It’s as Simple as “ABC” – Determining Whether Workers are Independent Contractors or Employees

[Updated 6/8/2018]

It has long been a challenge for California businesses to determine if a worker can be considered as an independent contractor or must be treated as an employee.  The distinction has great significance both for the business and the worker.  On April 30, 2018, the California Supreme Court dramatically changed the legal landscape and adopted a new standard for determining whether a worker is an independent contractor – the ABC test.  Dynamex Operations West, Inc. (“Dynamex”v. Superior Court.  All California businesses that have existing independent contractor relationships or are contemplating entering into such relationships should now carefully consider the new ABC test enunciated by the California Supreme Court and take immediate appropriate action to avoid costly and time-consuming litigation.

California businesses have often struggled to properly classify workers, in large part, because governmental agencies and courts have used different standards and tests in making this determination.  While the predominate factor considered has been whether the hiring business has the right to control the means and methods of how the work is to be performed, a variety of secondary factors are also considered, none of which are singularly determinative.  Secondary factors to consider have included the worker’s opportunity for profit or loss depending upon his managerial skill, the worker’s investment in equipment or materials required for his work, whether the service requires a special skill, the degree of permanence of the working relationship, whether the service to be provided is an integral part of the hirer’s business, and whether the parties believe they are creating an employer-employee relationship, among other factors.

Dynamex Decision

Under the ABC test announced by the California Supreme Court, all workers are presumed to be employees of the business that hires them, and it is the business’s burden to overcome that presumption by establishing each part of the following ABC test:

  1. The business cannot control, or have the right to control, or otherwise direct, the worker’s means and methods of performing services, as provided either in the contract created for such work or in practice (for example, mandating work during the typical Monday-Friday workweek, beginning work at a particular time each day, requiring work at the business’s offices, or working under the supervision of a company manager); 
  2. The worker must perform services that are outside the hiring company’s usual course and scope of business (for example, a plumber that is retained to fix or replace plumbing in a real estate office); and 
  3. The worker must be engaged in his/her own independently established trade, occupation or business for the services to be provided to the hiring company.  Typically these involve workers with specialized skills (electricians, computer software designers, etc.), who have other customers and clients, advertise their services, and have formed a separate business entity.

In the Dynamex case, for example, the workers that sued were delivery drivers for Dynamex.  Dynamex is a nationwide package and document delivery company. Its workers claimed they were misclassified as independent contractors and should have been protected as employees under California law since they performed the essential job duties of Dynamex’s delivery business — they delivered packages and documents to Dynamex’s customers.  In fact, in Dynamex, these workers had been classified as employees until 2004, when Dynamex adopted a new policy and contractual arrangement under which the status of each driver was changed to independent contractor.  Probably not a thoughtfully considered decision.  Although Dynamex took steps to demonstrate that drivers were independent because they could make their own work schedules, were free to reject a requested delivery if they notified Dynamex promptly, and could decide for themselves the sequence of their deliveries and the routes they would take, there was evidence of control since the workers were required to obtain and pay for a Nextel cellular phone to receive assigned deliveries, to wear Dynamex badges and shirts, and to attach Dynamex decals to their own vehicles used to make deliveries.  And, significantly, Dynamex could terminate the drivers in their discretion, at-will.

Explaining Parts “A,” “B,” and “C”

Part “A” is very similar to the “right to control” standard that governmental agencies and courts have utilized in the past and had been one of the factors to consider in determining the legal status of a worker.  As a result of Dynamex, the absence of the right to control the worker is not merely a factor to consider, it is a requirement that the hiring company has the burden of establishing for independent contractor status.  In order to meet Part A, the hiring company must establish that the worker is free from its control in performing the means and methods of the work.  Yet, a business “need not control the precise manner or details of the work” in order to be considered to have the necessary control sufficient to lead to employee status.

Part “B” requires businesses to establish that the worker provides services that are different than those provided by their own employees.  The services provided must be incidental to, and not part of, the hiring entity’s core business.  If an accounting firm hires a painter to paint the inside of its offices, or a gardener to maintain the landscaping, the workers are performing services outside the accountant’s normal business and, thereby, establishes the Part B requirement for independent contractor status.  But what about a clothing manufacturer that hires a work-at-home seamstress or a baker hiring a cake decorator?  These workers, even though they work outside the business premises or have specialized skills, would likely not be considered as independent contractors.

Part “C” requires that the worker actually has taken steps to create his or her own independent business.  Such evidence might include having created a separate corporation or limited liability company, having their own employees who could perform the required services, providing services for other customers in addition to the hiring business, and advertising their services for new clients or customers, as well as maintaining business cards and a separate business address.  All of these actions help establish that they are truly “independent” contractors and are actually engaged in an independent trade, occupation or business.  However, simply stating in an agreement that the hiring business will not prevent the worker from engaging in an independent business or providing services to other customers is not sufficient alone to establish the worker is engaged in an independent business, occupation or trade.

What Does the ABC Test Mean for Your Business?

No bright-line standard has existed to guide businesses to avoid the trap of misclassifying workers.  Relevant governmental agencies and the courts have often made this determination on a case-by-case basis.  Not surprisingly, the misclassification of workers has been the subject of much litigation in California.  While the new ABC test is designed to clarify decades of confusion, in practice, many more workers will likely now be treated as employees.  And, the penalties for misclassifying workers as independent contractors instead of employees can be severe.  For example, California Labor Code § 226.8 provides that if the California Labor and Workforce Development Agency or a civil court finds willful misclassification, penalties can be assessed between $5,000-$15,000 for each violation.  If a pattern and practice is found, penalties between $10,000-$25,000 for each violation may be imposed.

Should businesses be concerned?  You bet. While changing suspect existing independent contractor relationships is critically important, businesses will still be exposed to civil claims and penalties for past misclassifications if those workers previously did not meet the ABC test.

If your business has existing independent contractor relationships with any workers, it is time to re-examine those relationships and decide whether they withstand the new ABC test.  You must assume that all workers are your employees unless you can establish all three parts of the ABC test.  If there is doubt, now is the time to change the nature of those relationships and carefully consider future arrangements with workers.

[This article was updated 6/8/2018 – The retroactivity of the Dynamex decision remains an open issue.]

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