Nancy A. Bertrando

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New Risks to Employers Who Misclassify Their Employees as Independent Contractors

May 24, 2012Article
Greenberg Glusker Client Alert

Many employers improperly classify their workers as independent contractors when, in fact, they should be treated as employees.  The following article first sets forth the general guidelines governing independent contractors under California law and then sets forth significant new risks associated with misclassification.

California Common Law Test

Under California law, there is a rebuttable presumption that all workers are employees rather than independent contractors, and the burden is on the alleged employer to disprove employee status.  Different courts and administrative agencies use different tests for determining whether a worker is an independent contractor, but be cautioned that administrative agencies charged with orders to collect more revenue for their state or federal government are becoming increasingly more aggressive in challenging and assessing employers for misclassifying their workers.

Under California common law, at least 10 factors are used to determine whether a worker should be classified as an employee or independent contractor.  However, California courts tend to apply whichever factors appear to fit the factual circumstances of the services performed, rather than follow any rigid formula.

The most important test of an employment relationship is whether the principal has the right to control the manner and means by which the worker accomplishes the end result.  More control by the principal signals an employment relationship, while control only as to the end result suggests an independent contractor relationship.

The second most important factor under the California common law is whether the independent contractor is doing work integral to the principal’s business or that is often done by the principal’s employees.

The third most important factor is whether the worker may be terminated without cause or notice by the principal, as “at will” status is indicative of an employment relationship.

Additional factors applied by California courts include:

(a)  whether the individual  performing services is engaged in a distinct occupation or business;

(b)  whether this occupation is usually performed under the direction of the principal or by a specialist without supervision;

(c)  the skill required in the particular occupation, and whether that skill is associated with the regular business needs of the principal;

(d)  whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work;

(e)  the method of payment, whether by time or job;

(f)   whether the worker has a set schedule or can set his or her own hours;

(g)  whether or not the worker is restricted from working for other companies; and

(h)  whether or not the parties intended to create an employer-employee relationship.

In addition to all of the foregoing factors, California courts may analyze whether it would be fundamentally unfair to classify a worker as an independent contractor instead of as an employee.  For example, because the Workers’ Compensation Act is liberally construed to extend benefits to all persons injured in their employment, courts are often persuaded to extend its coverage to persons classified as independent contractors.  Thus, a court may find that a worker is an employee, rather than an independent contractor, in order to provide a remedy to a low-wage earner injured during the provision of services.

Risks of Misclassification

Historically, there have always been significant risks in misclassifying any worker as an independent contractor rather than an employee.  Not only will taxing authorities expect the employer to pay any outstanding taxes, penalties and interest, but the employer may be liable for unpaid wages and overtime, interest on the unpaid wages, a potential civil penalty for failure to pay minimum wage, attorneys’ fees incurred by the employee in prosecuting the claim, and a penalty of up to 30 days’ wages for failing to pay final wages to any worker who has stopped working for the employer, in addition to countless other penalties for payroll violations.

An employer could always be liable for failing to secure workers’ compensation insurance for the employee, which could include penalty assessment and stop orders for failure to secure coverage, up to 10 days’ wages for any worker who loses time because a stop order prohibited the worker from performing services for the employer, and criminal penalties, including imprisonment.

Finally, the misclassified employee could always claim an entitlement to employee benefits that were not provided when he or she was erroneously classified as an independent contractor, as well as unemployment insurance benefits when the relationship ends.

In addition to all of that, as of January 1, 2012, it is unlawful for any person or employer to willfully misclassify an individual as an independent contractor.  Willful misclassification means avoiding employee status for an individual by voluntarily and knowingly misclassifying him or her as an independent contractor.

This new law also makes it unlawful for an employer to charge an individual who has been willfully misclassified as an independent contractor a fee or to make any deductions from compensation for any purpose – including for goods, materials, space rental, services, government licenses, repairs, equipment, maintenance or fines arising from the individual’s employment – if any of those fines or deductions would have violated the law had the individual not been misclassified.

If the California Labor and Workforce Development Agency or a court determines that a person or employer has violated this new law, the person or employer will be subject to a civil penalty of $5,000 to $15,000 for each violation, in addition to any other penalties or fines permitted by law.  If the Agency or a court determines that a person or employer is engaging in a pattern or practice of these violations, the civil penalty will be from $10,000 to $25,000 for each violation.

Furthermore, any person who for money or something else of value knowingly advises an employer to treat an individual as an independent contractor to avoid employee status will be jointly and severally liable with the employer if the individual is found to be misclassified.  This provision does not apply to employees who provide advice to their employer or to attorneys who provide legal advice.

Finally, to add insult to significant financial injury, offending employers will also be required to post on their website that they have committed a “serious violation of the law by engaging in willful misclassification of employees.”

Conclusion

It is advisable at the outset of any independent contractor relationship to carefully examine the business realities of the relationship, keeping in mind particularly the degree of control that must be exercised over this individual’s performance of the required duties.  Employers who are confident that their needs for a particular individual can be met with he or she falling within the confines of the tests outlined above should have counsel draft an agreement to document the relationship.  Employers who are concerned that they are misclassifying their workers should discuss those concerns with counsel in order to identify ways in which to best protect them from any future liability.

Questions?

Nancy A. Bertrando chairs Greenberg Glusker’s Employment Law Group. She exclusively represents employers in all aspects of employment law and employer relations. She can be reached at 310-201-7483 or [email protected].