Last year, the California Supreme Court decided Dynamex Operations West, Inc. v. Superior Court of Los Angeles, a landmark decision that dramatically increased the risk of misclassifying individuals as independent contractors. As previously reported, although Dynamex replaced the longstanding Borello standard with the “ABC” test, it also left two critical questions unaddressed. First, Dynamexdid not address whether the ABC test applies retroactively. Second, Dynamex did not decide whether its scope was limited to coverage under the Industrial Wage Commission’s (“IWC”) Wage Orders or if its holding generally applied to the Labor Code as a whole. In the last five days, both questions have been answered.

On May 2, 2019, the Ninth Circuit found that Dynamex applies retroactively under California law in Vazquez v. Jan-Pro Franchising International, Inc., the most notable decision to date regarding Dynamex’s retroactivity. Shortly thereafter, on May 3, 2019, the Division of Labor Standards Enforcement (“DLSE”), California’s wage and hour enforcement agency, issued a letter opining the ABC test applies to both the IWC Wage Orders and any Labor Code provisions that enforce requirements set forth in the Wage Orders. Although neither the Ninth Circuit nor the DLSE can authoritatively interpret California law, these developments indicate that Dynamex’s scope—which governs hundreds of thousands of independent contractor relationships throughout the state—has continued to expand its already extensive reach.

Revisiting Dynamex and the ABC Test

Under the ABC test, a worker is presumed to have “suffered or permitted to work,” and thus, “an employee,” unless the putative employer proves:

(a) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;

(b) that the worker performs work that is outside the usual course of the hiring entity’s business; and

(c) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Note that each of these requirements need to be met in order for the presumption that a worker is an employee can be rebutted, and for a court to recognize that a worker has been properly classified as an independent contractor. Prong B of the ABC test is particularly notable because it seemingly precludes businesses from using independent contractors to deliver or provide their core product or service. Under Borello, the longstanding prior standard, many companies and industries built the use of independent contractors into the core of their business models. Those companies and industries now face existential challenges in the legal paradigm created by Dynamex and its progeny.

Application of Dynamex by the Ninth Circuit in Vasquez

Vasquez’s lengthy procedural history began in 2008 with a putative class action filed in the U.S. District Court, District of Massachusetts by janitors against JAN-PRO, an international commercial cleaning franchisor. The janitors’ minimum wage and overtime claims stemmed from allegations that they were misclassified as independent contractors as part of JAN-PRO’s franchising model. Several of the plaintiffs resided in California, and as a result, the Massachusetts District Court severed the California plaintiffs and transferred their claims to the Northern District of California.

In the Northern District, JAN-PRO prevailed on a summary judgment motion as to the janitors’ minimum wage and overtime claims. The plaintiffs appealed. While on appeal, the California Supreme Court decided Dynamex, and the Ninth Circuit subsequently ordered the parties to brief the effect of Dynamex on their case.

In its opinion, the Ninth Circuit examined California precedent and found that applying Dynamexretroactively is consistent with the state’s “legal tradition” to apply judicial decisions retroactively. While the Court acknowledged that there is an exception to apply judicial decisions retroactively, it held that the exception is not applicable to the Dynamex decision. Rather, the Court reasoned that there is a strong presumption in favor of retroactivity, Dynamex only clarifies existing law, and that California state courts provide no indication of an intention to limit Dynamex to new cases. As part of its opinion, the Ninth Circuit acknowledged that the California Supreme Court’s denial of a petition asking it to state that Dynamex should be applied prospectively was only “a data point for us to consider.”

Although the Ninth Circuit properly remanded the case to the Northern District to decide the merits, it nonetheless offered “guidance” on the analysis. It urged the district court to focus on Prong B of the ABC test, raising the serious question of whether the janitors performed work outside the “usual course” of JAN-PRO’s business. As expected, although JAN-PRO markets itself as a “commercial cleaning company,” JAN-PRO has continued to argue that it is a franchising business and not a cleaning business—a contention that will likely prove dispositive either way on remand.

The DLSE Expands the Scope of Dynamex in New Opinion Letter

The day after the Ninth Circuit decided Vasquez, the DLSE issued an opinion letter which examined the scope of Dynamex’s ABC test and concluded that it goes beyond the four corners of the Wage Orders to also apply to the Labor Code. The DLSE reasoned that because the IWC Wage Orders lack independent enforcement power, but are instead premised on the legal authority of the Labor Code, “the IWC employer definitions are imported into the Labor Code provisions” that “enforce specific requirements directly set forth in the wage orders.”

Accordingly, the DLSE declared that California Labor Code provisions which implicate obligations under the wage orders are therefore subject to the ABC test, including Labor Code sections: 226 (itemized wage statements); 226.7 (meal and rest periods ); 510 (overtime); 512 (meal and rest periods); 1182.12 (minimum wage); 1194 (overtime); 1194.2 (liquidated damages); 1197 (minimum wage); and 2802 (reimbursement of expenses).

The DLSE also recognized a narrow exception for waiting time penalty claims under section 203, noting that the analysis turns on whether the claim is derivative of concurrent minimum wage and overtime claims: “Thus, where section 203 serves to enforce the underlying minimum wage and overtime obligations of the wage orders, application of the ABC test to these claims would be appropriate.” That is, the DLSE explained that Dynamex would apply to section 203 except in the rare circumstance where a worker asserts a standalone section 203 claim not premised on underlying minimum wage and/or overtime claims.

As mentioned above, while the DLSE is the administrative agency authorized to enforce California’s employment laws, including the Wage Orders, the California Supreme Court (most notably in Dynamex itself) has repeatedly held that the DLSE’s interpretations are not entitled to deference ordinally accorded to formal administrative regulations, and that courts must independently determine the meaning and scope of the provisions of the Wage Orders. That being said, companies that utilize independent contractors (and particularly those who use them at scale) would be wise to take the DLSE’s enforcement posture into account when evaluating potential exposure.

Key Takeaways

As a result of Vasquez, companies defending misclassification claims in the Ninth Circuit now face additional liability for up to several years before the April 2018 Dynamex decision. In addition, the DLSE’s opinion letter has essentially confirmed that it hopes to expand rather than just maintain Dynamex’s broad sweep, increasing the already-heightened regulatory pressure on companies who use independent contractors.

As your company assesses its retroactive and future risk of misclassification, we offer you Ghandi’s simple and frank advice: “The future depends on what you do today.” To that end, the list below identifies action items that can be taken now to mitigate the risk of future misclassification claims:

• Identify all 1099 recipients that are paid to individual social security numbers for the last four years to identify the risk associated with potentially misclassified employees.
• Conduct a risk analysis to confirm all independent contractors are properly classified.
• Confirm in your risk analysis that the independent contractors do not provide services that are part of your core business offerings.
• If necessary, reclassify independent contractors and start burning down your statute of limitations.
• Establish a checklist and process for onboarding independent contractors that contemplates the ABC test.
• In light of the U.S. Supreme Court’s recent decisions affirming the validity of arbitration agreements, including those that contain class action waivers, consider including private arbitration agreements to resolve any disputes that arise from your relationship. Given that class actions often fail to account for the individual interests and experiences of putative class members, and are generally considered less efficient but more expensive than private arbitration, including such provisions in your independent contractor agreements may be beneficial to both parties.