Did the California Supreme Court Poison the Gig Economy?

The landscape of the freelance economy is bound to change following a recent decision from the California Supreme Court. The resulting decision from Dynamex Operations West, Inc. v. Superior Court has made it much more difficult for employers to classify individuals as independent contractors. Now, companies of all sizes may have to reclassify many of their independent contractors as employees or else shift the work of independent contractors to other employees. If they don’t, they may be required to pay steep penalties.

How Did We Get Here?

In California, employers’ rights and responsibilities are governed by three distinct sources of legal authority: statutes, regulations, and court rulings. Sometimes, each source of legal authority comes to a different conclusion regarding what employers are required to do. When those situations arise, it is critical to determine which source of authority determines policy — a question not always easy to answer.

Prior to Dynamex, workers were classified as independent contractors or employees based on a test fashioned by the California courts. That test focused primarily on the degree of control that a company exercised over a worker. If the company exercised sufficient control, then the worker had to be classified as an employee and not an independent contractor. The test required courts to examine and balance numerous factors, such as whether the worker had the opportunity to share in the profit or loss in the endeavor and whether the company provided the worker with the tools needed to perform the work.

Separately, and for many years, California courts have decided whether two companies jointly employed the same workers by relying on a more expansive test based primarily on guidance from the Industrial Welfare Commission (IWC). That test held that an employment relationship exists whenever a company “suffers or permits” an individual to work. Until Dynamex, the discrepancy between these two tests remained unexplored because each test was applied to different questions. If the issue was one of joint employment, then the test from the IWC applied. If instead a court were asked to determine whether someone was an independent contractor or an employee, then it applied the test created by the courts.

Dynamex radically changed the gig economy landscape because it incorporated the IWC’s expansive view of the employment relationship into the independent contractor question. This makes it far more difficult for companies to show that independent contractors are properly classified and need not be reclassified as full employees. Specifically, under the new Dynamex test, it is now assumed that every worker should be classified as an employee rather than an independent contractor. To contradict this assumption, a company must now demonstrate all three of the following conditions are met:

1. The worker is free from the company’s control and direction (both under contract and in reality)
2. The worker performs work outside the usual course of the company’s business
3. The worker is customarily engaged in an independently established trade, occupation, or business

What Companies Should Do:

The Dynamex ruling is momentous because, to a certain extent, there is nothing that many companies that rely on the gig economy can do. It is highly improbable that Lyft, Uber, GrubHub, and other similar businesses will be able to satisfy the new test with respect to many of their workers. This means many companies will have to seriously consider whether they need to reclassify large portions of their California workforces. By contrast, other national companies may be better positioned to deal with this change because the Dynamex test is substantially similar to those used in some East Coast states like Massachusetts, Delaware, and New Jersey.

The key for most companies is to minimize risk, which can be done through arbitration, contractor, or staffing agreements. Now that the US Supreme Court has favorably resolved the question of arbitration agreements as a condition of hire, companies would do well to roll out arbitration agreements, lowering the chances of facing costly class action lawsuits. Companies should also review and revise agreements between a business and independent contractors since the Dynamex ruling emphasizes those agreements will be under much closer scrutiny. Auditing contracts to ensure compliance with the new classification test is extremely important. If a business regularly uses independent contractors to fill employee vacancies, now also might be a good time to work with a staffing agency for certain vacancies.

The Dynamex decision expressly ties the definition of employment to the particular source of legal authority. While it is arguable that this has always been the case, it is now a certainty.

Pablo Orozco (porozco@nilanjohnson.com ) is a labor and employment attorney at Nilan Johnson Lewis.