On April 30th, a peculiar earthquake rocked the Golden State. The locus of the jolt wasn’t deep subsurface but reverberated out from the hallowed chambers of the state’s Supreme Court. And while this is a relatively quiet tremblor thus far, the aftershocks may well reshape some key social, economic, and business systems and norms.
Judicial decisions usually turn on narrow questions. But sometimes a ruling squarely addresses pressing social issues with consequential results. The California Supreme Court’s unanimous ruling on key questions of worker classification standards in the Dynamex Operations West case on April 30th is a major shift on a critical question with wide-ranging impacts. Observers see it as a clear victory for workers and their advocates and a challenge for a quite a few businesses that adopted a model relying on independent contractors.
At issue was the proper standard, as well as burden of proof, for classification of workers by employers under the state’s jurisdiction. The Court dropped the current 10-factor test noting the difficulty it presents to both hiring businesses and workers “to determine in advance how a particular category of workers will be classified, [thereby] leaving the ultimate…determination to a subsequent and often considerably delayed judicial decision.”
In place of the traditional test, the Court endorsed a simpler “ABC” standard. Under the ABC test, a worker is presumed to be an employee, unless: A) The individual is free from the employer’s control and direction; B) The individual performs work that is outside the usual course of the employer’s business; and C) The individual customarily engages in an independently established trade, occupation, profession, or business of the same nature as that involved in the work performed.
The Los Angeles Times further elaborated that companies that want to classify workers as contractors and avoid paying them wages and benefits as required by state law must prove the workers are running their own businesses. Legal scholars, attorneys, unions, and workers’ advocates contend the outcome raises questions about an employment model — designating workers as independent contractors rather than employees — favored by Silicon Valley start-ups and that has been growing in traditional sectors as well. The ruling will strengthen protections for workers. Some businesses may need to shift away from using independent contractors and other firms with regular employees may be stronger competitors than before the ruling as a result. The lion’s share of workers in the US are covered by traditional employer/employee relationships. That dominant system evolved to offer mutual benefits to investors, business owners, and workers. Both the social contract for workers and our public system of laws and regulations to protect workers are largely premised on this model.
The practical effect on companies’ misclassification of workers is significant. In the California case, the nationwide package and delivery service provided by Dynamex Operations West was performed by drivers who were classified as employees until 2004. Thereafter Dynamex deemed drivers as independent contractors. It was far from simply a rhetorical shift. When workers are no longer considered employees, they and their families lose employer contributions toward benefits such as health insurance, retirement, and social security and may be ineligible for unemployment insurance or workers’ compensation. As firms jettison costs, workers shoulder increased risks and costs, lack protections such as wage and hour requirements and occupational safety provisions, and have fewer remedies to address discrimination, abuse, and harassment. One calculation suggests that shifting from direct employees to independent contractors may lower or “move off budget” 20 to 30 percent of labor costs. But moving those costs off a business’s budget doesn’t make them disappear — it shifts them to the backs of workers, their families, and taxpayers. As the Court noted “the potentially substantial economic incentives [for a firm to misclassify workers]…include the unfair competitive advantage the business may obtain over competitors that properly classify similar workers.”
The ruling is good for taxpayers. Worker misclassification to independent contractor status is so widespread that the California State Labor Commissioner estimated that it has been reducing payroll revenues to the state by $7 billion annually. When misuse of the classification system cuts revenues, other taxpayers pay more or state spending priorities and benefits to citizens get cut. There are differential impacts across companies as well. Some businesses may gain, and others may face some jeopardy from the ruling. If two companies have employees earning $18 per hour (all costs included) and one shifts their employee to independent contractor status, that pay out may fall from $18 to only $12.60 per hour. That is a large, unfair price and cost advantage if the status is misclassified. As our earlier blog noted, lowering costs by a firm’s misclassification of workers falsely signals lower costs to consumers that don’t reflect the true, larger impacts.
The ruling raises challenges for gig economy business models such as Uber, Lyft, and others. They’ll need to decide how and if they can comply with a new standard in California. The ruling of course only affects the Golden State. But as host to Silicon Valley and a disproportionate share of the country’s red-hot software development and start-up venture capital ecosystem, the ruling has a direct and indirect influence. Beyond Uber and Lyft, other firms in the state, such as Grubhub, FedEx, as well as many modest-sized and newer firms that rely on the same model, may have to reconsider reliance on independent contractors. But could the ruling be a “blessing in disguise?” Quality and brand reputation depend on customer/worker interactions, as many service businesses re-learn each day. Can user-friendly mobile screens and slick algorithm make up for disgruntled workers? One study shows that as few as 4 percent of Uber drivers remain on the platform from one year to the next. A more stabilized employee/employer model might just lead to much-improved worker loyalty and dampen such an alarming churn rate. Wouldn’t that cut cost of customer acquisition and retention?
In the ruling’s aftermath, more businesses will adopt compulsory arbitration provisions in independent contractor agreements. Labor law attorneys already noted that the effect of the California decision on Uber will be delayed somewhat due to their standard “binding arbitration” clause. The arbitration requirement makes it harder to get legal recourse or regulatory relief in the courts through class action suits. Other firms are already being advised to expand use of arbitration clauses as potential protection — or to delay a reckoning — from the ruling in California. This approach gets added tradition under the US Supreme Court’s May 21st 5-4 ruling in Epic Systems Corporation. The Court’s narrow majority decision strengthened the hand of employers to use binding arbitration clauses in hiring contracts that effectively abrogate workers’ class action efforts to litigate compliance under the National Labor Relations Act.
The battle is joined on issues that will significantly shape the future of work in the gig economy and other sectors in California and well beyond. California is now aligned with New Jersey and Massachusetts standards for worker classification. Those three states alone account for 25 million workers. And some are forecasting that “other states are highly likely to follow California’s example and establish similar precedents and new standards.” But there is momentum in the opposite direction as well. Our Future of Work Initiative colleagues’ recent blog noted that many states considered bills to alter their standards governing worker classification in 2016-2018 sessions. All would ease the way to switching to independent contractor status and thereby “in fact create more economic insecurity for workers.” For a tally of actions to adopt or reject these proposals, see this NELP update.
Is it possible to rise above the regular skirmish lines and find a consensus for change? Now is the time for concerted work to develop laws and regulations that better balance the interests of workers, businesses, investors, communities, consumers, and society. Probably even more states will become legislative, judicial, and regulatory battlegrounds — as well as potential proving grounds for innovative solutions. However, most worker protections and regulations, such as Fair Labor Standards Act and National Labor Relations Board provisions, are federal and national issues. For decades, one interest or another held and often exercised veto over exploring a modernization of the federal standards for classification. With the evolution of our economy and business models, the time seems ripe to find balance points that would be served by an artful update of an aging system.
Keep in touch
Learn how the Economic Opportunities Program is helping low- and moderate-income Americans connect to and thrive in a changing economy. Follow us on social media and join our mailing list to stay up-to-date on publications, blog posts, and other announcements.