If your company hires independent contractors and wishes to ensure that your agreements comply with the latest California laws, we can help! Our experienced attorneys can craft an agreement tailored to the needs of your business. Please contact us for assistance creating an independent contractor agreement.
First…Can Your Worker Legally Be an Independent Contractor?
In order to protect your business, it is important to first examine whether your workers can be classified as independent contractors under California law. Simply agreeing with your workers to an independent contractor arrangement is not enough. Nor is it enough to have your workers operate remotely, or to allow them to pursue other work opportunities while they are working for you.
California law used to weigh a number of different factors in determining whether a worker was an employee or an independent contractor, and these were mostly focused on the control the hirer had over how the work was performed. But new rules took effect in 2018 that restricted who could lawfully be considered an independent contractor. Now, companies must also demonstrate that their contractors have a separate business, and that the business is of a different type than the company’s usual line of work.
2018 Changes in California’s Independent Contractor Law:
The California Supreme Court’s landmark decision in Dynamex Operations West v. Superior Court, 4 Cal. 5th 903 (2018) threw out a 30-year old multi-factor test used to determine if a worker is properly classified as an independent contractor, or if they must be an employee. (The previous test followed a case called S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations, 48 Cal. 3d 341 (1989). So, if you have seen references in other blogs or articles to the “Borello factors,” that is no longer the current standard.)
Before Dynamex, California courts considered factors such as: whether the hirer can “control the manner and means” of accomplishing the work; the extent to which the work requires supervision; the skills required to do the work; who supplies the tools and locations for work; whether the work is temporary or permanent; whether the work is paid by the hour or by the job; and whether the parties believe they are in an independent contractor relationship. Under the previous law, courts tended to give factors related to “control” the most weight – a contractor’s ability or inability to decide where, how, and when to work would often be determinative.
The Dynamex ruling eliminated many of these Borello factors. The Dynamex opinion begins with the presumption that that all workers are employees unless proven otherwise. The burden is therefore on the hiring company to prove that they have properly classified their workers as independent contractors. And, in order to prove an independent contractor relationship, a hirer must meet all three prongs of the new “ABC test”:
To be an independent contractor, the worker must be free from the hirer’s “control and direction.” What does this mean? Dynamex added to a long line of cases discussing the importance of the hirer’s control over how the work is performed in deciding whether a worker is properly classified as a contractor. Control is determined “in fact,” that is, as the company’s practices actually work, not just what the written contract provides. Dynamex also relied heavily on a prior California Supreme Court case, Ayala v. Antelope Valley Newspapers, 59 Cal. 4th 522, 533 (2014), which held that “control over how a result is achieved lies at the heart of the common law test for employment.” Yet that court clarified that “control” refers to the amount of control an employer can exercise under the contract, and is not limited to how much control a hirer actually exercises.
- To be an independent contractor, the worker must also perform work “that is outside the usual course of the hiring entity’s business.” According to the Dynamex court, borrowing from an earlier case, Martinez v. Combs, 49 Cal.4th 35 (2010), employees include “all individual workers who can reasonably be viewed as ‘working in the [hiring entity’s] business.’” By contrast, an independent contractor – like a plumber hired for occasional repairs to facilities – “would have been realistically understood, instead, as working only in his or her own independent business.” As the Court explained,
Thus, on the one hand, when a retail store hires an outside plumber to repair a leak in a bathroom on its premises or hires an outside electrician to install a new electrical line, the services of the plumber or electrician are not part of the store’s usual course of business and the store would not reasonably be seen as having suffered or permitted the plumber or electrician to provide services to it as an employee. On the other hand, when a clothing manufacturing company hires work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that will thereafter by sold by the company, or when a bakery hires cake decorators to work on a regular basis on its custom-designed cakes, the workers are part of the hiring entity’s usual business operation….
Dynamex at p. 959-960.
As a result, simply hiring someone who will work from home will not meet factor “B,” even if the person never sets foot in your offices, if the nature of the person’s work is the same as your company’s business. Consequently, in order to have a lawful independent contractor relationship, the worker must perform work that is outside your company’s usual course of business.
To be an independent contractor, the worker must ordinarily work in the trade for which the hiring company is seeking her services. Factor “C” is related to factor “B” in that it requires that the worker be engaged in the trade or business for which your company is hiring the worker. The contractor should also have their own separate business. To determine whether your potential contractors meet this factor, ask to see their documentation. Do they have licenses for their business? Have they formed a corporation (C-Corp, S-Corp, or LLC)? Do they have a formal name for their business that they use in advertising or on their business cards? Once again, whether or not the worker believes him or herself to be an independent contractor is no longer relevant, so it is best to learn what you can about the nature of the worker’s business to ensure you can prove that he or she “ordinarily works in the trade” that is thesubject of the contract with you.
Although the Dynamex opinion expressly said that its holdings were intended to apply to cases involving the California Wage Orders (which govern payment of minimum wage, overtime, meal and rest breaks, among other things), the definition of “independent contractor” under Dynamex’s ABC test is making its way into other areas of the law, including for taxes and workers’ compensation.
For example, there are at least some indications that the EDD is relying on the new “ABC” test in its tax audits. Laura Curtis, a policy advocate with the California Chamber of Commerce, claimed the EDD has been performing audits and filing cases against companies for misclassifying employees as independent contractors using the “ABC” standard. Kevin Smith, “Ruling on independent contractors leaves entrepreneurs in limbo.” San Gabriel Valley Tribune, Oct 25, 2018,
The Independent Contractor Agreement: Key Provisions
In order to avoid the potential pitfalls of the new “ABC” test, it is important to ensure that the independent contractor agreement itself shows compliance with the rules.
- Establish the Contractor Has A Separate Business:In light of the changes in the law summarized above, an important element of an independent contractor agreement is a provision demonstrating that the contractor has a separate business, and that the business does not encompass providing the same goods or services that your company provides. Ideally the independent contractor agreement should state that the contractor has his or her own business and provide the name of that business if possible. The agreement should also state the company’s and contractor’s respective usual business operations.
- Clearly Define the Scope of Work, Duties, and Compensation: The independent contractor agreement should clearly define the work that the contractor is expected to perform, the contractor’s responsibilities, and, of course, the manner in which the contractor will be compensated. The type of compensation (piece-rate, commission-based, etc.) should be stated in the contract as well as the amount of compensation. Moreover, because benefits such as health insurance, paid time off and participation in a company 401K are generally available to employees only, the agreement should state that the contractor will not be receiving these benefits.
- Establish that the Contractor Controls How the Work Will Be Done: An independent contractor agreement should also expressly set out the aspects of the work that the contractor will control. For example, can the contractor decide how many hours to work? How many days? How many projects to take on? Does the contractor use his or her own equipment to perform the work? Is the contractor allowed to use his or her own judgment in how each project is completed? If so, the agreement should say so.
Likewise, if the contractor has the option to rent or lease equipment from your company for work purposes, or if the contractor must sometimes or always be at a certain location as a necessary condition of performing the work, that should also be in writing.
Reimbursement of expenses is another important topic. Although employers are required by the California Labor Code to reimburse employees’ expenses incurred for business purposes, the same is not true of independent contractors. A true independent contractor, with his or her own separate business, should be able to account for expenses, and any associated tax deductions, without seeking reimbursement from your company. Therefore, if you do not intend to reimburse your contractor’s business expenses, the agreement should say so.
- Responsibility for Withholding and Paying Taxes: The agreement should clearly state that the hiring company will not be withholding taxes pursuant to an IRS Form W-4 or the state equivalent, and will not issue a W-2 reflecting earnings. A key difference between an employee and an independent contractor is that employers withhold taxes for employees and issue W-2’s for earnings. Not so for independent contractors. The contractor will be responsible for stating income and expenses on an IRS Form 1099 and for paying all applicable state and federal taxes.
- The Arbitration Agreement & Class Action Waiver: A key provision in any independent contractor agreement should be an arbitration provision with a class action waiver. Although California courts have become more restrictive as to independent contractors, the United States Supreme Court continues to expand companies’ ability to require arbitration.
In May 2018, the Supreme Court issued a landmark decision in Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018). That case upheld class and collective action waivers in employer-employee arbitration agreements. The Epic decision effectively saved Uber from a class action claiming misclassification of drivers, when the Ninth Circuit applied Epic in a September 25, 2018 decision, finding that Uber’s arbitration agreements effectively barred class actions by its drivers.
Thus, including an arbitration clause with a class action waiver in your company’s independent contractor agreements will help protect your business from costly class action lawsuits. However, workers may still be able to bring a different type of collective action under the California Private Attorneys General Act (“PAGA”), because the California Supreme Court ruled in Iskanian v. CLS Transportation Los Angeles LLC, 59 Cal. 4th 348 (2014), that the right to sue in court under PAGA cannot be waived by agreement. However, it is still advisable for arbitration clauses to waive any “collective actions” in the event the Iskanian decision is ever overturned. Then, the contractor agreement should also include a severability clause so that if the “collective actions waiver” portion of the arbitration clause is found to be unenforceable, the remainder (e.g., the class action waiver portion) would still be enforceable.
Regardless of whether you are just starting a brand new company, run a ‘mom & pop’ business, or you already have a large established corporate enterprise with hundreds of locations across California, we are able to grow with you and meet your legal needs.