Many California-based businesses depend on the use of independent contractors to handle certain specialized tasks and projects outside of their own expertise. Businesses that contract with independent contractors to perform certain services benefit from such a relationship because independent contractors are not entitled to several of the rights afforded to employees under California’s Labor Code, which can substantially increase a business’ overhead costs. Under the Labor Code employees have the right to a minimum wage, overtime compensation, meal and rest breaks, accurate and itemized wage statements, to name a few. Naturally, businesses have tried to use the “independent contractor” classification as a way to avoid the applicability of California’s strict labor laws, thereby saving substantial sums when it comes to their overhead costs. Misclassifying an employee as an independent contractor however, can result in costly litigation, as well as pecuniary and non-pecuniary penalties that outweigh the benefits of misclassification.

Pursuant to California Labor Code Section 226.8, it is unlawful for an employer to willfully misclassify an employee as an independent contractor.[1] “Willful misclassification” is defined as “voluntarily and knowingly misclassifying that individual as an independent contractor.” In 2015, broadening the sweep of liability under Section 226.8, a Court of Appeal in California held that liability under the section applies not only to the employer who make a misclassification decision with respect to an employee, but also to any employer who is aware that a joint-employer has willfully misclassified an employee and fails to remedy the misclassification. Noe v. Superior Court, 237 Cal.App.4th 316 (2015).

Many employers incorrectly assume that if they merely classify a worker as an “independent contractor” from the outset of the working relationship, then the worker is an independent contractor. A superficial classification of a worker as an independent contractor, that does not take into account the working relationship and applicable legal standards, is likely to expose an employer to a substantial risk of liability and litigation. The California Supreme Court’s recent landmark decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles County, provided a much stricter standard for determining independent contractor status than the previous common law test.

Under California’s prevailing wage and hour laws, a non-exempt employee is entitled to: (1) minimum wage; (2) meal and rest periods; (3) overtime; (4) itemized wage statements; (5) accurate payroll records; (6) reimbursement for business expenses; (7) timely payment of wages and other labor code requirements. Cal. Labor Code §§ 1182.12; 512; 510; 226; 200; and 204. Since independent contractors are not privy to such entitlements, employers who attempt to avoid the above obligations by misclassifying employees will likely be found to have also violated these requirements.

Thus, if an employer is found to have misclassified an employee in one respect, that likely means a waterfall of other violations. Employers in such a position are shell-shocked when they realize they are liable to at least one or several employees for multiple wage and hour violations. Furthermore, several of these violations carry with them statutory penalties and civil penalties which can be recovered directly by an employee, by the Labor Commissioner enforcing violations of the Labor Code, or through a Private Attorney General Act (PAGA) lawsuit brought by an employee. In California, the statute of limitations for these wage claims is typically three years, but in some cases the statute can extend to four years if an employee sues under Business and Professions Code Section 17200 for Unfair Business Practices. As such, it is more important now than ever for businesses to understand the consequences, both pecuniary and non-pecuniary, of misclassifying an employee as an independent contractor

Critically, for small businesses and employers, it should be noted that effective January 1, 2016, Labor Code Section 558.1 was enacted to allow employees who have had their rights violated under Labor Code Sections 203, 226, 226.7 1193.6 1194, or 2802 to hold liable any person acting on behalf of an employer who might be the owner, director, officer, or managing agent of the employer. Thus, for a small business owner who makes the mistake of misclassifying his or her employees, the potential exposure and liability extends beyond their business entity, as they may be held personally liable.

In addition to liability exposure for wage and hour violations for misclassification of employees as independent contractors, Section 226.8 imposes substantial penalties against an employer if the Labor and Workforce Development Agency (“LWDA”) or court determines the misclassifications were willful. Per Section 226.8(b), an employer may be subject to a civil penalty of at least $5,000 and up to $15,000 for each misclassification. Per Section 226.8(c), if the LWDA or court finds that the employer misclassified their employees, the employer is subject to a civil penalty of at least $10,000 and up to $25,000 for each violation. Thus, depending on how many employees were misclassified by an employer, these penalties can pile up quickly enough to destroy the business of an employer.

Finally, if the financial exposure and liability created by Section 226(b) and (c) was not damaging enough to an employer’s business, Section 226 (e) provides that a court or the LWDA shall also impose nonmonetary penalties in instances where an employer is found to have willfully misclassified an employee. Specifically, an employer shall be ordered to post, on their website (or a public location if they have no website), a notice that (1) the employer has committed a serious violation of the law by engaging in the willful misclassification of employees, (2) the employer has changed its business practices in order to avoid committing further violations, (3) any employee who believes that he or she has been misclassified as an independent contractor may contact the LWDA, and (4) the notice is being posted pursuant to state order. An officer of the employer must then sign this notice and it must remain prominently displayed for one year. Certainly, this non-pecuniary penalty can cause substantial damage to a business’ goodwill and reputation.

Ultimately, under the new Dynamex test, employers are much more limited with respect to which workers they can properly classify as independent contractors moving forward. Nevertheless, choosing to forego this assessment at the inception of every potential employment relationship can be a devastating mistake which can come back to haunt an employer several years later.

[1] If the employer is a licensed contractor, the new law further requires the agency to notify the CSLB, and requires the CSLB to initiate its own action against the contractor.