Danger: Misclassifying Employees Can Lead to Huge Liability!

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1 Danger: Misclassifying Employees Can Lead to Huge Liability! Paying your workers and laborers as independent contractors? Avoiding paying overtime just because certain employees are on salary? Think twice. These employment practices could potentially end up being the most costly in the hundreds of thousands of dollars--mistakes your business could experience. California law presumes that all employees are non-exempt employees unless employers successfully prove that they are independent contractors within the meaning of the law or that they are exempt. Under California s wage and hour laws, all employers (with some exceptions) owe to non-exempt employees the following duties, to: (1) pay at least minimum wage; (2) provide meal, rest, and recovery periods; (3) pay overtime; (4) provide itemized wage statements; (5) maintain accurate payroll records; (6) reimburse employees for certain business related expenses; and various other obligations. Some employers seek, at their peril, to avoid some or all of these obligations by classifying workers as independent contractors or as exempt employees. Such actions will expose employers to the employees claims for the unpaid wages, penalties, civil penalties or citations, and attorney s fees. As we discuss below, recent California state and federal court opinions have made it even easier for workers to be classified as non-exempt employees. The employee classification issue often arises in the context of class action litigation against large employers, but the resulting case law applies to large and small employers alike. Therefore, all employers should educate themselves on the law in this area and audit employment practices and policies, with the assistance of legal counsel, for red flags that could trigger potential liability under the Labor Code. Independent Contractor Misclassification In all of the following cases, the courts determining employment status disregarded independent contractor agreements and instead looked to the fact-specific practicalities and expectations of the working arrangement between the hiring party and independent contractor to examine the hiring party s right to control the worker s activities. Most of the court cases have been in the context of class action litigation, and these cases are instructive for small as well as large employers Employment Relationship Defined The plaintiffs in the case of Ayala v. Antelope Valley Newspapers, Inc. (2014) 59 Cal. 4th 522 were newspaper delivery couriers alleging they were improperly classified as independent contractors and denied overtime pay, meal and rest periods, expense reimbursements, and other rights in violation of the Labor Code. The California Supreme Court held that, under the common law, the primary 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 (quoting the opinion in S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations (1989) 48 Cal. 3d 341). Therefore, although the plaintiffs had entered into written contracts stating they were independent contractors, the Court disregarded the independent contractor label and emphasized the level of control the hiring party exerted on the plaintiffs despite such language in the contracts. Further, the Court emphasized that the existence of an employment relationship depends on the hiring party s right to control, whether or not that right is actually exercised. One of the strongest indicators of an employment relationship is whether the hiring party possesses the right to terminate the worker without cause. The Court acknowledged that other secondary factors could be used to assess an employment relationship (such as whether the worker was in a distinct occupation, whether the worker used his own tools, whether the worker set his own schedule, etc.), but held that the primary test for employment status would be the right to control test. Ultimately, the Court found that the trial court improperly denied class certification because the trial court mistakenly focused its attention on how the hiring party s rights were actually exercised instead of focusing on the hiring party s rights to control, regardless of how it exercised those rights. Similar to the Ayala case, the plaintiffs in the Dynamex Operations West, Inc. v. Superior Court

2 (2014) 230 Cal. App. 4th 718 case involved a class of delivery couriers who were allegedly misclassified as independent contractors and denied wage and hour rights under the Labor Code. The Court of Appeal s opinion in Dynamex is significant because it expands the definition of an employee. While the Ayala opinion examined only the definition of an employee under the common law, the Dynamex opinion addressed whether plaintiffs seeking class certification could use the alternate, broader definition of an employee found in Industrial Welfare Commission (IWC) Wage Orders for claims brought under those orders (such as failures to pay overtime, or to provide meal and rest breaks). Specifically, the Court held that for claims brought under an IWC Wage Order, to employ means (a) to exercise control over the wages, hours or working conditions, OR (b) to suffer or permit to work, OR (c) to engage, thereby creating a common law employment relationship. (citing Martinez v. Combs (2010) 39 Cal. 4th 35). The to suffer or to permit to work definition is particularly significant because it expands the definition of employer to any entity that has to ability to permit or to prohibit work. (Martinez, at 58.) On January 28, 2015, the California Supreme Court granted review of the Dynamex case making the opinion un-citable and non-binding. The California Supreme Court s review on this threshold issue is eagerly anticipated. The Right to Control Applying California law, several federal court opinions found employment relationships based on the employer s right to control notwithstanding the existence of independent contractor agreements. In Ruiz v. Affinity Logistics Corp (2014) 754 F.3d 1093, delivery truck drivers asserted they were improperly classified as independent contractors. The Ninth Circuit Court of Appeals found that the drivers were employees because Affinity controlled the manner and means of how the drivers performed their work. Affinity required its drivers to sign independent contractor agreements that gave Affinity the right to terminate without cause. The drivers were also given procedures manuals that outlined procedures of how to load the trucks, deliver and install goods, and interact with customers. Affinity controlled the drivers rates, schedules, and routes. Additionally, Affinity controlled the appearance of its drivers by requiring uniforms and prohibiting drivers from wearing earrings or showing tattoos. Affinity also closely monitored and supervised the drivers by requiring them to report to warehouses to attend meetings. The Court found that all of these details support the finding of an employment relationship. The case of Alexander v. FedEx Ground Package System, Inc. (2014) 765 F.3d 981, 988 involved facts similar to the Affinity case. FedEx classified its drivers as independent contractors, but the Ninth Circuit found that the drivers were employees under California law due to FedEx s right to control the manner and means of their work. FedEx controlled the drivers schedules, vehicles and appearance. FedEx argued that it did not, however, control specific routes, and drivers were given discretion over what routes to take or the order of package delivery. Importantly, the Court held that absolute control is not required to find employee status, and employee status can still be found even if there is some degree of freedom in the work. Overtime Exemption Misclassification Overtime exemption misclassification is increasingly litigated. Employers do not need to pay exempt employees overtime or to provide them meal and rest breaks, etc. Whether an exemption applies depends on the employee s job duties. A complete list of exemptions can be found at The following cases show that courts assessing whether an exemption applies will look past written job descriptions, and instead look at how an employee actually spends his or her work day. The courts will also examine the employer s realistic expectations for the job to see if an employee is expected to perform a high degree of nonexempt duties despite the exempt classification. In Duran v. U.S. Bank Nat. Ass. (2014) 59 Cal. 4th 1, the California Supreme Court reversed a lower court s decision to certify a class action brought by U.S. Bank employees who had been classified as exempt under the outside salesperson exemption. The plaintiffs were salaried employees alleging they had been misclassified as exempt and were thus entitled to overtime pay

3 which the employer failed to pay. To qualify for the exemption, employees must spend more than 50% of their workday engaged in sales activities away from the employer s place of business. While the Duran opinion primarily addresses class action procedure (and raises the burden for plaintiffs to obtain class certification), the opinion also reaffirms the requirements for the outside salesperson exemption. In examining whether this exemption applies, courts will examine both the job description and how the employee actually spends his or her time to see if more than 50% of the time is spent away from the employer s offices for sales activities. Courts will also examine whether how the employee spends his or her time diverges from the employer s realistic expectations. For example, evidence that shows that most of the company s sales force spends more than 50% of their time working inside the company s office will be relevant to show that the company s expectations regarding outside sales work was unreasonable. Thus, such evidence would tend to show that such employees were misclassified as exempt. In Martinez v. Joe s Crab Shack (2014), 231 Cal. App. 4th 362, the plaintiffs were salaried managerial employees of a restaurant chain. They allegedly had been misclassified as exempt and sought unpaid overtime. Despite the managerial discretion written into their formal job descriptions, the plaintiffs were assistant managers whose duties in practice were identical to the duties of nonexempt employees, and they practiced little managerial discretion. Further, the plaintiffs were expected to work at least 50 hours per week and were not paid overtime. The employer argued that the class should not be certified since the employees could not recall exactly how they spent their time (which the California Supreme Court in Duran had identified as an element in a misclassification case). The Court of Appeal, however, held that courts in overtime exemption cases must analyze the employer s realistic expectations and classification of tasks rather than ask the employee to identify in retrospect whether, at a particular time, he or she was engaged in an exempt or nonexempt task. The Court emphasized that the focus should remain on the employer s policies and procedures and the employer s realistic expectations. Potential Liability for Employers Under Labor Code 226.8, if an employer is found to have willfully misclassified employees as independent contractors, it can be fined $5,000-- $10,000 per incident if the misclassifications are isolated incidents. If an employer is found to have engaged in a pattern or practice of willful independent contractor misclassification, the employer can be fined $10,000 to $25,000 per incident in addition to other penalties authorized by law. Willful misclassification is defined as avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor. The Department of Labor Standards and Enforcement or the misclassified employee are authorized to seek these penalties in an administrative or civil action. Importantly, Labor Code also requires that if a licensed contractor is found to have violated this statute, the violation must be reported to the California State Licensing Board at which point the CSLB must initiate disciplinary action, up to and including loss of license, against that licensee. Additionally, if an employer is found to have misclassified an employee as exempt or as an independent contractor, that employer will also likely be found to have violated the wage and hour laws that were not followed due to the misclassification. Violating California s wage and hour laws can be financially crippling for an employer even if the violations were unintentional. Wage and hour violations typically carry lengthy statute of limitations periods (3 years for unpaid wages, and failures to provide meals and rest period). A misclassified employee s damages therefore can add up quickly and can expose even small employers to massive liability. To illustrate, an employer with just 10 employees earning $20 an hour over three years could be subject to a $156,000 liability ($200 a day x 5 days a week x 156 weeks) if it failed to provide those employees with statutorily required rest periods due to misclassification. Further, if both meal and rest periods were never provided, each employee may recover two hours of premium pay (an additional hour of pay at the regular rate) per day that a violation was found to have occurred. Therefore, the $156,000 exposure in our hypothetical above, would increase to $312,000 ($400 per day [2 hour premium pay of $40/hr for 10 employees] x 5 days a week x 156 weeks) if both meal and rest periods were never provided to employees. To simplify this complex information, we summarize the liabilities and penalties for the most

4 common wage and hour claims in the table below. Violation Relevant statutes Liability Meal period violation Cal. Labor Code 226.7, 512; 8 Cal. C. Regs 11010, et seq. Premium wage one additional hour of employee s regular rate of pay Rest period violation Cal. Labor Code 226.7; 8 Cal. Premium wage one additional C. Regs 11010, et seq. hour of employee s regular rate of pay Overtime violation Cal. Labor Code 510(a), 1194; 8 Cal. C. Regs 11000, et seq. Overtime rate 1 ½ times regular rate; interest, employee s attorney s fees and costs Minimum wage violation Labor Code 1182(b), 1194 Wages owed, interest, employee s attorney s fees and costs, liquidated damages Recordkeeping violation Labor Code 226, 1174 $750 penalty, additional penalties for willful failure to produce, employee s attorney s fees and costs Expense Reimbursement Labor Code 2802 Expenses owed, employee s attorney s fees and costs

5 Comment These recent case decisions demonstrate that courts will regularly look past written independent contractor agreements or written job descriptions and examine the fact-specific realities of workers work days to determine whether they were misclassified. Therefore, it is crucial for employers to educate themselves about misclassification issues and to revise their practices, if necessary, to avoid potential costly liability. --Christine C. Lee