California Labor Law: Misclassified Independent Contractors

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San Francisco, CA Employers should think twice before misclassifying employees as independent contractors to avoid paying employee benefits, overtime, meal compensation and business-related expenses under California labor law. On July 13, 2010, the 9th US Circuit Court of Appeals held that employers cannot use choice-of-law contracts to avoid California labor regulations.

By classifying their employees as independent contractors, employers can also avoid payments such as payroll taxes, workers' compensation insurance, unemployment insurance, disability insurance, social security and even minimum wage. And many employers get away with misclassifying employees because there is no specific definition of the term "independent contractor."

According to the California's Department of Industrial Relations (DLSE), "One must look to the interpretations of the courts and enforcement agencies to decide if in a particular situation a worker is an employee or independent contractor. In handling a matter where employment status is an issue, that is, employee or independent contractor, DLSE starts with the presumption that the worker is an employee."

That is exactly what happened this week when the court held that, although workplace contracts may be subject to out-of-state law, actual workplace terms and conditions affecting workers in California are governed by California statutes.

The decision stemmed from three California truck workers who said they were improperly classified as independent contractors and denied employee benefits, including overtime, business-related expenses and meal compensation. Eagle Freight Systems (EGL) required the workers to sign contracts acknowledging their status as independent contractors subject to the labor laws of Texas. California's multi-faceted test of employment, however, showed an employment relationship between the drivers and EGL. As well, the Internal Revenue Service (EGL's request) and the Employment Development Department of California (plaintiff Mohit Narayan's request) determined that Narayan was an employee for federal tax purposes.

EGL might have considered a similar case in 2008, where FedEx settled a California labor lawsuit and agreed to pay $26.8M in a worker classification dispute. The case originated in 1999 when employees of RPS (later to become FedEx Ground) claimed lost overtime and expense reimbursements because of their classification as independent contractors. Critics said the settlement showed that the drivers proved their case in California.

Two years earlier a small courier business, JKH Enterprises, had reclassified its drivers as independent contractors, which resulted in a penalty assessment of $1,000 per worker. According to the DLSE, "JKH unsuccessfully challenged the hearing officer's decision …and the decision is now final and authority for future enforcement actions by the Labor Commissioner and private parties.

"All employers are urged to be aware of this important decision and the myriad consequences of misclassification of employees including:
  • Stop orders and penalty assessments pursuant to Labor Code section 3710.1;
  • Liability for overtime premium, meal period pay, and other remedies available to employees under the Labor Code and Orders of the Industrial Welfare Commission;
  • Exposure for tort liability for injuries suffered by employees when workers compensation insurance is not secured (LC section 3706);
  • Exposure for unfair business practices (B&P section 17200);
  • Tax liability and penalties;
  • Criminal liability (LC section 3700.5)
"All California businesses that have, or are considering, utilizing independent contractors to regularly perform work that is integral to the business of the company, should both seek qualified legal advice and carefully review the JKH decision."

Did EGL take into consideration the FedEx and JKH settlements?

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