Within this week I have had three conversations with associates about the risk and the conundrum of retaining 1099 talent versus hiring a W2 employee.

Here is how four different agencies determine 1099 / W2 relationships. 

At the same time, I received a highly informative update from our friends at the “Law Offices of Omar Figueroa” educating their CA clients of the new recently passed CA Labor Law. (Read Below)

Pay attention to the differences. The state and federal agencies are!

A5

EMPLOYEE OR INDEPENDENT CONTRACTOR? BE CAREFUL HOW YOU CLASSIFY WORKERS

By Andrew Kingsdale, Esq. and Lauren Mendelsohn, Esq. 

Overview

When hiring a new worker, whether permanent or temporary, should that person be treated as an “independent contractor” or an “employee”? Over the past decade or so, a number of industries, including the cannabis and technology industries, have moved away from hiring employees and towards bringing on more independent contractors as a way to increase operational agility and cut costs, since independent contractors do not have to be given the same benefits as employees, such as a minimum wage, worker’s compensation insurance, unemployment insurance, paid sick leave, and paid family leave. This has resulted in many workers losing out on benefits that they otherwise would have been entitled to, which has been criticized as unfair.

A new California bill, Assembly Bill 5, which has passed through both chambers of the state legislature and now awaits Governor Newsom’s signature, presumes that most workers are “employees” based on a 3-prong test (the “ABC Test”) and places the burden on the company to prove otherwise. Penalties under both federal and state law for misclassifying an employee as an independent contractor can be severe, including civil penalties of up to $25,000 per willful violation and damages for unpaid wages, so cannabis-related companies should think carefully before treating new workers as “independent contractors.” (See Labor Code § 226.8.)

 

UPDATE (6/18/19): Governor Newsom has officially signed AB 5 into law.

Background: Borello and the Multi-Factor Test

From 1989 until 2018, the seminal case in California for determining whether a worker is an employee or an independent contractor was S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (“Borello”). That case came up with a long list of factors that should be weighed against each other to determine someone’s employment status, with the most important factor being whether the employer controls the details of how the work will be performed (Borello, 48 Cal.3d at 350). Other factors include: whether the worker could be discharged at will without cause; whether the worker is engaged in a distinct occupation or business; the method of payment (by the hour or by the job); who provides the supplies, the necessary tools, and place to work; whether the work being done is part of the regular business of the person who hired the worker; the length of time for the services to be performed; the amount of supervision provided to the worker; and whether the parties believe there is an employer/employee relationship (Borello, 48 Cal.3d at 350-351). Due to the number of factors involved, this test was often difficult to apply.

Dynamex Ruling and the “ABC Test”

In Dynamex Operations W. v. Superior Court (2018) 4 Cal. 5th 903 (“Dynamex”), delivery drivers for a nationwide package and document delivery company, Dynamex, sued the company for misclassifying them as independent contractors rather than employees. Under their agreements with the company, the drivers were required to use their own vehicles, and to pay for all of their own transportation expenses, as well as all taxes and workers’ compensation insurance.  Dynamex assigned specific package deliveries to drivers, but the drivers could refuse assignments. Dynamex generally expected drivers to wear Dynamex shirts and badges, and attached Dymnamex decals to their vehicles, but the drivers were also free to work for other delivery companies. The drivers were permitted to hire other persons to make deliveries assigned by Dynamex, but Dynamex could terminate its agreement with any driver without cause, on three days’ notice. (See Dynamex, 4 Cal. 5th at 917-18.)

The California Supreme Court held that these drivers should have been classified as “employees” and not “independent contractors” for purposes of Industrial Welfare Commission (IWC) Wage Order No. 9, which imposes certain employer obligations such as overtime, minimum wages, meal and rest breaks, and certain record-keeping requirements on the transportation industry. The Court announced a new test—the “ABC Test”—for making this determination.

This standard “presumes a worker hired by an entity is an employee” (Dynamex, footnote 20, emphasis added), and “the burden [is placed] on the hiring entity to establish that the worker is an independent contractor who was not intended to be included within the wage order’s coverage” based on the ABC Test factors” (Dynamex at 957).

Taking it a Step Further: Assembly Bill 5

The California legislature took the holding in Dynamex a step further in Assembly Bill 5 (“AB 5”) by codifying the ABC Test and expanding it beyond just IWC Wage Orders so that it also applies to the Labor Code and the Unemployment Insurance Code. AB 5 adds the following language to the state’s Labor Code:

Labor Code § 2750.3

For purposes of the provisions of this code and the Unemployment Insurance Code, and for the wage orders of the Industrial Welfare Commission, a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all of the following conditions are satisfied:

(A) The person 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.

(B) The person performs work that is outside the usual course of the hiring entity’s business.

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

Except as expressly provided in AB 5, it will apply to work performed on or after January 1, 2020 for most purposes, and beginning on July 1, 2020 for purposes of workers’ compensation. In addition, certain provisions apply retroactively. Thus, employers could be liable for past as well as future violations. (Proposed Labor Code § 2750.3(i); Proposed Labor Code § 3351(i).)

Exceptions to AB 5

While AB 5 makes the “ABC Test” the default method in California for determining whether a worker is an employee or an independent contractor, there are certain occupations and types of relationships that are exempted from this test, and will be governed either by the previous Borello test or by some other standard.

The first exception is for specific occupations. These include certain licensed medical professionals such as physicians, dentists, and veterinarians; licensed insurance providers; licensed attorneys, engineers, architects, private investigators, and accountants; certain securities broker-dealers or investment advisors; certain direct salespersons; and commercial fishermen working on American vessels. (Proposed Labor Code § 2750.3(b).)

The second exception is for certain contracts for professional services between a hiring entity and an individual. This category includes (but is not limited to) marketing services; graphic design; services provided by a freelance writer or photographer; and services provided by a licensed cosmetologist or esthetician; provided that the requirements set forth in AB5 are met. (Proposed Labor Code § 2750.3(c).)

There are also distinct exceptions for real estate licensees and repossession agencies, relationships between contractors and individuals performing work pursuant to a construction subcontract; and “motor club services.” (Proposed Labor Code § 2750.3(d), (f), (h).) The remaining exceptions include certain business-to-business contracting relationships where specific criteria are satisfied; and relationships between a referral agency and a service provider if the delineated conditions are met. (Proposed Labor Code § 2750.3(e), (g).)

Analysis of “ABC Test” in Practice

Upon closer examination of these ABC Test factors, one can see why it is so difficult to meet the “independent contractor” definition. Take, for example, this hypothetical scenario:

An edibles manufacturer licensed by the Manufactured Cannabis Safety Branch within the California Department of Public Health wants to temporarily hire an experienced cook during a particularly busy time of the year, but the manufacturer does not want to go through the process, expense, and commitment of bringing on a new “employee.” There is no time to train the cook, so she must have relevant and recent experience cooking the same type of edibles that the manufacturer sells. But she also is given flexible hours, allowed to use her own equipment, and she remains free to work for other/competing edibles manufacturers as well.

Can this temporary cook be treated as an independent contractor? First, you might examine whether the cook can remain “free from the control and direction” of the hiring manufacturer (part A of the ABC Test).  Wouldn’t the licensed manufacturer need to direct the cook to follow certain recipes? Wouldn’t the licensed manufacturer want and need to control the quality of this cook’s work? Similarly, how can the manufacturer find a cook who performs work “outside the usual course of the [manufacturer’s] business” (part B of the ABC Test), which business is cooking?  Isn’t the licensed manufacturer hiring the cook precisely because she regularly works in the same line of business? In short: this temporary hire probably should be classified as an “employee,” and not as an “independent contractor.”

One of the factors of the old Borello test that was not included in the new ABC Test is whether the parties believe there is an employer/employee relationship. Many independent contractor agreements contain provisions to the extent of “Nothing herein creates an employer/employee relationship between Company and Contractor.” A provision like this is essentially useless now if the type of work is one that is subject to the ABC Test–regardless of what the parties agree to in writing, a court would still find the worker to be an employee if any of the factors set forth in Dynamex and reaffirmed in AB 5 are not met.

Beyond the standard fines, California cannabis companies also face potential licensing risks from misclassifying employees as independent contractors.  For example, every applicant for a state-issued commercial cannabis license that has “20 of more employees” must entered into a labor peace agreement. (Bus. and Prof. Code § 26051.5(a)(5)(A).) Additionally, employers with two or more “employees” must ensure at least one supervisor and one employee have successfully completed a Cal/OSHA 30-hour general industry outreach training course. (Bus. and Prof. Code § 26051.5(a)(11).)  As part of their annual applications, licensees must certify compliance with these requirements on their applications, so they should be careful not to miscount “employees.” The Bureau of Cannabis Control’s regulations also require that a non-storefront retail delivery driver be directly employed by the retail licensee, and violation of this rule could result in a suspension, fines, and potentially even license revocation (16 Cal. Code of Regs. §5415(a); BCC Disciplinary Guidelines).

Conclusion

It is expected that Governor Newsom will sign AB 5 into law (he has until October 13, 2019 to sign or veto the bill). In the coming years the new “ABC Test” spelled out in AB5 will be further refined and explained, both in the courts and through subsequent legislation. For now, the easiest way for California employers to ensure compliance with the law is to classify and treat new hires as “employees” unless they can positively demonstrate that all three prongs of the ABC test are satisfied, which is a high bar to meet, or unless they fall into one of the exceptions, which are limited. While other alternatives may exist, there is something to be said for being able to exert control over the people working at your facility, which can’t be done with independent contractors. If you are considering how to staff your business, we suggest contacting legal counsel to make sure that you classify your workers properly to avoid penalties.

 

This information is provided as an educational service and is not intended as legal advice. For questions regarding employees and independent contractors, please contact the Law Offices of Omar Figueroa at (707) 829-0215 or info@omarfigueroa.com to schedule a confidential legal consultation.