Employers frequently struggle with determining when a service provider should be classified as an independent contractor, as opposed to an "employee." Getting the answer to that question wrong can prove significant in many ways. For example, misclassifying an employee as a contractor can result in numerous wage and hour violations, including the failure to pay overtime, the violation of meal and rest period laws, the failure to pay wages due and owing at the time of termination, the failure to properly reimburse expenses, violations of state and federal tax laws, and eligibility for employee stock options and benefits, among other things.

In Maria Ayala et al. v. Antelope Valley Newspapers, Inc. (June 30, 2014), the California Supreme Court generally addressed when independent contractor misclassification claims can proceed as class actions. In answering the class action questions presented, however, the court further clarified the test to determine when a service provider is an employee and not a contractor. The court's decision underscores the primacy of a hirer's right to control, as well as the significance of an agreement, in making the classification determination. As discussed below, Ayala highlights the need for employers to carefully consider classification decisions, as well as the risks associated with not doing so.

Background

In Ayala, several newspaper carriers sued a newspaper publisher in a purported class action, arguing that it improperly treated them as independent contractors instead of as employees. The carriers alleged various statutory and wage order violations, including the failure to pay them overtime, provide required breaks, and reimburse them for business expenses incurred. The trial court denied the carriers' efforts to certify the matter as a class action because the carriers had not demonstrated that common questions predominated for members of the asserted class, which is a requirement for class certification. The Court of Appeal reversed in part, agreeing with the trial court that claims for overtime pay and meal and rest breaks could not proceed as a class action because they required individualized inquiries, but also finding that such individualized inquiries were not necessary to determining a hiree's employee status for the remaining claims.

The Decision

The California Supreme Court affirmed the appellate court's decision and remanded to the trial court to reconsider class certification using the legal principles it outlined in the decision.

In order to determine whether the carriers' claims could go forward as a class action, the court had to decide whether the question of employee status could be commonly resolved (that is, resolved as to all the individuals alleged to be class members). To do that, the court explained, it first had to properly identify the test for determining employment status. Noting that the plaintiffs had proceeded in the trial court solely "on the basis that they are employees under the common law," the Ayala court restricted its analysis of whether an employer-employee relationship exists to the "common law test."

The Ayala court made it clear that "control over how a result is achieved lies at the heart of the common law test," and that "[t]he principal test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired." It stressed that "what matters" is not how much control a hirer exercises, but how much control the hirer retains the right to exercise." Just because a certain amount of freedom of action is inherent in the nature of the work does not change the character of the employment where the employer has general supervision and control over it. The court further explained that "[p]erhaps the strongest evidence of the right to control is whether the hirer can discharge the worker without cause, because 'the power of the principal to terminate the services of the agent gives him the means of controlling the agent's activities.'" Similarly, the court observed that a "worker's corresponding right to leave [the job] is similarly relevant," because while an employee may quit, an independent contractor is legally obligated to complete his contract. In short, the court opined that whether a right of control exists can be assessed by asking whether or not, if instructions were given, the worker would be obligated to obey the instructions "on pain of at-will termination for disobedience."

While the court unequivocally identified the "right to control" as the "central inquiry," it did also note that certain "secondary factors" could prove important in determining employment status in any given case.¹ Indeed, the court stated that the significance of any one factor and its role in the overall calculus used to determine employment status could vary from case to case.

Finally, the court also addressed the relevance of a written contract in assessing employment status under the common law test. The court explained that, while it was not conclusive, a contract is a significant factor in the employment status analysis because it speaks to the "hirer's right to control a hiree's work." That is because the existence of the right to control and supervision (which may be discerned from the contract) can establish the existence of an agency/employment relationship. As stated by the court, "[t]hat a hirer chooses not to wield power does not prove it lacks power," and a contract can inform whether the hirer retained such power. In this case, the defendant newspaper publisher had entered into a form contract with the carriers. The court noted that at the certification stage, the form contract is examined not for "what it says," but for the uniformity of control it spells out over the members of the putative class. For instance, the form contracts in this case (two form contracts were used in the relevant period) laid out, similarly for all carriers, the newspaper's control over the timing and manner of delivery and its right to terminate the contract on 30 days' notice without cause. Notwithstanding, the court did caution that the parties' course of conduct is still relevant, if it provides evidence that the "practical allocation of rights [is] at odds with the written terms."

While the discussion above has focused on the Ayala court's discussion of the common law test applicable to determining employment status, Ayala is, above all, a class certification ruling. Wage and hour class action practitioners will therefore want to study the decision carefully, especially when dealing with a purported independent contractor class. As to the class certification analysis, the court decided that whether the issue of employee status can be resolved on a classwide basis "depends on the degree to which it appears the hirer's legal right of control, however great or small, was similar for all members of the putative class—as evidenced, for example, by a standard contract that was common to all." Stressing the importance of determining how much control the hirer retains the right to exercise, as opposed to how much control the hirer actually exercises, the court framed the question as follows: "...is there a common way to show [the hirer] possessed essentially the same legal right of control with respect to each of its carriers? Alternatively, did its rights vary substantially, such that it might subject some carriers to extensive control as to how they delivered, subject to firing at will, while as to others it had few rights and could not have directed their manner of delivery even had it wanted, with no common proof able to capture these differences." Again, the key question in such cases is the availability of classwide proof regarding the right to control.

Implications for Employers

State and federal governments have stepped up efforts to identify companies that are misclassifying employees. For example, the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) have entered into a memorandum of understanding in an effort to "improve compliance with the laws and regulations administered by the IRS and DOL." The DOL similarly has entered into deals with many state labor departments (including those of California, New York, and Washington), hoping to improve compliance with applicable employment and tax laws. A single claim with a state agency can therefore trigger a full-scale audit of service providers classified as independent contractors in the past several years. In highlighting the class action risks associated with the misclassification of employees, Ayala serves as a wake-up call for all employers, especially those in California. To minimize the risk of employee misclassification and potentially expensive class actions brought by workers misclassified as contractors, employers should, at a minimum:

1. Ensure that they sufficiently understand how to properly classify workers and grasp the significance of the "control test." While other factors such as those in the IRS' "20-factor" test are relevant, in California, focusing on control is critical;
2. Take steps to ensure that those it has hired as contractors (as well as those it will hire in the future) are correctly classified. Such steps should include understanding the extent of control the company will have over the contractor, the nature of the work to be performed, how long the contractor will perform the work, and reviewing any documentation describing the relationship;
3. Review form contracts used with contractors. Ayala underscores that a contract likely will be important in any analysis of the right to control the contractor in question, as well as all those similarly situated. Companies should, therefore, carefully review their independent contractor/consultant contract with counsel to ensure that the contract does not betray a company's control over how a contractor does his or her work, including a review of those provisions addressing the termination of the relationship;
4. Consider adding mandatory arbitration and class action waiver provisions in their employment and consulting agreements. Where an arbitration agreement already exists, but does not include a class waiver, consider adding such a waiver. Post-Ayala, employers should anticipate an increase in class actions involving independent contractors. An arbitration clause that includes a class waiver should decrease the likelihood of getting hit with such a class action as recent decisions suggest that employers will be able to enforce such waivers²; and
5. Take disputes with contractors seriously. Where risk of misclassification is high, employers should consider resolving the dispute early and securing a properly drafted release. Similarly, employers should not take agency claims for granted as these may mushroom into full-blown audits or class action matters. Again, where the risk of misclassification exists, consider an early amicable resolution.