On 30 April 2018, the California Supreme Court issued a sweeping decision, adopting a new expansive misclassification test that starts with the presumption that workers are employees: Dynamex Operations West Inc. v. The Superior Court of Los Angeles County. While not directly addressing the risks of misclassification in the franchise business model, the Court’s adoption of the “ABC test” to determine whether delivery drivers were improperly classified as independent contractors rather than employees certainly raises concerns for franchisors with operations in California.
Prior to 2004, Dynamex, a nationwide package and document delivery company, classified drivers who performed pickup and delivery work as employees. In 2004, Dynamex adopted a new policy and contractual arrangement under which all drivers were considered independent contractors rather than employees.
In April 2005, a class action complaint was filed alleging that, since December 2004, Dynamex misclassified delivery drivers as independent contractors. Plaintiffs argued they continued to perform the same tasks as they had when they were classified as employees with no substantive changes to the means of performing their work or the degree of control exercised by Dynamex. They claimed the misclassification led to Dynamex's violation of California’s Industrial Welfare Commission (IWC) Wage Order No. 9, which governs minimum wages, maximum hours, and meal and rest breaks, as well as various violations of the Labor Code. And, as a result of these violations, the plaintiffs alleged that Dynamex had also engaged in unfair and unlawful business practices under California’s Business and Professions Code section 17200. The case worked its way up to the California Supreme Court after Dynamex challenged an appellate court's ruling classifying Dynamex workers as employees.
The New “ABC Test”
Throughout the litigation, the plaintiffs and Dynamex argued different standards should be used for determining the question of employee status. Rather than select the standard proposed by either party, the Court adopted the so-called "ABC test" that is utilized in other jurisdictions (for a variety of purposes, but often in the unemployment insurance context), including Connecticut, Delaware, Maine, Massachusetts, New Hampshire, New Jersey, Vermont and Virginia. Under the Dynamex approach:
- First, there is a presumption that the worker is an employee. The burden is on the hiring entity to establish that the worker is an independent contractor who was not intended to be included within the wage order's coverage.
- Second, to meet this burden, the hiring entity must establish each of the three factors embodied in the ABC test:
A. That 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. 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.
Failure to satisfy any one of the three parts means that the worker will be treated as an employee.
Potential Impact on Franchise Companies
While commentators on the Dynamex decision have primarily focused on its potential to upend the gig economy, the decision is also alarming to franchisors that have operations in California.
In adopting the ABC test, the Court in Dynamex noted that “Because in many cases it may be easier and clearer for a court to determine whether or not part B or part C of the ABC standard has been satisfied than for the court to resolve questions regarding the nature or degree of a worker’s freedom from the hiring entity’s control for purposes of part A of the standard, the significant advantages of the ABC standard — in terms of increased clarity and consistency — will often be best served by first considering one or both of the latter two parts of the standard in resolving the employee or independent contractor question.”
In support of that position the Court cited two franchise cases: Awuah v. Coverall N. Am., Inc., 707 F.Supp.2d 80, 82 (D. Mass. 2010) (considering only part B of the ABC standard) and Coverall N. America v. Div. of Unemployment, 857 N.E.2d 1083, 1087 (Mass. 2006) (considering only part C of the ABC standard). Relying on parts B and C of the ABC test, the courts in those two cases found that franchisees in the Coverall franchise system had been incorrectly classified as independent contractors and were instead employees of the franchisor.
The California Supreme Court’s adoption of a standard that allows employee status to be determined by reference to the difference in the type of work performed or the customarily independent nature of the business being conducted does not address the realities of the franchise business model. Assuming the Dynamex case would be applied in the franchise context, the potential for California courts to avoid a control analysis under part A of the ABC test and instead rely on parts B and C of the test does not bode well for franchisors.
The franchise community will be watching carefully to see what effect the Dynamex decision may have on pending franchise cases where misclassification is alleged. Given the high stakes and sweeping language in the decision, franchisors with franchisees in California should work with counsel to closely monitor developments.