside of an employment relationship such as hiring freelancers or contract workers.  Based on an individualized analysis with no bright line rule, Borello’s multi-factor test has afforded businesses flexibility in structuring positions to support an independent contractor  relationship.  Yet, the consequences of misclassification are severe, exposing businesses to liability for minimum and overtime wages, denied rest and meal breaks, unreimbursed work-related expenses and tax liability.  While Uber and other gig economy companies have become embroiled in high-profile litigation over independent contractor issues, businesses across the spectrum are affected as well.

Dynamex Imposes Inflexible Standard

In Dynamex Operations West, Inc. v. Superior Court (Dynamex), the California Supreme Court has just upended Borello, by recognizing a different standard for determining whether workers should be classified as employees or independent contractor for purposes of California’s wage orders.  These wage orders impose obligations relating to minimum and overtime wages, reporting time pay, uniforms and meal and rest periods.

In Dynamex, delivery drivers filed a class action against defendant claiming that Dynamex had misclassified its delivery drivers as independent contractors, rather than employees, in violation of the applicable wage order.  Based on the definition of “employ” contained in the wage orders, the Court recognized that a worker is considered an employee of an entity that has “suffered or permitted” the worker to work in its business. The suffer or permit to work definition is broader and more inclusive than the traditional test adopted by Borello.

The Supreme Court interpreted the suffer and permit to work standard as placing the burden on the hiring entity to establish that the worker is an independent contractor who was not intended to be covered by the wage order.  The Court concluded that, in order to meet this burden, the hiring entity must establish each of these three factors:

(1) that the worker is free from the control and direction of the hiring entity in performing the work;
(2) that the worker performs work that is outside the usual course of the hiring entity’s business; and
(3) that the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

The first factor is similar to the control factor recognized as a primary consideration under Borello’s common law test.  While businesses may structure the work arrangement in a manner to demonstrate an absence of control, the same is the not true under the second factor.  Even if the worker has a specialized skill, works from home and does not perform work under the direction or control of the hiring entity (factors considered under Borello), the mere fact that the worker’s services are part of the entity’s usual course of business defeats independent contractor status.  The Court cited as an example a bakery that hires cake decorators to work on a regular basis on its custom-designed cakes, which it found to be part of the hiring entity’s usual business operation.  On the other extreme, the Court found that a plumber hired by a retail store to repair a bathroom leak would not be considered to perform services that are part of the store’s usual course of business.  There are numerous consulting arrangements that are now vulnerable under this factor.

Similarly, the third factor places another significant hurdle to establishing independent contractor status because it requires the worker to independently decide to engage in this business relationship, as opposed to being designated as an independent contractor by the hiring entity.  The Court found that an individual meeting this requirement “generally takes the usual steps to establish and promote his or her independent business – for example, through incorporation, licensure, advertisements, routine offerings to provide the services of the independent business to the public or to a number of potential business, and the like.”  Accordingly, this factor suggests that the worker would need to establish some sort of independent business entity or identity.

The Supreme Court has recognized that its ruling marks a major departure from past cases and defies guidance by the California Labor Commissioner following the Borello multi-factor test.  In adopting this broad standard for the employment relationship, the Court considered the economic consequences of classifying workers as independent contractors, with businesses avoiding payroll taxes and workers’ compensation obligations, and workers assuming financial burdens.

Takeaways for Business Owners

While this newly recognized standard provides greater clarity than the Borello multi-factor balancing test, it imposes a very high burden for employers seeking to classify workers as independent contractors.  It should be noted that the Borello test for now will continue to apply in contexts outside of California’s wage orders and should be evaluated as well.  Yet, Dynamex may effectively end up being the benchmark because it imposes a higher, more rigid standard applying to wage and hour violations that typically are the greatest source of exposure for businesses misclassifying workers as independent contractors.

Business owners and management should immediately, through the advice of employment counsel, review all current independent contractor arrangements to ensure proper classification under this new standard.  Before classifying a worker as a “consultant,” i.e., independent contractor, businesses will need to consider primarily whether the worker has an independent business and whether the nature of worker’s services is similar to the business’.  Decisions to treat a worker as a consultant motivated by financial reasons alone or because the individual works from home will now be suspect. Under appropriate circumstances, however, the California courts will likely continue to recognize independent contractor status for traditionally recognized independent contractors such as attorneys, accountants and construction trades who perform services independent of the hiring entity’s business.