On October 9, 2011, Governor Brown signed into law Senate Bill 459 regarding independent contractors. The law significantly increases the risks and penalties for misclassifying workers as independent contractors by imposing significant penalties on employers found to have engaged in a misclassification, as well as on non-lawyer advisors (like accountants) who advise an employer to engage in such treatment.
The Governor’s signature comes just days after the IRS announced its new Voluntary Classification Settlement Program (VCSP). The VCSP provides generous forgiveness of most of the amounts that would otherwise be due at the federal level for those employers that reclassify independent contractors as employees. As we warned at the time, acceptance of the VCSP might be a trap because it could make defense of non-IRS actions almost impossible. However, if the classification of workers as independent contractors is not well-founded, the new California law provides still another reason to make changes.
In some industries, use of independent contractors is widespread, but not easily justified. The fact that (i) others in the industry are doing the same thing, or (ii) it saves money, will not be useful defenses. Instead, employers treating workers as independent contractors should go through the detailed factual analysis of what constitutes an independent contractor vs. an employee. We review the rules for independent contractors in this recent article.
The law applies to “willful misclassification” of a worker as an independent contractor. The law defines:
“Misclassification” means avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.”
The law does not otherwise describe or provide standards for what is “voluntary and knowing”. Since an employer is certainly aware when it engages an individual as an independent contractor rather than as an employee, the above definition provides little defensive assistance to an employer. Even in the unlikely event that an employer does not have actual knowledge of the treatment, the “knowing” standard is likely to be interpreted as including constructive knowledge, which in turn includes what the employer purportedly should have known.
Violators are subject to civil penalties of $5,000 to $15,000 per violation, in addition to any other penalties or fines permitted by law. Violators engaged in a “pattern or practice” of violations are subject to a civil penalty of $10,000 to $25,000 for each violation. The law provides no definition of “pattern or practice”, leading to the possibility that the higher penalties might be assessed where an employer has misclassified more than just a single individual.
Employers found to have engaged in any violation must post a prominently-displayed notice on the employer’s Internet website advising employees and the general public of its violation. Employers without a website must have the notice “displayed prominently in an area that is accessible to all employees and the general public at each location where a violation occurred.” The notice, which must (i) remain for one year and (ii) be signed by a corporate officer, must state that:
- The employer “committed a serious violation of the law by engaging in the willful misclassification of employees”.
- The employer “changed its business practices to avoid committing further violations”.
- “Any employee who believes he or she is being misclassified as an independent contractor may contact the state Labor and Workforce Development Agency”, whose mailing address, email address and telephone number must be listed in the notice.
- “The notice is being posted pursuant to a state order.” The notice must remain posted for one year.
The construction industry makes widespread use of independent contractors. If the violating employer is a licensed contractor, the agency or court that made the determination is directed to transmit the determination to the Contractors’ State License Board, who, in turn, is directed to initiate disciplinary action against a licensee within 30 days.
Although the California Labor Commissioner is charged with enforcement of this new law, individuals may file their own complaints judicially. As a practical matter, by creating a private right of action with enormous penalties, class action litigation presents a much greater threat than government enforcement.
The law is effective on January 1, 2012. SB 459 will appear as Sections 226.8 and 2753 of the California Labor Code.
The determination of whether a worker is an employee or an independent contractor is based on a common law test that requires significant judgment. If litigation is required, the presentation can usually be improved with a testifying accountant who can both (i) present the business’s situation, and (ii) draw comparisons to other economic situations that provide important insights as to the correct answer.