Court Ruling Makes Independent Contracting More Difficult: What to Do
On April 30, 2018, the California Supreme Court issued a unanimous decision in the case Dynamex Operations West Inc. v. Superior Court that is likely to result in companies becoming even more reluctant to hire individuals as independent contractors. More than ever, it's critical that independent consultants take steps to maximum their chances to pass what is likely to become a stricter compliance process. Otherwise, it's very likely that companies will demand that a "W-2" employee do the work, even if you hired through a staffing agency. (See PICA's related 2-minute video, "Friends Don't Let Friends W-2"TM.)
Although this decision directly affects only California companies, corporations in other states are likely to pay attention to it. Because of the importance of California, other states often follow California's lead when interpreting their own laws. At the very least, it's likely to make companies in other states more cautious when hiring consultants as independent contractors.
In general, the legal test of whether an individual may properly be classified as an independent contractor varies depending on:
- the specific law at issue;
- whether it is a state or federal law;
- the entity making the determination; and
- the specific facts of the relationship.
This makes for a very uncertain and messy situation.
Significance of the Dynamex Ruling
At issue in the Dynamex case was which legal test should be used in determining whether an individual is an employee or an independent contractor under the California Wage Orders. (In California, minimum wage, overtime rules, meal and break periods, along with similar employment requirements, are set forth in various wage orders issued by the California Industrial Welfare Commission.)
Prior to the Dynamex case, California had used a multi-factor test established by the California Supreme Court in 1989 in S.G. Borello & Sons, Inc. v. Department of Industrial Relations. Under Borello, the primary consideration in determining whether an employment relationship existed was whether the company had the right to control the manner and means by which the worker performed the work. Where control was lacking, a worker was likely to be found to be an independent contractor. In addition, secondary factors, such as the degree of skill required to perform the work, the method of payment, and the nature of the company's business, could be considered in making the ultimate determination.
In the Dynamex ruling, the California Supreme Court was careful to stress that it was not expressing an opinion as to whether the Borello test was still applicable to claims brought under the California Labor Code or under any other California law (such as worker's compensation or unemployment insurance). It was only deciding the test to be applied under the California Wage Orders.
The problem with this distinction is two-fold. First, out of caution, California employers are likely to follow the most restrictive test, the new Dynamex test. Second, there is now uncertainty as to what the California Supreme Court will decide when faced with the question of which test should be used with respect to other California labor and employment laws. It will take years for this uncertainty to be resolved, and meanwhile, the uncertainty is likely to cause employers to seek refuge in the most restrictive test so that they know that they are safe. (The fines and penalties related to misclassification can be massive.) In all likelihood, corporate compliance departments will demand that individuals seeking to be classified as independent contractors meet the Dynamex test. This is why it's important to understand this recent ruling, and what you need to do to preserve your independent contractor status.
Under the Dynamex ruling, the hired worker is presumed to be an employee. The company has the burden of proving that the worker is an independent contractor by showing that a three-part test (the "ABC" test) is met.
The company must prove:
A. That the hired worker is free from the company's control and direction both under the terms of any contract and in how the work is actually done;
B. That the work being done by the hired worker is outside the usual course of the company business; and
C. That the hired worker is customarily engaged in an independently established trade, business, or occupation of the same nature as the work he or she performs for the company.
All three parts of the test must be met.
Understanding the ABC Test
The first requirement aligns with the previously established "right to control" test and is nothing new. The independent consultant must control how, when and where the work is done. The company must only contract for the end product, not how it is achieved.
The second requirement means that the hired worker must perform work that is outside of the company's usual course of business. In Dynamex, the company's business was providing delivery services to various customers. Because the workers at issue were driving the trucks, the workers were performing work that was found to be part of the "usual course" of the company's business. The Court's reasoning focused on the hiring company''s "primary" business purpose. This reasoning is useful for independent consultants because you are being employed to provide consulting services which presumably are not in the usual course of the client's business. For example, an organizational change consultant hired to provide consulting services to an apparel company would probably satisfy this part of the test even if the apparel company had an organizational effectiveness department because the company's primary business is apparel, not organizational change services.
It is the third requirement of the ABC Test that will be the most problematic for self-employed consultants. The California Supreme Court held that an independent contractor has ordinarily "been understood to refer to an individual who independently has made the decision to go into business for himself or herself." Evidence of such activity usually consists of "incorporation, licensure, advertisements, and offering to provide services to the general public or potential customers." In addition, the California Supreme Court referenced decisions from other courts that relied on such factors as: having business cards, sending invoices prior to payment, having a business telephone, having a business location, and being paid by more than one entity. Although the Court made it clear that none of these particular actions are required to prove that an individual is engaged in an independent business, it is clear that in the absence of these factors, or many of them, the courts will be reluctant to conclude that the individual is engaged in an independent business. (The Court did stress that merely because an individual is free to contract with other companies is not sufficient to show that the individual was engaged in an independent business.)
What To Do
It's because of this third part of the test that independent consultants need to pay attention to how they operate. Here are some of the things you can do to demonstrate that you are an independent business.
- Form a Limited Liability Company or incorporate. (While operating as a sole proprietorship is certainly legal, it may not be enough evidence under the ABC Test.)
- Get all appropriate business licenses.
- Have business cards.
- Have a dedicated business telephone line.
- Have your own web domain and business email account.
- Have a website where your services are offered to the general public.
- Have a written contract with your client (ensuring, among other things, that the consultant retains control over the manner and method of performing any work).
- Advertise. (For example, use Google AdWords and take screen shots as evidence.)
- Establish business social media pages.
- Submit invoices to the client for all amounts due.
- Have more than one client, preferably at the same time.
- Don't work exclusively for one company or for a long period of time.
- Have a business location and/or a business address, even if it's a P.O. box.
- Be a member of professional associations related to your business.
[Note: Nearly all of these factors are discussed in greater detail on the PICA website, especially in the Being a Business section.]
Bottom line, the Dynamex decision has made a bad situation worse. Companies will be hesitant to hire individuals as independent contractors and instead will force them into a "W-2" relationship. Take steps now to improve your chances of remaining independent. The longer you can show that you have been engaged in an independent business, the more likely that the ABC test will be satisfied. There's a saying, "If it looks like a duck, walks like a duck, and quacks like a duck, then it's a duck." The same is true now for self-employed professionals. You need to look like a business, be set up like a business, and act like a business in order to be paid like a business.
~ ~ ~CAVEAT: This "Legal Alert" provides information about a specific state court ruling. It is not intended to be, and should not be construed, as legal advice for any particular fact situation. Your situation depends on your particular facts. Reading a summary of a specific court decision is no substitute for consulting with, and obtaining the advice of a, qualified employment attorney in the State or States in which you work and reside. Only an attorney can provide you with legal advice for your particular situation.
ABOUT THE AUTHOR: Henry Telfeian is a labor relations and employment attorney as well as the general counsel for the Professional Independent Consultants of America, Inc. (PICA) A cum laude graduate of Harvard Law School, he is an active member of the State Bar of California and of various federal courts including the U.S. Supreme Court.