Notwithstanding—and perhaps because of—the emergence of the so-called "sharing economy" and its proliferation of disruptive new business models, as well as calls to re-examine the traditional and familiar employee versus independent contractor construct, the risks associated with the misclassification of independent contractors continue to grow.

California Labor Code Section 226.8 makes it unlawful for an employer to "engage in" the act of "voluntarily and knowingly misclassifying [an] individual as an independent contractor" and provides for penalties in the case of worker misclassification. The statute states: "It is unlawful for any person or employer to engage in . . . willful misclassification of an individual as an independent contractor." The statute defines "willful misclassification" as "avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor." Persons or employers who violate Section 226.8 are subject to fines ranging from $5,000 to $25,000 per misclassified employee.

In Noe v. Superior Court (Levy Premium Foodservice Ltd. P'ship) (June 1, 2015), the first published decision to address liability under Section 226.8, the California Court of Appeal determined that under that law, the liability associated with misclassifying workers as independent contractors, as opposed to employees, rests not just with the party that makes the misclassification decision, "but also extends to any employer who is aware that a co-employer has willfully misclassified their joint employees and fails to remedy the misclassification." As a result, under certain circumstances, co-employers/joint employers can be liable for the use of workers misclassified as independent contractors, even if the contractors are provided by a third party, and that third party was responsible for making the decisions regarding the misclassified contractor.

Background

Anschutz Entertainment Group (AEG), which owns entertainment venues, such as the Staples Center in southern California, contracted with Levy Premium Foodservice to provide food services at the venues. Levy then contracted with Mark Saranoff and his affiliated companies, Canvas Corporation, Canvas Vending, and iCandy (collectively "Canvas") to provide workers to sell food at the venues. Several former Canvas vendors filed a wage and hour class action against AEG, Levy, and Canvas, alleging that the defendants were joint employers and jointly liable for a number of Labor Code violations resulting from the misclassification of the vendors as independent contractors. The plaintiffs brought claims against all alleged joint employers for their alleged failures to: (i) pay minimum wage; (ii) pay wages upon termination of employment; and (iii) furnish accurate wage statements and maintain accurate payroll records. In addition, the plaintiffs sought recovery of penalties under Section 226.8.

AEG and Levy filed motions for summary judgment, arguing in part that they were not joint employers, and that the undisputed evidence established that Canvas alone made the decision to classify the vendors as independent contractors (and that, therefore, Canvas was the only party that could be liable under Section 226.8). The trial court denied the motions for summary judgment in part because there were triable issues of fact as to whether AEG and Levy were indeed joint employers of the alleged misclassified workers that Canvas provided to them. As a result, the non-Section 226.8 claims against all defendants survived, meaning they will be decided at a trial. As to the Section 226.8 claim against AEG and Levy (the only claim really at issue in Noe), the lower court ruled that the claim could not survive because neither entity made the alleged misclassification decisions. In coming to this conclusion, "[t]he court acknowledged that plaintiffs had 'advanced evidence' showing AEG and Levy knew Canvas was 'not paying the vendors minimum wage' and that Canvas should have been classifying its workers 'as employees, rather than independent contractors.'" This evidence included: (1) emails in which a Levy human resources representative acknowledged that Canvas only paid the vendors on a commission basis and questioned whether this practice violated wage and hour requirements; and (2) the fact that Levy directly hired some of the vendors who sold food at AEG events, and after hiring them, classified them as employees, not independent contractors. Despite the existence of this evidence, the trial court found there was no Section 226.8 violation because the evidence did not show that AEG or Levy was actually responsible for the "initial classification decision." In essence, the court defined "engage in" to mean "commit."

The appellate court reversed the trial court's decision on the Section 226.8 claim. It concluded that Section 226.8's language (making it unlawful for any person or employer to "engage in . . . [w]illful misclassification") "is broad enough to encompass joint employers who knowingly acquiesce in a co-joint employer's decision to misclassify their joint employees." According to the appellate court, joint employers "engage in" prohibited misclassification where they have, through their acts or omissions, "knowingly participated or involved themselves in the willful misclassification decision," and "a joint employer who knowingly acquiesces in a co-joint employer's decision to willfully misclassify their joint employees has necessarily 'involved' itself in that misclassification decision."

The court's conclusion that liability under Section 226.8 is not limited to employers who make the misclassification decision, but also extends to those "engaging in" the act of willful misclassification, was informed not simply by the court's construction of the statutory language, but also by what the court perceived to be the legislative intent behind the statute. The court believed that in enacting Section 226.8 (as well as recently enacted Labor Code 2357 which expressly creates joint liability for paid consultants that "knowingly advise[] an employer to misclassify an employee" as an independent contractor), California's legislature intended to: (i) create a broad deterrent against the practice of employee misclassification; (ii) stop the perceived increasing abuse of independent contractor status posing a serious threat to workers' rights; (iii) halt abuses that it believed had created an unfair playing field for all the "responsible employers" who continued to honor their lawful obligations to employees; (iv) address the "societal consequences" of worker misclassification, such as the widespread denial of standard employee protections and "the loss of state income;" and (v) end the use of independent contractors to "streamline the business and cut costs."

The Noe decision was not a completely unfettered victory for the plaintiffs, however, as the court also held that the plaintiffs did not have a private right of action to enforce Section 226.8 through a direct claim. Rather, the plaintiffs could only pursue such a claim through a Private Attorney General Act (PAGA) action.

Implications for Employers

Noe highlights the risks associated with the misclassification of workers, even for those employers who did not make the actual classification decision. While in Noe the court addressed liability under Section 226.8, employers should not ignore the fact that the two other companies alleged to be joint employers will face trial on whether they are joint employers. If they are found to be joint employers, they will be exposed to potential liability for millions of dollars in penalties under Section 226.8 and monetary damages under the other Labor Code sections at issue in the case, namely the sections making it unlawful to fail to pay all wages upon discharge, to not provide itemized wage statements, and to fail to maintain accurate payroll records. While not at issue in Noe, the misclassification of independent contractors can increase risks regarding the failure to withhold and pay payroll taxes and the failure to reimburse an employee for all necessary expenditures or losses incurred in discharging his or her duties as an employee (i.e., to not make the employee pay for the tools and equipment necessary to do the employee's job, or to reimburse other job-related expenses).

Employers should also be aware that on January 1, 2015, a new law went into effect in California requiring any business entity that obtains workers from a labor contractor to share with the labor contractor all civil legal responsibility and liability for paying wages and obtaining valid workers' compensation coverage for any workers supplied by the labor contractor. Thus, under this new law, even if the business entity is not the wage claimant's employer or joint employer (and therefore has no duty to pay wages), the entity is nonetheless jointly liable for the contractor's labor code violations.

Finally, it is not just California cracking down on misclassification and targeting joint employers. Last year, for example, New York's Fair Play Act went into effect imposing stiff sanctions (including potential criminal liability) for the willful misclassification of certain commercial drivers. In addition, as recently as this month, a U.S. Department of Labor representative reportedly stated that the federal government is looking into misclassification among joint employers and going after the "lead" companies that benefit from staffing companies that have misclassified workers.

To minimize the risk of being held liable for a third party's decision to misclassify employees, employers should, at a minimum:

1. Ensure that they sufficiently understand how to properly classify workers. Such classifications generally fall within the realm of human resources, and employers should ensure that such personnel are well trained in the area of worker classification. An employer should consult with internal or external legal counsel regarding challenging or risky classification decisions, or when assistance may be required to push back on instructions to classify the employee as a contractor. When in doubt, err on side of classifying a worker as an employee.
2. Exercise greater care and diligence when relying on third-party providers to provide workers, especially workers that the third party may classify as independent contractors. Using established and reputable third-party labor providers likely reduces the risk that an employer will be responsible for unpaid wages or penalties owed because of worker misclassification.
3. Consider how best to address and rectify potential misclassification, including confirming with third party labor providers that workers are properly classified and that prompt measures will be taken to rectify any improper worker classifications. While employer steps in this area may indeed raise factual disputes as to whether the party using the third-party labor is a joint employer (or was "engaged in" the classification decision), assuming such risks is likely necessary.
4. Carefully review contracts with third-party staffing companies to ensure they are clear as to who employs the worker, and who will assume the financial liability for misclassifying the employees. While well-drafted contracts with indemnity provisions will not relieve an employer of all risks associated with misclassification, they can help mitigate some of the financial consequences of the misclassification—and incentivize the staffing company to get the classification correct in the first place.
5. Exercise additional caution when employing individuals previously retained by a staffing company supplying workers to the employer. In Noe, the evidence of employer involvement in the classification decision included the alleged joint employer hiring a worker and classifying the worker as an employee, notwithstanding the fact that the staffing company previously classified the worker as a contractor. Employers should seek the advice of counsel when switching the classification of a worker from an independent contractor to an employee or vice versa to make sure the risks of doing so are understood and appropriately mitigated.
6. Consider obtaining Errors and Omissions, Directors and Officers, and Employment Practices Liability insurance policies that provide coverage for misclassification claims, especially for those resulting from the misclassification decisions of third parties.