On Sunday, October 9, 2011, Governor Brown signed into law Senate Bill 459 (“SB 459”), which increases the penalties that can be assessed against employers who willfully misclassify as independent contractors individuals who should be treated as employees. The law, which will become effective on January 1, 2012, also requires employers who are found to have engaged in such misclassification “to display prominently” for one year on their Internet websites a notice to employees and the general public announcing that the employer “has committed a serious violation of law by engaging in willful misclassification of employees.”
Brown’s action comes just days after the IRS announced its new settlement initiative, the Voluntary Classification Settlement Program (“VCSP”),1 allowing employers not under audit to come forward and reclassify independent contractors as employees and pay a significantly reduced employment tax. As employers are well aware, however, the benefits of reduced employment taxes should be balanced against other potential significant collateral consequences, such as class action exposure for back unpaid overtime, meal and rest break penalties, and medical and pension expenses that would otherwise have been due misclassified contractors.
SB 459 makes it unlawful for any person or employer (a) to engage in “willful misclassification” of an individual as an independent contactor, and (b) to charge any fee or make any deduction from such individual’s compensation for such expenses as space rental, services, repairs, goods or materials, where such deductions would have been unlawful had the individual been classified as an employee. In general, any such deduction from an employee’s wages would be unlawful.
New Fines and Penalties
Violation of the statute carries exposure for a “civil penalty” of between $5,000 and $15,000 for each violation; if the employer is found to have engaged “in a pattern or practice of [those] violations,” the civil penalty is increased to $10,000 to $25,000 per violation. While the law doesn’t specify, presumably a single classification decision affecting a group of similarly situated individuals could state multiple violations, for each of which a separate monetary penalty could be assessed.
New Notice Requirement
Employers found to have engaged in either of the above violations must post a notice “display[ed] prominently” 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 be signed by a corporate officer, must state: (a) that the employer has been found to have “committed a serious violation of the law by engaging in the willful misclassification of employees,” (b) that the employer has “changed its business practices to avoid committing further violations,” (c) that any employee who believes he or she is being misclassified may contact the state Labor and Workforce Development Agency, whose mailing address, email address and telephone number must be listed in the notice, and (d) that the notice is being posted “pursuant to a state order.” The notice must remain posted for one year.
Agencies Permitted to Enforce
The new law specifies that not only the California Labor and Workforce Development Agency, but also the State Labor Commissioner pursuant to a “Berman” hearing under Calif. Labor Code §98, may make the relevant findings of violation and impose penalties. This latter provision is significant: the “Berman” hearing process affords several advantages to prevailing employees, including that the decision of the Labor Commissioner is immediately enforceable as a judgment; if the employer appeals, it must post a bond equal to the amount of the award; and attorneys’ fees are imposed on employers who unsuccessfully appeal but not on employees who unsuccessfully defend. In addition, if the employer appeals, an employee who cannot afford to hire a lawyer receives free representation by the Labor Commissioner’s office.
Risks and Uncertainties
As is often the case with legislation, the devil is in the details. First, while significantly higher penalties may be assessed where the employer is found to have engaged or is still engaging in a “pattern or practice” of willful misclassification, the law provides no definition of “pattern or practice.” A risk therefore exists that the higher penalties might be assessed in any situation where an employer is found to have misclassified more than a single individual.
Second, while the statute does provide a definition for “willful misclassification,” as meaning “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor,” the statute does not describe or provide any standards for what will be considered “voluntary and knowing” misclassification. Since, presumably, an employer is well aware when it engages an individual as an independent contractor rather than an employee that it is doing so, the fact that this is a conscious decision on the employer’s part may create a risk that, however well-intentioned and/or well-informed that decision may be, it might be considered “voluntary and knowing,” and hence a basis for slapping the employer with the increased fines.
Significance for Employers
The U.S. Bureau of Labor Statistics estimates that independent contractor misclassification represents a $3-4 billion per year tax shortfall problem, so both state and federal agencies have more than sufficient incentive to pursue it. To that end, a year ago, the U.S. Department of Labor’s “Plan, Prevent and Protect” initiative promised a crackdown on independent contractor misclassification, and the IRS assisted in that initiative by committing to audit 6,000 employers over a three-year period with respect to such issues.
This new law ups the ante for employers with respect to independent contractor misclassification issues. Employers are already subject to employment and withholding tax obligations with regard to individuals misclassified as independent contractors. This new law adds another layer of potential claims and penalties and facilitates those claims by giving the state Labor Commissioner the independent right to investigate and prosecute them. For these reasons, employers should work with experienced employment counsel to review their independent contractor relationships and ensure they “get it right” with respect to classification issues, and if the current classification is not legally supported, to devise ways to remedy the situation with a minimum of legal exposure.
For more information on this alert, please contact any of the lawyers listed below:
John Adkins, firstname.lastname@example.org, 617.951.8551
Jenny Cooper, email@example.com, 617.951.8473
Louis Rodriques, Co-chair, Labor and Employment Group, firstname.lastname@example.org, 617.951.8340
This article was originally published by Bingham McCutchen LLP.