Doing the Right Thing: Avoiding the Risks Inherent in Correcting Misclassification of Independent Contractors

So much has already been written about AB5¹ , and yet, so much more is left to discuss. Many articles have been written on the overbreadth of the new law, many questions posed as to the exemptions seemingly arbitrarily granted for certain workers, and many news pieces on the costly impact to California businesses, such as the darkened curtains of local symphony orchestra non-profits² .

Lately, coverage of AB5 has shifted to legal challenges to the law.

First came the truckers, soon after Uber and Postmates and, last but certainly not the least, the freelance journalists³. California businesses and their attorneys are waiting with bated breath to see how those lawsuits play out. Others are exploring how to gain exemptions in 2020. Uber, Lyft, and Doordash have pooled together a reported $90 million dollar fund to push through a ballot measure that allows app-based drivers to remain classified as independent contractors despite AB5⁴ .

The UC Berkeley Labor Center reports that, although the planned ballot initiative claims to guarantee drivers 120% of the minimum wage ($15.60 in 2021), in reality, drivers could receive as little as $5.64 per hour – a non-livable wage⁵ .

Also in the news is the state of New York, which in addition to following California’s lead, is contemplating a compromise third worker category – the “dependent worker,” an independent contractor with limited employment rights, such as the right to unionize, strike, and demand minimum wage⁶. This year (and the next few to come) will certainly bring changes to the worker classification landscape. Whether the changes will be big, small, good, or bad, or maybe all of the above, we can only wait to see.

Meanwhile, however, employment lawyers are advising their clients as best they can. And one of the most common questions asked is: “How do we convert independent contractors to employees?”⁷. This question is, or should be, immediately followed up with: “Can we get a [prophylactic] release?”—as in a release of claims arising from the prior mis-classification of the worker.

This is a tricky question.

First, the relatively new California Government Code section 12964.5⁸ prohibits an employer from requiring an employee to sign a release as a condition of employment or continued employment. Knowing California courts’ stance on the employee’s relative bargaining power⁹ , it is highly risky to state that such a release is not, at least implicitly, a condition of continued employment. Releases under that section allow only “a negotiated settlement agreement to resolve an underlying claim under this part that has been filed by an employee in court, before an administrative agency, alternative dispute resolution forum, or through an employer’s internal complaint process.”

Because this provision is in the Government Code, and AB5 only extended the Supreme Court’s Dynamex decision¹⁰ to cover the definition of “employee” in the Labor and Unemployment Insurance Codes¹¹ , an otherwise misclassified independent contractor is, arguably, not an “employee” covered under Government Code Section 12964.5; and, therefore the parties may freely enter into a release agreement.¹²

A safer approach is, however, to operate under the assumption that the worker was most likely misclassified, because the retroactive “ABC” test, now codified by AB5, is almost impossible to satisfy in most circumstances. Most employers understand that, if their contractor is an integral part of their business, then that worker fails the “B” prong of the ABC test.¹³ If so, then the worker may be entitled to the protections of Section 12964.5, and a release obtained in the course of converting the independent contractor to employee would not be valid.

Additionally, Labor Code section 206.5 prohibits the release of a claim for “wages due” unless “payment of those wages has been made.” California courts have held that the enforceability of agreements to release claims for Labor Code violations turns on whether a bona fide dispute over the employee’s past wages exists.¹⁴

Perhaps then, the only avenue for an enforceable release is for the company to notify its workers of the potential misclassification issue, thereby establishing “an underlying claim that has been filed by [the worker] … through [the] employer’s internal complaint process.¹⁵” In essence, the company would obtain a release very similar to a Pick Up Stix-type release¹⁶. Such releases must only release past claims and must not purport to exonerate the employer from future violations. And, as a settlement of a bona fide dispute, the release must not condition the payment of wages concededly owed on the release’s execution¹⁷.

An employer who misclassified workers in the past has a good chance of successfully establishing a bona fide dispute; either in the nature or amount of any wages owed (e.g., whether the misclassified worker has worked any overtime, as the hiring entity was likely not keeping time records for the independent worker), or whether any penalties were owed (non-compliant meal and rest breaks, inaccurate wage statements, etc.).

To cover all bases, however, a release should explicitly exclude from its scope certain claims that are not susceptible to be waived or released by operation of law. Such non-waivable claims include any undisputedly due wages¹⁹ ; employee reimbursement and indemnification rights²⁰ ; and the employee’s right to bring actions for wrongful death and personal injury against the employer in certain circumstances²¹ .

Furthermore, an agreement between an employer and employee to work for less than minimum wage or not to receive overtime premium wages is void – the employee may still be entitled to receive the unpaid minimum wage and overtime, interest, and costs and attorney’s fees²² . An employee who did not receive minimum wage may also recover liquidated damages in an amount equal to the unpaid minimum wages and interest²³ .

In misclassification claims, the independent worker often alleges to have worked such a large number of hours that the compensation received for the worker’s services falls to a rate below minimum wage. Compounding this issue, the minimum wage calculation must also take into account any un-reimbursed expenses incurred by the worker²⁴ .

Thus, the employer obtaining a release from an independent contractor should require the worker to represent and warrant the number of hours worked, and must ensure that the consideration paid to the worker is sufficient to cover any unpaid minimum wages and overtime compensation. Otherwise, the release is vulnerable, and the employer risks liquidated damages and plaintiff’s attorney’s fees²⁵. Due to these risks, entities desirous of enforceable releases that would likely not trigger an agency investigation or a lawsuit are advised to consult an employment attorney before executing such releases.

[1] AB 5: WORKER STATUS: EMPLOYEES AND INDEPENDENT CONTRACTORS, Chapter 296, 2019-2020 Session, September 19, 2019 (hereinafter “AB5”).
[2] See, e.g., Shelley Henderson, Room with a View: Invasive AB 5, OC BREEZE, Jan. 2, 2020 (available at https://www.oc-breeze.com/2020/01/02/150260_room-with-a-view-invasive-ab-5/, last accessed Jan. 21, 2020); Sarah Weber, Special Report from Californians for the Arts: AB5 and the Arts Industries, ACSO.org, Nov. 16, 2019 (available at https://www.acso.org/index.php?option=com_dailyplanetblog&view=entry&year=2019&month=11&day=15&id=43:special-report-from-californians-for-the-arts-ab5-and-the-arts-industries, last accessed Jan. 21, 2020); Gabrielle Canon, California’s controversial labor bill has passed the Senate. Experts forecast more worker rights, higher prices for services, USA TODAY, Sept. 11, 2019 (available at https://www.usatoday.com/story/news/politics/2019/09/10/what-californias-ab-5-means-apps-like-uber-lyft/2278936001/); Carolyn Said, AB5 gig work bill: All your questions answered, SF CHRONICLE, Sep. 16, 2019 (available at https://www.sfchronicle.com/business/article/AB5-gig-work-bill-All-your-questions-answered-14441764.php).
[3] See, e.g., John F. Kunstler et al., California Truckers Drive Challenge to Dynamex and AB 5, NAT’L LAW REVIEW, November 18, 2019 (available at https://www.natlawreview.com/article/california-truckers-drive-challenge-to-dynamex-and-ab-5); Jennifer Carsen, Postmates, Uber challenge AB-5 in suit, HR DIVE, Jan. 3, 2020 (available at https://www.hrdive.com/news/postmates-uber-challenge-ab-5-in-suit/569697/, last accessed Jan. 21, 2020); Suhauna Hussain, Freelance journalists file suit alleging AB5 is unconstitutional, LA TIMES, Dec. 17, 2019 (available at https://www.latimes.com/business/story/2019-12-17/freelance-journalist-ab5-lawsuit).
[4] See, e.g., Kate Conger, Uber, Lyft and DoorDash Pledge $90 Million to Fight Driver Legislation in California, NY TIMES,
Aug. 29, 2019 (available at https://www.nytimes.com/2019/08/29/technology/uber-lyft-ballot-initiative.html?auth=login-google1tap&login=google1tap).
[5] Ken Jacobs and Michael Reich, The Uber/Lyft Ballot Initiative Guarantees only $5.64 an Hour, UC BERKELEY LABOR CENTER BLOG, October 31, 2019 http://laborcenter.berkeley.edu/the-uber-lyft-ballot-initiative-guarantees-only-5-64-an-hour/
[6] New York State Dependent Worker Act (A.08343/S.06538) (available at https://legislation.nysenate.gov/pdf/bills/2019/A8343); see also Rebecca Smith, New York State’s Dependent Worker Act falls short for gig workers, NATIONAL EMPLOYMENT LAW PROJECT BLOG, June 17, 2019 (available at https://www.nelp.org/news-releases/new-york-states-dependent-worker-act-falls-short-for-gig-workers/, last accessed January 21, 2020).
[7] This process requires: 1) proper termination of any existing contractor agreement; 2) suitable messaging for the changes; and 3) proceeding with the company’s usual hiring practices.
[8] Added Stats 2018, ch 955, § 4 (SB 1300), effective January 1, 2019.
[9] See, e.g., Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal.4th 83, 115 [99 Cal.Rptr.2d 745, 6 P.3d 669] (“[W]e must be particularly attuned to claims that employers with superior bargaining power have imposed one-sided, substantively unconscionable terms as part of an arbitration agreement.”); Ontiveros v. DHL Express (USA), Inc. (2008) 164 Cal.App.4th 494, 509 [79 Cal.Rptr.3d 471] (“The Court finds that in light of the multiple provisions that are substantively unconscionable, the agreement shows on its face an intent to impose upon Plaintiff, as the weaker party, an inferior forum that works to the employer’s advantage.”).
[10] Dynamex Operations W. v. Superior Court (2018) 4 Cal.5th 903, 232 Cal.Rptr.3d 1, 416 P.3d 1.
[11] Lab. Code §§ 2750.3; 3351 (section 3351 extends the definition of “employee” under section 2750.3 to California’s workers compensation system only as of July 1, 2020).
[12] This obviously assumes that the company has not already been hit with a misclassification claim either in court or before an administrative agency, which the parties are clearly free to settle.
[13] Dynamex, 4 Cal.5th at 961 (“[A] hiring entity must establish that the worker performs work that is outside the usual course of its business in order to satisfy part B of the ABC test.”)
[14] See Watkins v. Wachovia Corp. (2009) 172 Cal. App. 4th 1576, 1587, 92 Cal. Rptr. 3d 409 (distinguishing between wage claims that are “concededly due” from those wage claims where a bona fide dispute exists). Some may argue that the entire agreement may be void if it is in violation of section 206.5, but no court has granted such sweeping scope to the provision. A “severability cause” or “savings clause” is, nevertheless, always advisable.
[15] Gov. Code § 12964.5.
[16] Chindarah v. Pick Up Stix, Inc. (2009) 171 Cal.App.4th 796 [90 Cal.Rptr.3d 175]
[17] Id. at 803.
[18] Lab. Code § 2804.
[19] Lab. Code § 206.5.
[20] Lab. Code §§ 2800, 2802.
[21] Lab. Code § 2803.
[22] Lab. Code § 1194.
[23] Lab. Code § 1194.2.
[24] A failure to reimburse a worker for work-related expenses may reduce that worker’s income below minimum wages, and be a basis for a constructive termination claim as well. See Vasquez v. Franklin Management Real Estate Fund, Inc. (2013) 222 Cal.App.4th 819, 828-829, 166 Cal.Rptr.3d 242 (employee was paid less than the minimum wage a result of paying for the gasoline and vehicle maintenance his schedule required).
[25] These risks are in addition to potentially serious PAGA penalties that exceed the scope of this article. See generally, Lab. Code §§ 2698 et seq.