A landmark decision issued by the California Supreme Court will have far-reaching implications for any California businesses that use contract workers, across all industries and especially those in the "gig" economy, like Uber and Lyft.

The unanimous decision last week, in a case brought by drivers working for a delivery company, puts in place a three-part test to determine who can be classified as an independent contractor.

This decision expands the definition of "employee" under the California Wage Orders and imposes an affirmative burden on companies to prove that independent contractors are being properly classified.

As a result of the California Supreme Court's decision, the court adopted a new standard for determining whether a worker is "employed" by a business. The new "ABC" test mandates that a worker IS an employee unless the business meets all three of the following criteria:

• A - That the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact.
• B - That the worker performs work that is outside the usual course of the hiring entity's business.
• C - That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

The decision specifically applies to wage orders of the state's Industrial Welfare Commission, which regulates wages, working hours, work breaks and other conditions.

The ABC test applies only to alleged misclassification under California's wage orders. It is therefore possible that a worker could be deemed an employee under an applicable wage order (and thus able to pursue claims for minimum wage and overtime violations and the like), and a contractor under other laws (governing, for example, business expense reimbursement, payroll taxes, unemployment benefits and compensation claims that arise outside the wage orders).

It is unclear how California's courts and its Department of Industrial Relations will apply the new test, and specifically, the critical question posed by Part B: When is a worker performing work that is outside, versus within, the entity's business? Many businesses in the so-called gig economy are uniquely at risk with respect to this inquiry.

Employee Classification in California up to Now

As an employer, you are no doubt familiar with the need to decide whether a worker is an employee or a contractor. If a worker is an employee, you as the employer then have specific legal obligations, such as withholding taxes from their wages, meeting wage and hour laws, and providing workers' compensation insurance. If a worker is an independent contractor, you don't have to meet most of these kinds of obligations.

It has always been difficult to make the proper distinction between employee and contractor - in California the common test for identifying an employee relationship has long been to examine who has the right to control the manner and means of accomplishing the work at issue.

After hearing Dynamex Operations West, Inc. v. Superior Court, Cal., a case that has been in litigation for nearly 20 years, the court held that any test adopted should have a broad application to effectuate the purpose and objectives of the wage orders. They ended up scrapping the commonly-used standards from two earlier cases (Borello, 1989 and Martinez, 2010) in favor of the more rigid "ABC" test used by several other states.

The Criteria of the New ABC Test

The first test should not come as too much of a surprise to businesses, since it is similar to the common law standard with which most are already familiar. It is the B and C tests that will be the game-changers.

A: Free from Control and Direction
The court concluded that a worker who is, either by contract or by practice, subject to the type and degree of control a business typically exercises over employees should be considered an employee. Accordingly, businesses must now establish that workers are free of such control to meet this part of the test.

The court confirmed that a business "need not control the precise manner or details of the work" in order to be found to have maintained the necessary control sufficient to lead to a finding of employee status.

As we noted above, this is familiar territory for most businesses.

B: Outside the Usual Course of Business
This second test tries to determine whether workers can reasonably be viewed as individuals who are providing services to the business in a role comparable to that of an employee, rather than in a role comparable to that of a traditional independent contractor.

Workers whose roles are "most clearly comparable" to those of employees include workers whose "services are provided within the usual course of the business" and would "ordinarily be viewed by others as working in the hiring entities' business."

So, this criterion expands those within the definition of employee to include almost any worker who engages in the same kind of business as the hiring entity.

The court used the example of a retailer that hires a plumber or electrician to perform maintenance at its establishment. This would be hiring someone outside of the company's regular business and thus would demonstrate independent contractor status. On the other hand, a clothing manufacturer that hires a work-at-home seamstress, or a bakery hiring a cake decorator, would typically not be able to make such a demonstration.

C: Customarily Engaged in Independent Trade
The third test attempts to identify workers who have created an independent business. If a worker has independently made the decision to go into business for him- or herself, they are likely to be found to satisfy this final criterion. If, on the other hand, they are "simply designated as an independent contractor by the unilateral action of a hiring entity," there is a substantial risk they will be found to be employees.

The upside? The court stated that a business does not necessarily have to prove that workers in question took steps such as incorporation, licensure, advertising, etc. to pass this test.

The downside. The court also said that the simple fact that a company does not prohibit or prevent a worker from engaging in such an independent business is insufficient to establish that workers have independently made the decision to go into business for themselves.

What the Future Holds

We can't emphasize enough what a dramatic shift this ruling is for California wage and hour law. The court now imposes a burden on businesses to defend their classification of workers as independent contractors, and misclassification can result in significant legal exposure.

It is helpful that along with their decision the court provided a framework for complying with the ABC test, but we still will have to wait to see how California courts will apply the new standard, which may take several years.

However, given the significance of this decision, companies should immediately and carefully re-examine their contractor classifications to ensure compliance with the new rules.

Preferred Partner of