Headlines about Uber’s $100 million settlement of a class action by 240,000 drivers who claimed they were misclassified as independent contractors rather than employees caught the attention of businesses across California. That attention is warranted. Recent decisions by courts and government agencies are clear that labeling a worker an “independent contractor” is immaterial. Instead, courts and regulators look behind the designation to assess the extent of the company’s right to control the worker. While personnel and cost savings by hiring an independent contractor can be substantial, the expenses from misclassification can be far greater. The following is a brief summary of factors a business should consider and implement to reduce its misclassification risk.

California’s Labor Code presumes that a worker is an employee. To assess whether a worker is an independent contractor rather than an employee, the California Supreme Court in Ayala v. Antelope Valley Newspapers, Inc. (2014) 59 Cal.4th 522 stated, “[t]he principal test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.…what matters… is not how much control a hirer exercises but how much control the hirer retains the right to exercise.” When assessing the question of control, the IRS considers the following:

BEHAVIORAL: Does the company control or have the right to control what the worker does and how the worker does his or her job?

FINANCIAL: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

TYPE OF RELATIONSHIP: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

The California Department of Labor amplifies the independent contractor assessment factors at http://www.dir.ca.gov/dlse/faq_independentcontractor.htm.

The consequences from misclassification can be significant. They can include liability for years of unpaid tax withholdings, unpaid Social Security and Medicare contributions, unpaid workers compensation and unemployment insurance premiums, unpaid overtime, minimum wages, and work-related expenses. Reclassification as an employee can also lead to significant waiting time penalties, wage statement penalties, meal and rest break penalties, Private Attorney General Act penalties, and statutory penalties under Labor Code § 226.8(a) of $5,000 to $10,000 for each violation. If the misclassification is willful—voluntary and knowing— then the penalties increase to $10,000 to $25,000 for each violation. And, a class action successfully alleging misclassification can increase those costs by many times more.

With those exposures in mind, the following are pro-active steps businesses should take to minimize employee misclassification risks:

  • Review contracts to eliminate provisions that give the company the right to control the methods and means of accomplishing the work.
  • Review the contractor’s actual activities: who in fact controls the methods and means of performance. Evaluate whether the worker is truly in business for him or herself or whether the worker is economically dependent on the employer.
  • Check the duration of the contract—an independent contractor engagement is usually limited.
  • Consider adding mandatory arbitration and class action waiver provisions in employment and consulting agreements.

Proper worker classification is a critical risk management process. We are happy to answer your questions about this important issue.