We just wrapped up an SEO project for one of our clients, Patrick Kitchin of Kitchin Legal. We learned a lot during the process of working with him, so we invited him to provide us with a guest post on a topic that is near and dear to our hearts: remote workers. This blog covers work within the US, but the ethics questions at the bottom are essential for all businesses. As a Certified B Corp, we believe treating workers fairly is central to doing business for good. Read on to find out how laws like AB 5 and working with independent contractors apply to you.

Working with Independent Contractors
Co-workers Anna, from California, and Alessandra, from Venezuela

Working with Independent Contractors in California

Below, we’ll answer all your questions about working with independent contractors.

Do California Laws Apply to Out-of-State Independent Contractors?

Is the classification of an out-of-state worker as an independent contractor governed by California labor laws or by the laws and regulations of the worker’s home state?  The short answer is that employment-related laws of each state generally govern the rights of resident workers engaged in work within their home state. When two states’ laws might apply to a worker’s rights, the state with the greatest interest in the outcome of the matter usually governs.  The residence of the worker is generally determinative. So, determining whether a worker is an employee or an independent contractor would usually be decided under the laws of the worker’s state of residence if the work is to be performed there.

Many small California technology businesses operate almost entirely with remote workers and have often relied on technical workers from across the country (and worldwide) to conduct their businesses.  From software designers to technical analysts, a California-based business can now maintain a single-person operation here, with a workforce comprised of dozens of tech workers outside of the jurisdiction of California laws.  Small tech companies often classify, pay, and treat their entire remote workforce as independent contractors. How likely is it that this type of workforce arrangement complies with all applicable federal and state labor laws?  Not very likely.

The classification of workers affects small business owners around the world.  If you are operating a business in California using independent contractors living and working in other states, classification is an issue you must consider.

What Laws Govern the Classification of Independent Contractors in the U.S.?

Under the U.S. Constitution, each state has the right to control most aspects of the lives of its residents and to establish laws that govern workers’ rights within its borders.  The Tenth Amendment to the U.S. Constitution guarantees these rights.   Of course, employment anywhere in the United States is subject to a wide range of federal laws that govern workplaces across the country, including, for example, the federal Fair Labor Standards Act, Title VII of the Civil Rights Act, and the Occupational Safety and Health Act of 1970.  If state labor laws do not meet the minimum standards and requirements set out in these and other federal laws, the federal laws govern.

California’s employment laws provide additional protections to workers that are not available under federal law.  Take rest breaks, for example. Hourly, non-exempt employees working in California are entitled to two 10-minute rest breaks during a full work day.  That right is not provided under the federal Fair Labor Standards Act.

Out-of-state companies that come into California to conduct business are particularly vulnerable to inadvertently establishing employment policies and practices that violate California employment laws.   At times, businesses new to California seem unaware that California and federal employment laws differ significantly. 

California companies, in turn, conduct business in other states when they hire a resident there to perform work. Consequently, this makes California companies also particularly vulnerable to unintentionally violating other states’ employment laws, particularly concerning how the company classifies, pays, and treats its workers.

Most California-based Workers are Employees, Not Independent Contractors

During the past two years, California has made it easier to determine who is an employee and who is an independent contractor.  Assembling Bill 5 (“AB-5”), passed into law in September 2019, codifies into state law the California Supreme Court’s ABC Test set out in its 2018 Dynamex case.  The ABC Test challenges how the gig economy has operated for the past decade.  It is now virtually impossible to classify individuals working within California as independent contractors if they perform work within the usual course of the hiring entity’s business. 

Under the ABC Rule, a worker is an employee unless the employing party can prove:

A. The hired person 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.    The hired person performs work outside the usual course of the hiring entity’s business.

C.    The hired person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

(For more on the ABC Test, please see my articles on the passage of AB-5 and work within the fitness studio industry after AB-5.)

The multi-factor or “economic realities test”

For decades employers have been guided by a more flexible definition of “to employee” in California.  The multi-factor or “economic realities test” announced by the California Supreme Court in S. G. Borello & Sons, Inc. v Dept. of Industrial Relations differentiated employees from independent contractors based on 11 factors, including the amount of control over the worker, the permanency of the relationship and the intention of the parties.

This multi-factor test made it feasible, at times, to create working relationships with persons inside of California who could be appropriately classified and treated as independent contractors by doing the company’s work.  We did so by drafting contracts that expressly identified the worker as an independent contractor, giving more control over the work performance to the contractor. Often the agreements just created a legal fiction on paper to disguise the fact that the person likely was an employee all along.  Telling that story is no longer possible for most people working in California.

This means that if you employ workers in California, AB-5 and the ABC Test will apply to you.  If you cannot meet all three parts of the ABC Test, the worker is an employee and not an independent contractor.

But what about persons who are residents of other states that you engage in working remotely for your California business?  Can they still be classified as independent contractors?

California is Not the Only State that Relies on the ABC Test

At least 33 other states have adopted some version of the ABC Test!  In each of these states, a similar analytic approach used in California will be applied to determine the nature of the working relationship between the two parties.  This means that a resident of another state who is improperly classified as an independent contractor working for a California-based company might have the right to sue the California company for damages in their own state’s courts.

I have prosecuted several wage and hour lawsuits against out-of-state and foreign companies that failed to provide Kitchin Legal’s clients with proper overtime pay, meal and rest breaks, and other employment benefits.  Some cases were valued at over $100,000 in damages for a single underpaid person. The risks associated with misclassification are very real.

What Kinds of Claims Could be Brought by a Misclassified Out-of-State Worker?

Like California, all states have passed labor laws establishing employer obligations and employee rights.  Those laws differ in significant ways. Underlying those laws, federal employment statutes set federal minimum wage, mandate certain record keeping and establish fundamental rights that workers in every state must be afforded.  Workers’ rights are closely regulated and purposefully biased toward safeguarding the wage and safety rights of employees in every state.

Claims relating to how compensation was paid, records kept, reimbursements made, and how certain working conditions were maintained are commonly called “wage and hour” claims. Most hourly-paid remote tech workers are generally paid more than state or local minimum wage for their work.  But often, such workers are not paid overtime in accordance with local state laws when they work long days and/or long weeks.

Workers who are paid on a project basis are different.  A remote worker might be paid a flat rate for completing the design of a website, for example.  Whether it takes the designer 40 or 60 hours to complete a project sometimes is not accounted for in the payment.  Furthermore, whether all of that work is performed in a few very long days or over weeks is not sometimes not addressed in the remote worker contract.

Specific working conditions can raise the minimum wage and overtime wage problems, as well as issues relating to recordkeeping under federal and state laws.

In addition, companies employing remote workers as independent contractors do not generally pay for the internet service they need to perform their work and sometimes require workers to purchase and use specific software in their work.  If the worker’s home state laws are similar to California laws, a worker could seek reimbursement of business expenses from the California company in a lawsuit.

What are the Risks of being Sued for Misclassification?

These are thorny issues for small companies that rely on well-paid workers in other states who want to be treated as independent contractors. Costs associated with employees are significantly higher than those associated with contractors.  There are specific financial benefits that flow to the company that relies on independent contractors. Think of workers’ compensation insurance, timekeeping and payroll systems, and various work-related business expenses that having remote employees cost.  Protections for workers are greater too.

It is unlikely that a small website design company operating out of the owner’s home in San Francisco will be sued by a remote worker in another state whom they misclassified as an independent contractor.  Unless the potential damages are substantial, it is too expensive to prosecute many wage and hour cases. Furthermore, obtaining a recovery of monetary damages from a small company in another state at the end of a very long and expensive litigation process is very difficult.

In addition to economic issues, small companies should evaluate a critical ethical issue.  Is it right that the employing party and the worker (often of unequal bargaining power) can negotiate and define the nature of their working relationship—even if their decision violates employment laws that were put into place to protect the worker?  I think this question is at the crux of the challenge that entrepreneurs and gig economy workers face today. 

When it is clear that the classification violates the law, the questions facing the business and the worker are pretty different.

The worker should ask themselves if they value the relationship highly enough, either financially or for other reasons, to work without all of the employment benefits guaranteed them under their state’s laws.  Is the tradeoff they are making a fair one? The worker should ask themselves a lot of what-if questions too. What if I am injured on the job? Or if the other party decides not to pay me for my work? What if the other party sexually harasses me?  Protections from these events are greater for employees.

The business owner should ask themselves about fairness and a more practical economic question.  Does the company trust and value the relationship highly enough to accept 100% responsibility for the decision to classify a worker as an independent contractor if the company is sued?  It is not a defense to most employment claims to say that the worker agreed to be paid in a way that violates the law. The employer owns those kinds of decisions.

 The Takeaway

Work in the gig economy is raising ethical and legal issues redefining the relationship between workers and their employers.  From my perspective as an employment attorney, I advise my clients that it is essential to evaluate the ethics of the working relationship.  The relationship should be fair and equitable. This is not just because it is correct but also because it will make an employment lawsuit less likely to come calling.

Finally, does the working relationship always need to be classified correctly in the gig economy?  What role do the parties’ needs play? Is it acceptable for the two parties to opt out of our labor laws to satisfy their individual needs?  These questions are more difficult to answer now. And, of course, the right answers are non-binary.

Patrick Kitchin is the founder of Kitchin Legal, APC, an employment law firm in San Francisco, California.  Patrick represents both employees and employers in a broad range of employment matters. With more than 25 years of experience and an AV Preeminent rating from Martindale Hubbell, Patrick Kitchin is a trusted voice in employment law in California.  Please visit the Kitchin Legal Takeaway, Patrick’s employment law blog, and Kitchin Legal’s YouTube channel for more information about California law.  If you have questions about this topic or others affecting workplaces in California, please schedule a free initial consultation with Patrick by emailing him at [email protected].