Competing Tests: Employee or Independent Contractor? Saving the Franchise Model

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Lewitt Hackman

Assembly Bill 5 took effect in California on January 1, 2020 and governs when a business can treat a worker as an employee as opposed to an independent contractor. Under AB5 and its “ABC” test, a hiring entity may only classify a worker as an independent contractor if:

A. The worker will be free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact;

B. The worker will perform work that is outside the usual course of the hiring entity’s business; and

C. The worker will be customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

Due to industry concern that AB5 could result in a determination that the franchise business model is an employment relationship between a franchisor and a franchisee and/or a franchisee’s employees, the International Franchise Association (IFA) proposed an amendment to AB5 to protect the franchisor/franchisee model.

As submitted, the IFA amendment stated that a franchisee would not be deemed an employee of a franchisor rather than an independent contractor unless a court of competent jurisdiction determined the franchisor exercised a type or degree of actual control over the franchisee or the franchisee’s employees not customarily exercised by a franchisor to protect the franchisor’s trademarks, service marks and/or trade dress, including quality control of products and services. The California State Legislature officially adjourned in August 2020 without adopting the IFA amendment.

To further complicate the California employee/independent contractor issue, on October 22, 2020, in an action questioning the application of AB5 to gig workers in the transportation business, a California appeals court ruled that an injunction restraining Uber Technologies Inc. and Lyft, Inc. from classifying their drivers as independent contractors was valid. The companies are considering an appeal to the California Supreme Court, whose 2018 ruling in Dynamex Operations West, Inc. v. Superior Court of Los Angeles spawned AB5. The appellate court’s ruling comes less than a week before California voters will be asked to decide Proposition 22, a ballot measure that would exempt Uber and Lyft from AB5 and keep rideshare drivers and delivery workers classified as independent contractors.

DOL Proposed Rule on Independent Contractor Classification

On September 22, 2020, the U.S. Department of Labor (DOL) under President Donald J. Trump issued its proposed Rule on when workers may be classified as independent contractors not subject to the minimum wage, overtime and other requirements of the Fair Labor Standards Act (FLSA), rather than as employees covered by the FLSA. If the proposed DOL Rule is accepted in its current form, employers will use a five-step test different from AB5’s “ABC” test to classify workers as employees and independent contractors and possibly eliminate the franchise industry’s concern that an employment relationship may be found to exist between a franchisor and a franchisee and a franchisee’s employees.

However, if adopted, the DOL’s Rule will not affect state laws or court decisions using different tests for independent contractor status, such as AB 5 in California, the “ABC” test in New Jersey, Connecticut, Massachusetts and other states, the right-to-control test applicable in New York and pending legislation in other states.

The DOL proposed a five-step process for determining if a worker is an employee or an independent contractor. The two primary factors in making this determination are:

  • The nature and degree of the worker’s control over the work performed for the potential employer; and
  • The worker’s opportunity for profit or loss based on his or her initiative or investment in the work.

Under the first factor, if a worker does not control his or her own schedule or does not have the ability to work for other employers, the worker will likely be found to be an employee. However, if a worker can set his or her own schedule and take work from other sources, the worker will likely be found to be an independent contractor.

Under the second factor, if a worker can only affect his or her own income by working more hours for a potential employer, the worker will likely be found to be an employee. Alternatively, if a worker can earn profits or suffer losses from his or her management of his or her expenditures, the worker will likely be found to be an independent contractor.

And, according to the DOL, if the two factors discussed above come to the same conclusion, “their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposite classification” so “the bulk of the analysis is complete.”

Consideration of the remaining three factors, the amount of skill required for the work, the degree of permanence of the working relationship and whether the work is part of an integrated unit of production, will not outweigh the assessment under the first two factors.

Public comments on the proposed Rule are due by October 26, 2020. The DOL must respond to the comments to prepare its final Rule, which could include revisions that incorporate worker and/or employer concerns.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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