Companies are always looking for ways to lower their bottom lines, particularly when it comes to their staffing. Similarly, more and more workers are looking for flexibility to pursue personal business ventures and alternative work avenues outside of the traditional nine-to-five. Freelancing, or working as an independent contractor, is an attractive option for both California employers and workers.
But for California employers, a recent Supreme Court of California decision has severely limited employers’ abilities to classify workers as independent contractors. Because of this recent decision, employers may now be unwittingly walking into a trap when hiring someone as an independent contractor.
Dynamex Operations West, Inc. v. Superior Court was based on a class-action lawsuit waged against Dynamex Operations West Inc, a document and package company with big-name clients such as Amazon. The suit alleged that Dynamex sought to misclassify its delivery drivers and label them as independent contractors instead of employees.
Affirming the Court of Appeals’ prior judgment, the California Supreme Court clarified the definition of “independent contractor,” providing lower courts with more specific guidelines to follow when determining whether a worker is an “employee” versus an “independent contractor.”
The Dynamex Three Part “ABC” Test:
Previously, classifying a worker as an independent contractor was set forth in a multi-factor “totality of the circumstances” test set forth in the case S.G. Borello & Sons, Inc. v. Department of Industrial Relations.
Although the determination regarding independent contractor vs. employee in Borello examined a multitude of factors, the most important factor was the level and degree of control the employer had over the worker.
Generally speaking, the more control the employer had over how, when, and where the work was performed, the more likely the worker was an employee. Thanks to the Dynamex decision, the California Supreme Court has substantially narrowed employers’ ability to deem a worker an independent contractor.
Under the Dynamex three part test, the business has the burden of proving that the worker meets all three of the factors in order to be considered an independent contractor:
- They must show the worker is independent from any control of the employer;
- The worker performs in a capacity that is outside the core business of the company; and
- The employee has an established trade, business, or occupation outside of their employment
Under the Dynamex test, it is difficult to see how any worker could ever be classified as an independent contractor. Consider the following example: A successful blogger enters into an independent contractor agreement with another blogger to write articles for his/her website from her home.
Under the new test, it is very likely the employer will fail at least parts A and B of the test. To some degree, the blogger will need to control when the articles are finished and how they are written. Not to mention, the services are most certainly a core part of the blogger’s business (article writing).
Implications and Penalties for California Employers:
It is clear that those hit hardest by the ruling will undoubtedly be California employers using independent contractors. Fines for misclassification of an independent contractor can be levied against the company both from the state as well as from the IRS.
These fines can range from $5,000-$15,000 per violation for state labor code violations to a minimum of 1.5% of the wages paid levied by the federal government. And there’s even more bad news for employers: some of the labor code violations are enforceable through the California Private Attorney General Act, meaning attorneys’ fees and costs are recoverable by the misclassified worker, thereby further exposing California employers.
Hiring an independent contractor is an attractive option to most employers, especially small businesses. It gives a company the opportunity to have someone work fewer hours without the heavy burden of paying employment taxes or any state/federal withholdings. It also alleviates the employer from being required to make certain retirement contributions it offers to employees.
Not only does hiring an independent contractor appeal to businesses, it also appeals to workers. Many people are bootstrapping their own businesses and do not want to be beholden to a company where they are required to work particular hours. Others want the flexibility of indicating whether they will accept certain work and/or projects from their employer.
However, with the imposition of the Dynamex ruling, it is difficult to see how the incredibly successful “gig” economy can survive.
This ruling has many business owners concerned about the consequences of mislabeling someone as an independent contractor and being challenged. As a result, we may expect to see a slowdown in the hiring and creation of jobs, particularly in the small-business sector.
If you are an employer in the state of California and have independent contractors working for you, it is vital that you understand how misclassifying someone as an independent contractor versus as an employee can affect your bottom line. Contact Trestle Law today to discuss your businesses’ employment needs and how you can protect yourself.
Getting the courage to take a leap into entrepreneurship is tough on its own. Believe me, as a former law firm employee turned law firm owner, I know the challenges new business owners face. But, it’s time for me to put on my lawyer hat, and give you a rundown of the top 5 legal mistakes new business owners make time and time again. Hopefully, this list will help you avoid these pitfalls and get you moving in the right direction!
Failing to Budget for Professional Services
For many individuals, a business starts with a unique idea. Those marvelous ideas are honed, tinkered-with, and developed over late nights, early mornings, and lost weekends. For the majority of entrepreneurs, the leap from full-time job to business owner is not one taken lightly. The majority of entrepreneurs that I have worked with spend considerable time, energy, and funds before they fully commit to leaving their full-time jobs. They set aside capital for operating expenses, government fees, and office equipment.
The amount of energy and focus people are willing to dedicate to starting a legitimate business venture begs the question: why are so many entrepreneurs hesitant, or even downright against, setting aside startup capital to pay for professional fees?
Everyone knows lawyers and accountants can be expensive. But it can be even more expensive if you are stuck with fines and penalties for doing something incorrectly. One of the best pieces of advice I’ve received from a business owner friend of mine was, “work on your business, don’t work in your business.” It’s important to remember what your strengths are. Nobody is an expert at everything. It is better to hire out, contract out, or delegate out the work you know isn’t in your wheelhouse, and spend your time on your strengths.
Now, I know there are those do-it-yourself companies out there that can get your basic business structure set up, but those companies typically use boilerplate documents that don’t always contain the right provisions for your business. A well-crafted shareholder agreement or operating agreement is going to be essential down the road when you’re looking to sell your business, or solicit potential venture capital. No investor wants to give their money to a business with messy books.
Plan to set aside about $2,000-3,000 for professional services. I know that sounds expensive, but let’s be serious. A well-crafted website can set you back at least $2,000, so investing in something as crucial as your legal and financial stability will be well worth the money spent. Start vetting accountants and attorneys early on – preferably before you launch your business. Many attorneys offer consultations at no charge to you, so you can at least understand what kind of person you want to work with.
Finalizing your Brand without Knowing the Competition
I can’t stress this one enough. Your business is your brand. Consumers find you, identify you, and relate to you by the brand you choose. However, developing a brand that infringes on another already-existing brand’s rights can prove disastrous for a new business. You can be faced with litigation, damages, and ultimately have to change your business name. Imagine investing time, money, and energy in a business name and logo, only to get a cease and desist letter from an attorney saying you are infringing on their client’s trademark. Believe me, it happens more often than you think. I once helped an established local restaurant stop a fledgling restaurant in another county from using the same restaurant name.
Ultimately, the defendant restaurant wound up having to change its name. Hiring an attorney to perform a clearance search can really save your business dollars in the long run. Remember, trademark rights in the United States are not based on the first to register, but the first to use a particular mark in commerce. So, you can still infringe on another’s mark even if they do not have a federal trademark registration. An experienced trademark attorney can perform a clearance search and evaluate potential likelihood of confusion with other existing trademarks and common law marks that are in use.
Hiring without Developing HR Guidelines
Human Resource (or HR) guidelines provide a framework for how employees are expected to behave. They describe the company’s standards, objectives, and goals for all areas of employment. This includes termination, recruitment, benefits, compensation, and employee relations. HR Guidelines provide instructions on how staff should be performing their jobs and behaving. These are the policies that keep everyone on the same track, as moving parts of a machine designed to achieve a specific goal.
Without them, the parts cannot work in tandem, and you will end up with a fragmented, and ultimately broken workforce. This may seem like a dramatic way to look at things, but believe me, I’ve seen first-hand just how important proper guidelines can be in the workplace. People like to be aware of exactly what is expected of them. HR Guidelines make workers feel more confident and capable of working as part of a team. No business can survive without them.
Failing to Incorporate
The word ‘corporation’, stems from the Latin term, ‘corpus’ which means ‘body’. When a company incorporates, it evolves into a legal person in the eyes of the law. As such, it can be sued, sell and buy property, be taxed, establish contracts, and even commit crimes. Perhaps the most important aspect of a legal corporation, is that it provides protection for its owners regarding personal liability. A corporation becomes a legal entity, separate from those who created it.
Most often, I hear business owners state that they are not “quite there yet” with their business to warrant incorporating. That’s an understandable viewpoint, considering a corporation or LLC require certain annual/biannual filings, governmental fees, and added tax concerns. However, there’s that saying that goes, “dress for the job you want, not the job you have,” and I think the sentiments of that adage can apply to a business owner’s decision to incorporate. If you are running your business, and suddenly, you are “big enough” to incorporate, not only are you going to have to deal with the hassle of setting up your legal entity while also running your business, but you will need to change your bank accounts, and you will have to talk to your accountant about how transforming into a legal entity will affect your taxes for the year. Often times, while you may be worried about the cost of setting up the entity, you will benefit from its structure in the long run.
No Shareholder Agreements
Even though you’re not legally required to have a shareholder’s agreement, I can’t recommend it enough. And I’m not just talking an agreement that outlines how the profits will be shared. I believe that the most important part of a shareholder agreement is your exit strategy. Sadly, most US marriages end in divorce. A business relationship is very similar to a marriage in terms of tying yourself financially to another person. When the relationship ultimately breaks down, emotions run hot, making any kind of decision regarding the business much more difficult. In addition to an exit strategy, shareholder agreements ensure that everything remains fair and straightforward within a company. They ensure that responsibilities for shareholders and the running of the company have been properly planned. Without formal shareholder agreements, you increase the potential for conflicts arising between shareholders, leading to a disrupted and ineffectively run business.
I once witnessed the dissolution of a company where shareholder agreements weren’t implemented, due to the personal circumstances of one individual. Because there was no formal paperwork, each shareholder’s financial interest in the company was broken down and destroyed. Remember, a shareholders agreement can assist in raising finance from creditors and banks. It demonstrates the stability of a business, and shows that you are a sensible, forward-thinking business.
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