On September 8, 2011, the California legislature passed Senate Bill 459 prohibiting the willful misclassification of individuals as independent contractors. Labeled by some as the "Job Killer Act," this new legislation creates civil penalties of between $5,000 and $25,000 per violation. In addition to making it illegal to willfully misclassify individuals as independent contractors, the new law will also prohibit charging fees to or making deductions from the compensation paid to those misclassified workers. Although still requiring Governor Jerry Brown's signature, it is anticipated that this legislation will become law within 30 days.
The Law
SB 459 adds two new Labor Code sections, 226.8 and 2753, which
set forth the provisions of the new law with which all employers
need to comply. Specifically, section 226.8(a) provides that it is
unlawful for any person or employer to willfully misclassify an
individual as an independent contractor. An employer who has
willfully misclassified an individual is also prohibited from
charging that individual a fee or making any deductions from the
individual's compensation where such fee or deduction would
have been prohibited if the individual were not an independent
contractor. Subdivision (a) of 226.8 also provides a list of the
prohibited fees and deductions, including goods, materials, space
rental, services, licenses, repairs, maintenance and fines.
Subdivision (b) imposes penalties of between $5,000 and $15,000 for
each violation in addition to any other penalties permitted by law.
Under this new legislation, every deduction or fee charged to a
willfully misclassified independent contractor could give rise to a
separate penalty. Moreover, if either the Labor Workforce
Development Agency (LWDA) or a court determines that the person or
employer has engaged in a pattern or practice of violations, the
penalty is increased to between $10,000 and $25,000 per violation.
(§ 226.8(c)).
Section 226.8 also includes a non-monetary penalty. Any person or
employer who has violated subdivision (a) must prominently display
a notice on its Internet Web site (or if there is no Web site, in
an area accessible to all employees and the general public) which
states: (1) it has committed a serious violation of the law by
engaging in the willful misclassification of employees; (2) it has
changed its business practices to avoid further violations; and (3)
that any employee who believes he is being misclassified may
contact the LWDA. The notice must also include the mailing address,
email address and telephone number of the LWDA. (§ 226.8(e)).
Additionally, the notice must be signed by an officer (or owner)
and must be posted for one year. (§ 226.8(f)). The new law
also provides that any licensed contractor who violates section
226.8(a) must be reported to the Contractors' State License
Board, which must initiate disciplinary action against the
offending contractor. (§ 226.8(d)).
To prevent employers from avoiding these penalties and notice
requirements, successor corporations or businesses are liable for
the former entity's acts where one or more of the same
principals or officers are engaging in the same or similar
business. (§ 226.8(h)).
Significantly, the version of SB 459 passed by the Senate was much
watered down from the version initially proposed. The initial
proposal contained onerous record-keeping requirements, that would
have required employers to keep records related to all independent
contractors for two years. It would also have made it a misdemeanor
to fail to keep those records or provide the LWDA access to them.
The proponents of the original Bill also wanted all employers to
give independent contractors a form created by the EDD specifying
(1) that they were classified as an independent contractor; (2) the
factors used by the EDD to determine independent contractor
classification; (3) the details of the independent contractor's
tax obligations; (4) the telephone numbers for the EDD and the
Labor Commissioner; and (5) a notice that they could seek advice
regarding their employment status. While these provisions were also
dropped, they may resurface in the future.
Purpose
According to proponents of the legislation, reports show that 10 to 30% of employers misclassify workers as independent contractors, costing the state billions in lost revenue. In 2008, the Tax Audit Program conducted 6,356 audits and investigations, resulting in assessments totaling $193,761,599 and identifying 64,539 previously unreported employees. Proponents argue that this legislation will help address the loss of standard employee protections, such as minimum wage, overtime, health and vacation benefits, anti-discrimination laws, and safety regulations, which do not apply to independent contractors. Although affecting all industries, the new law will have a significant impact on construction and transportation companies as well as employers using seasonal, short-term, and direct salespersons.
The Test For Independent Contractors v Employees
This new law is particularly troublesome because the test for establishing whether a worker is an employee or an independent contractor is far from straightforward. Indeed, the California Department Of Industrial Relations states on its Web site: "There is no set definition of the term 'independent contractor' for all purposes, and the issue of whether a worker is an employee or independent contractor depends upon the particular area of law to be applied." Generally, an employee is an individual hired to perform services where the employer retains the right to control the manner and means of the employee's work. In contrast, an independent contractor is under the control of the principal only as to the result of his work and not as to the means by which such result is accomplished. Courts have established a multi-factor test to differentiate between these two standards, which is highly fact dependent. Under this new law, applying that test correctly is going to be critical to avoid the hefty penalties associated with getting it wrong.
Enforcement
The Labor Commissioner is charged with enforcement of this new law, but like other provisions of the Labor Code, it gives affected individuals the right to file a complaint. Although the bill does not specifically list its provisions under the Private Attorney General Act (PAGA), it could potentially give rise to PAGA representative actions as well.
What Does It mean For Your Business?
The potential civil penalties arising from this new law are
astronomical. For example, consider the penalties for a worker
improperly classified as an independent contractor who is charged a
fee to rent equipment essential to perform his duties. The civil
penalties for one year for this one individual could be tens of
thousands of dollars depending on the interpretation of "each
violation" and the penalty imposed. That penalty could rise
into the hundreds of thousands of dollars if a court finds a
pattern and practice of willful misclassification. Multiply that by
dozens or hundreds of misclassified workers and the numbers spiral
out of control.
The true impact of this new legislation, however, will hinge on
the interpretation of "willful misclassification."
Originally defined as "voluntary and intentional," the
Bill now defines willful misclassification as "avoiding
employee status for an individual by voluntarily and knowingly
misclassifying that individual as an independent contractor."
This change was intended to reflect a heightened standard so as to
avoid unintended consequences. Indeed, legislative staff commented
during passage of the Bill that "willful, generally an
intentional or voluntary violation of a known legal duty, is a
higher test and may make it more difficult to find a violation,
thereby constraining the number of enforcement actions."
In discerning the meaning of "willful misclassification"
other Labor Code provisions that apply a willfulness standard may
also be instructive. Terms such as "knowingly and
intentionally" (§ 226.6) and "willful
misconduct" (§ 4553) have been interpreted to suggest
that "willfulness" requires the person to know that the
thing which they are doing is wrong. Indeed, the California Supreme
Court, in analyzing willfulness in the context of one Labor Code
provision, stated: "Willfulness necessarily involves the
performance of a deliberate or intentional act or omission
regardless of consequence." Mercer-Fraser Company v.
Industrial Accident Commission (1953) 40 Cal. 2d 102, 117.
Conclusion
Employers should be vigilant to ensure that they have a sound basis for their decision to classify workers as independent contractors to avoid these penalties. Although the California Supreme Court's previous interpretation of "willfulness" suggests that employers will be protected unless they know that they have misclassified workers, interpretations can change between different statutory provisions, and this law remains untested. Furthermore, where workers raise concerns about their classification, employers cannot simply put their head in the sand and claim ignorance of the misclassification. At a time when the State is desperate for revenue, this is one to watch.
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