The California Labor Commissioner recently cited the Ritz-Carlton Hotel Company LLC and three janitorial contractors more than $2 million for misclassifying 155 janitors as independent contractors at its Half Moon Bay hotel. The citations include $1.9 million in wages and penalties payable to the affected workers.
The state found that Ritz-Carlton had hired out of state companies to provide janitorial services for its California location, and that company in turn subcontracted the labor to two other non-California based companies. None of these janitorial services were registered with the state’s mandated janitorial registration program. But their employees worked in California, and as I always remind you, employment law is dictated by where these employees perform labor, not where their company is based.
How did this happen? First, as I wrote about in my May Briefing on Joint Employment, California has a unique law that holds employers accountable for the labor violations of their contractors. In 2014, then Governor Brown signed into law the Wage Theft Protection Act, embodied in California Labor Code Section 2810. Many of you know Section 2810.5, which dictates that employers provide all non-exempt employees with a form containing various employment information. But there is another subsection of this Act, Section 2810.3, which makes employers liable for the Labor Code violations of the third-party workers providing labor services as part of the ordinary course of their business. These can include maintenance or janitorial services, and back in 2018, the Labor Commissioner also cited California based Cheesecake Factory and held them jointly liable for $8 million along with the janitorial company they had hired.
But the risk extends well beyond using outside companies, and employers routinely misclassify workers as independent contractors in other capacities. So, let’s do a deeper dive into this broader issue.
The people who work for you are presumed to be employees, under the law of California and many other states. “Employees” working in California get protections of the state Labor Code (overtime, breaks, minimum wage, expenses), which also allows them to sue for many of the violations, often leading to PAGA and class action lawsuits. They are also governed by similar federal wage and hour laws. Employees also receive protection from the federal and state anti-discrimination and harassment laws. Employees also have rights under worker’s compensation laws and state and federal occupational safety and health laws; they get unemployment insurance and disability benefits through California’s Employment Developmental Department. They receive social security benefits and must prove their status to work under the federal Immigration Act. We take certain payroll deductions from the checks we pay our employees, in part governed by the W-4 forms employees complete. We send them W-2 tax forms at the end of the year, and presumably they pay file and pay their federal and state taxes accordingly.
For the most part, the above laws and benefits do not apply to independent contractors (“ICs”). We issue individual ICs 1099 reports, and we rely on them to file and pay self-employment taxes and quarterly returns . (I know there are some exceptions which make all this a bit blurry; I am not getting into the weeds on this – I am just laying down some foundation.)
However, employers cannot just decide to make their workers independent contractors with the wave of a wand and the issuance of a 1099. And even if the workers themselves prefer this classification, these are rights they cannot waive. There have always been strict criteria used to determine who is an employee and who is an IC. For years, courts applied certain “tests,” some derived from the IRS 20 factors, some by factors set forth in a California Supreme Court decision stemming from 1989, S.G. Borello & Sons, Inc. v Department of Industrial Relations, (1989) 48 Cal. 3d 341 (“Borello”). This is what comprised what is called the “common law tests” for IC – “common law” meaning there was no particular statute that delineated this test.
But in 2018, the California Supreme Court pushed the button and annihilated what had previously been the gig economy in California, reinventing the independent contractor test in California with their decision in Dynamex Operations W Inc. v Superior Court (2018) 4 Cal. 5th 903 (“Dynamex”). The Dynamex decision destroyed the former test for ICs and replaced it with the new ABC test, leaving no industry safe in its wake. Real estate agents, app-based drivers, sound editors, freelance journalists, were all left scrambling, trying to determine what would happen considering this new normal.
Immediately, there was a rush to Sacramento to lobby for legislative “exceptions” to the Dynamex decision, while lower courts started to apply the new decision in real world settings. Different trade associations made their arguments about why and how there should be allowances for ICs in their industries, and a very long and convoluted statute emerged: AB 5. On the eve of the pandemic, January 1, 2000, when the world was just about to shut down, this new complicated piece of legislation was launched, dictating to Californians just who could and could not be an independent contractor.
When AB 5 was enacted at the start of 2000, it was hailed as the “end of the gig economy.” But as I told many back then, and as I have explained above, AB 5 did not pull the trigger on the IC status of many in this state. It had been the California Supreme Court in Dynamex that had decimated all the ICs in 2018; AB 5 actually created all the exceptions and safe harbor rules under the Dynamex decision. The first sentence of AB 5 so states: “Existing law, as established in the case of Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903 (Dynamex), creates a presumption that a worker who performs services for a hirer is an employee for purposes of claims for wages and benefits arising under wage orders issued by the Industrial Welfare Commission. Existing law requires a 3-part test, commonly known as the “ABC” test, to establish that a worker is an independent contractor for those purposes.” AB 5 also goes on to say that an individual providing labor or services has the status of employee rather than independent contractor unless the hiring entity demonstrates that the individual meets all the conditions.
When you peel back the very intricate layers of AB 5, there is some good news. The law gives us some very specific examples of where individuals CAN BE legitimate ICs. Where is this possible? For example, AB 5 lists “professional services” such as travel agents, graphic designers, real estate agents, manicurists, lawyers, doctors, commercial fishermen, and several others. It also created a “business to business” exception where the test would then be analyzed under the Borello standard. But falling into one of these professions does not magically transform workers into ICs. And there were a few clear gaps left by AB 5, especially for the entertainment industry and some others. Consequently, during the pandemic and throughout much of 2020, several trade groups, especially in the music industry, made their voices known and pushed back on the legislature. By September 2020, we had AB 2257, which is the successor and clean up legislation to AB 5 (and the current law in place).
It is not important to know all the little changes that AB 2257 made to the framework of AB 5 – just that it created even more exceptions to Dynamex, notably, many in the sound and music industry. And it changed “fisherman” to “fisherperson” (rightly so).
As with AB 5, there is the good news and not so good news about AB 2257. We now have better guidance about who can be an IC and who cannot be. For people like me, who do not like to live in the world of grey, that is helpful. When my clients call and want to know if a particular worker can be considered an IC, I jump on to my desktop, pull up AB 2257, and see if the profession or occupation is listed. If so, then we usually do a “Borello” type analysis – does this person work for other companies, have their own business license, have a fictitious business name, have other employees, have their own website and email, and other such factors. The bad news is, if the person my client wants to make an IC is NOT listed under AB 2257 or cannot fall within the business-to-business exception, we are done. There is no more ‘grey’ area under Dynamex. For example, doctors are listed in AB 2257. Speech therapists are not. Nor are most “salespeople.” Photographers can be ICs, but the models used in those photographs cannot be. The law is very specific.
As the Ritz-Carlton learned, hiring these workers through another layer does not change the above analysis. Janitors are not listed in AB 2257. Those workers needed to be someone’s employees, and they were not. This is why I go through this analysis with my clients during the audits I conduct.
And what is the exposure for a misclassification? Just on the EDD side, it can be up to $25K per person, whether the person would be an exempt or non-exempt level person. That can also be recovered by way of a PAGA case. For non-exempt employees, of course, you have all the Labor Code remedies of failing to pay wages, overtime, break pay, wage statement penalties, and assuming you failed to have these people sign handbooks, they are easy class action targets. They are also uninsured under worker’s compensation, undocumented for purposes of the immigration act, the list goes on. And some workers, like the “models” referenced above, who often just work for one day at a time and are hired through agencies, have become repeat plaintiffs in cottage industry class actions for failing to pay final wages timely. Be very careful how you are classifying and paying these workers. And be careful of the contractors and staffing agencies you use. There are good ones out there, who take great pains to classify and compensate their workers properly. They may be more expensive. But this is not a place to cut corners, as Ritz-Carlton and Cheesecake Factory have both learned.
Now, some of you have asked me about workers out of state. The above is an analysis of California law. But other states are getting more aggressive about refining their laws, so do not assume you are “safe” if your workers are out of state. You just will not be governed by AB 2257. Please, reach out and ask – about any of this. These are complicated tests and I’m here to help with all of it.
