Independent Contractor v. Employee: Considerations When Scaling in California
Under California law, independent contractors are generally less costly to a company than an employee because they do not require costs associated with, inter alia, workers’ compensation insurance, unemployment insurance, and entitlements such as overtime, meal and rest breaks and reimbursement for necessary work-related expenses.[1] This makes independent contractors more desirable than employees, at least initially, when trying to expand.
The independent contractor may also genuinely not want to be an employee because they value or need freedom over their time. In trying to proceed with independent contractor relationships, parties to a contract should remember that workers are presumed to be employees unless the hiring entity shows otherwise. They should also remember there are steep penalties for misclassifying an employee as an independent contractor, as discussed below.
The ABC Test
The “ABC test” sets forth factors a company must meet in order to classify a worker as an independent contractor, subject to exceptions. The test is as follows:
(A) The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
(B) The worker performs work that is outside the usual course of the hiring entity’s business.
(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.[2]
Typically, prong B is the hardest to meet. In order to meet prong B, the independent contractor essentially cannot do work that is related to the company’s business. An example of meeting the second prong is a retail store hiring an outside electrician to install a new electrical line.[3] An example of not meeting the second prong is a clothing manufacturing company hiring work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that the company will sell.[4] Generally, paralegals and legal assistants do not meet prong B in a law firm, since they perform work related to a firm’s business.
The Borello Factors
There are exceptions to the ABC test for certain occupations, including actively licensed lawyers and private investigators. When, as here, the ABC test does not apply to workers, generally, the Borello factors should be applied to determine whether a worker should be an employee.
The Borello factors are as follows:
(1) Whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result. The Borello Court referred to this as the “principal test” of an employment relationship. An independent contractor would have control over the manner and means of accomplishing the result.
(2) Whether the hiring party has the right to discharge at will, without cause.
(3) Whether the one performing services is engaged in a distinct occupation or business.
(4) The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision.
(5) The skill required in the particular occupation.
(6) Whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work.
(7) The length of time for which the services are to be performed.
(8) The method of payment, whether by the time or by the job.
(9) Whether or not the work is a part of the regular business of the principal, and
(10) Whether or not the parties believe they are creating the relationship of employer-employee.[5]
These factors are typically evaluated in combination. Additionally, the Borello Factors are applied to professional services contracts, business-to-business contracts, construction subcontractor contracts, and referral agency contracts, if certain other criteria are met.[6]
It is possible for attorneys to be independent contractors if they can, for example: control the manner and means of performing work for the hiring firm, set their own hours, use their own equipment, and work for other firms. Hiring firms would be wise to ensure their attorney independent contracts comply with the Borello factors.
Bona Fide Business-to-Business Contracts
Another way companies can engage non-employees include: bona fide business-to-business contracts. These contracts provide that a sole proprietor or other business entity can act as a “business service provider” to another “contracting business.”[7] Think: a paralegal who creates a business for herself and offers her services to multiple firms through UpWork.
Some key requirements include: The contracting business must demonstrate that the business service provider: is actually “free from the control and direction of the contracting business entity in connection with the performance of the work”; has any required business license or tax registration; provides services directly to the contracting business rather than to customers of the contracting business (with exceptions); can set its own hours and location of work; can negotiate its own rates; provides its own work equipment. The contract must also be in writing and specify the payment amount, applicable rate of pay, services to be performed and the payment due date.[8]
Consequences for Misclassification of Employees
Misclassifying an employee as an independent contractor can result in a company being subject to penalties and, for nonexempt workers like paralegals and legal assistants, backpay for unpaid overtime. Individuals and companies that knowingly misclassify their workers as independent contractors may be subject to “a civil penalty of not less than $5,000 and not more than $15,000 for each violation, in addition to any other penalties or fines permitted by law.”[9] A non-exempt misclassified employee could also be entitled to backpay in the form of unpaid overtime plus interest, as well as premium pay for meal and rest periods that the company failed to provide the worker.
So hiring employees may be the safest bet, at least for non-lawyer workers. In any case, it behooves hiring entities to take extreme caution when engaging independent contractors.
[1] See e.g., IWC Order 4-2001, Cal. Lab. Code § 2802.
[2] Dynamex Operations W., Inc. v. Superior Court of L. A. Cnty., 4 Cal.5th 903, 957-59, 61-63 (2018) (“Dynamex”)
[3] See, e.g., Enforcing Fair Labor Standards, 46 UCLA L.Rev. at p. 1159 cited in Dynamex supra, 4 Cal.5th at 959-60.
[4] (cf., e.g., Silent Woman, Ltd. v. Donovan (E.D.Wis. 1984) 585 F.Supp. 447, 450-452; accord Goldberg v. Whitaker House Coop, Inc. (1961), 366 U.S. 28, 81 S.Ct. 933 ) cited in Dynamex.
[5] S.G. Borello Sons v. Department of Industrial Relations, 48 Cal. 3d 341, 350-351 (Cal. 1989)(“Borello”)