In a lengthy, 82-page opinion concerning Dynamex Operations West, Inc. v. Superior Court of Los Angeles handed down on April 30, 2018, the California Supreme Court repudiated the Borello test for calculating whether individuals should be categorized as either employees or independent contractors as applied to payment guidelines established by the state’s Industrial Welfare Commission (IWC). The Dynamex decision significantly favors a more worker-centric precedent that has the potential to disrupt the current independent contractor marketplace. Specifically, the Court adopted a new standard that presumes that every worker is an employee as opposed to a contractor and shifted the burden to any corporation designating a worker as an independent contractor to proving that the categorization is justified per the recently-adopted “ABC test.”
Dynamex is a national same-day delivery company that, before 2004, considered its California-based drivers as employees. In late 2004, however, Dynamex reclassified these individuals as independent contractors in an attempt to cut operational costs. Subsequently, in April 2005, former employee Charles Lee filed suit on both his own and similarly situated Dynamex workers’ behalf, claiming that the corporation’s reclassification of its drivers constituted a violation of IWC wage order No. 9 that applies to the transportation market in addition to multiple provisions of the Labor Code. These violations, Lee alleged, meant Dynamex had taken part in unfair and illegal business operations under Business and Professions Code § 17200.
During the ensuing litigation, the trial court relied on precedent established in the 2010 Supreme Court case Martinez v. Combs—which designated three alternative interpretations of “employ” and “employer” as applied to the wage order—to certify a class action. The Martinez decision ruled that the act of employing had three differing definitions: (1) to control the hours, pay rate or working conditions; (2) to suffer or permit to work; or (3) to engage, subsequently manifesting a common law employment agreement. Importantly, the Martinez holding applied a joint employer examination—a fundamentally disparate issue from the issue as to whether an individual qualifies as a worker or independent contractor as a preliminary matter. Dynamex responded with an appeal arguing that the Martinez definitions (2) and (3) were inapplicable to this categorization, proposing instead that the multifactor analysis developed in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989) should be used to determine employment classification status. The Court of Appeal ruled against Dynamex’s position, ruling that Martinez applies to both joint employer and employee/contractor analyses and that the Borello test was not controlling in matters concerning IWC wage order requirements.
The California Supreme Court granted certiorari in order to settle the debate as to the distinction between employee and contractor designation in the wage order market. The Court first made clear that the widely misconstruing workers as independent contractors negatively impacts those individuals as well as competing entities and the public writ large. Accordingly, the Court proceeded to explain that the Borello decision required that the underlying remedial legislative objective of any employment statute must always be considered in deciding the classification of an employee. The Court also rejected Dynamex’s contention that Martinez applied solely to joint employment issues and that Borello’s “right to control” analysis is controlling. Therefore, the Court held that an individual should be considered an employee if the employer: (1) controls wages, hours or working conditions; or (2) suffers or permits work; or (3) engages, and thus creates a common law employment relationship. Still, the Court acknowledged that employment definition (2) from Martinez should not be interpreted literally as doing so would implicate individuals traditionally considered independent contractors such as plumbers and ultimately blur the common understanding separation between employees and independent contractors. Thus, the Court curtailed the scope of Martinez’s second definition by implementing the “ABC Test.”
Per the ABC Test, an individual is considered to have been “suffered or permitted to work” and thereby considered an employee in wage order matters unless the employer establishes: (1) that the individual is not controlled or directed by the hiring company regarding the performance of their work; (2) that the individual completes work outside the usual course of the given company’s business; and (3) that the individual is customarily performing an independent trade, occupation or business of similar nature as the work completed. Importantly, all of these stipulations must be met for the employer to rebut the presumption that an individual is an employee.
Implications for California Lenders Utilizing 1099 Contractors
The Dynamex ruling is an important one for the many California-based lenders who currently use 1099 contractors in their everyday business operations. The issue as to whether a given individual should be categorized as an employee or independent contractor carries significant weight for the worker, corporate entity and general public alike. If an individual is considered an employee, the hiring entity shoulders the burden of financing Social Security, state, unemployment, and payroll taxes in addition to offering worker’s compensation insurance and abiding by the multitude of state and federal laws applicable to wages, hours and working conditions.
Significantly, there is still some question as to whether the ABC test is applicable to wage claims that do not originate from a wage order. For example, reimbursement filings for business expenditures such as gas and toll fees that are not covered by a wage order and are recoverable solely per Labor Code § 2802 may still fall under the purview of the Borello test. Regardless, any corporate entity doing business in California that classifies workers as independent contractors should immediately consult with their legal team to reevaluate the employment status under the ABC Test analysis and recategorize any individuals as necessary in order to remain compliant under the existing wage order statutory scheme. Such entities should pay particular attention to stipulation (2) of the ABC Test—as it is a notoriously difficult standard to establish for companies that rely on independent contractors to produce an essential product or service. For example, a lender might be able to successfully categorize a marketing/customer support specialist as an independent contractor as the services they provide are distinct from the lender’s usual course of business—as opposed to a CPA or investment planner whose functions are inherently tied to the core lending industry services. This preventative measure will ensure California lenders mitigate the risk of costly litigation as this issue continues to develop.
In the meantime, it is important for California real estate brokers with 1099 contractors on their books to note that regulatory agencies and courts generally weight the totality of the employment circumstances in order to determine whether a given individual qualifies as a worker or independent contractor. Generally, these compliance entities focus on three main areas of the employment relationship to make a final determination:
- The degree of control the employer exercises over the worker’s behavior and work results (i.e., who controls training, where and when the individual conducts work activity, what equipment they use in the course of business, etc.)
- The extent of control the employer maintains over finances (i.e. Does the employer exercise majority control over the individual’s earnings or losses?)
- What is the relationship between the parties? (i.e., Does the individual get benefits and is it an ongoing, long-term relationship?)
Additionally, for lenders and brokerages that utilize the services of loan officers, originators or agents that they are consider classifying as 1099 independent contractors, the IRS publishes a convenient 20-point checklist such entities can reference in order to guide their employee designation analysis:
- Must the individual take instructions from your management staff regarding when, where, and how work is to be done?
- Does the individual receive training from your company?
- Is the success or continuation of your business somewhat dependent on the type of service provided by the individual?
- Must the individual personally perform the contracted services?
- Have you hired, supervised, or paid individuals to assist the worker in completing the project stated in the contract?
- Is there a continuing relationship between your company and the individual?
- Must the individual work set hours?
- Is the individual required to work full time at your company?
- Is the work performed on company premises?
- Is the individual required to follow a set sequence or routine in the performance of his work?
- Must the individual give you reports regarding his/her work?
- Is the individual paid by the hour, week, or month?
- Do you reimburse the individual for business/travel expenses?
- Do you supply the individual with needed tools or materials?
- Have you made a significant investment in facilities used by the individual to perform services?
- Is the individual free from suffering a loss or realizing a profit based on his work?
- Does the individual only perform services for your company?
- Does the individual limit the availability of his services to the general public?
- Do you have the right to discharge the individual?
- May the individual terminate his services at any time?
It is important to remember that no one question or characteristic of the employment relationship is definitive. The circumstances of every relationship within the employment context vary significantly. For example, there may be more of an appearance of exclusivity and control from a government regulator’s perspective by the employer if a licensed salesperson is designated as a 1099 contractor, but tied exclusively to a broker. Such a borderline designation could be deemed a violation of employment regulations and result in administrative and financial penalties. Thus, mortgage companies and brokerages should consult with experienced employment attorneys to help guide their ultimate determination if there is any degree of uncertainty.