On August 8, 2022, the New Jersey Supreme Court released its decision in East Bay Drywall, LLC v. Dep’t of Labor & Workforce Dev., ___ N.J. ___, ___ (2022) (A-7-21) (085770). With this decision, the Supreme Court illustrated the proof hurdles employers must overcome when classifying New Jersey workers as independent contractors instead of employees..
The decision highlights the necessity for employers to document the support for an independent contractor’s classification and produce the proof in response to a Department of Labor & Workforce Development (DOL) audit or inquiry.
In 2013, East Bay Drywall (East Bay) stopped reporting wages to the DOL. This triggered an audit by the DOL.
East Bay used 16 subcontractors (four individuals and 12 business entities). East Bay classified them as independent contractors. During the audit, East Bay provided the DOL auditors certificates of insurance, tax identification numbers, and business registrations for most of the subcontractors.
The East Bay owner also testified that the subcontractors were free to accept or decline work, and he believed some subcontractors worked for other businesses.
The DOL’s audit, conducted in 2017, concluded that the 16 subcontractors were employees rather than independent contractors. The DOL found the employer failed to provide sufficient evidence to conclude that the subcontractors were bona fide businesses distinct from East Bay.
East Bay appealed the audit’s findings to the Commissioner of Labor. The Commissioner of Labor upheld the findings from the DOL’s audit.
East Bay then appealed to the New Jersey Appellate Division and argued that its subcontractors met the three criteria under the “ABC” test (discussed below). East Bay argued that each subcontractor it hired was an independent entity, as it required certificates of liability insurance and tax identification numbers before hiring each of the workers.
East Bay won a partial victory in its appeal. The Appellate Division disagreed with the Commissioner regarding 11 of East Bay workers. The Appellate Court ruled these 11 workers had supplied up-to-date certificates of insurance for the audit period. Therefore, they were reclassified as independent contractors.
However, the Supreme Court disagreed with the Appellate Division’s finding.
The Supreme Court held that an independent contractor’s establishment as a separate corporate structure, such as a single-member limited liability company (LLC) or corporation accompanied by a certificate of insurance and publicly available business registration information, in and of itself, did not establish independent contractor status under the New Jersey Unemployment Compensation Act.
The Supreme Court grounded its findings upon the precedential ABC test. The ABC test was first recognized by the Supreme Court in Hargrove v. Sleepy’s LLC., 220 N.J. 289 (2015).
To support the classification of a worker as an independent contractor, the employer has the burden of proving all three of the ABC test prongs:
(A) Such individual has been and will continue to be free from control or direction over the performance of such service, both under his contract of service and in fact; and
(B) Such service is either outside the usual course of the business for which such service is performed, or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and
(C) Such individual is customarily engaged in an independently established trade, occupation, profession or business.
In its analysis in East Bay, the Supreme Court noted that the key question was whether the worker maintained a business independent of and apart from the employer. To satisfy the “C” prong, the employer must prove the supposed independent contractor’s business would continue when he stopped working for the employer in question.
In East Bay, the company argued that the workers had “independently established” businesses that satisfied the “C” prong and relied on the certificates of insurance and business entity registration information. Additionally, the head of the company testified that subcontractors were free to accept or decline work and would sometimes leave the job before they completed the work.
Although he testified that he believed some subcontractors worked for other companies, the Supreme Court noted he failed to produce any evidence to support those beliefs.
In reviewing the business registration and insurance information, the Court held these documents did not show whether the disputed entities were, in fact, independent businesses. Specifically, the court found that many of the entities in question were single-member entities that had no other employees.
In addition, many of these entities had their registrations revoked before the 2017 audit.
The Supreme Court also noted that several of the entities had insurance certificates that were effective only for one year of the audit period (2013-2016). The Court also found East Bay had failed to provide evidence that the entities advertised, maintained independent locations, or had employees.
In holding that East Bay failed to show it had properly classified the subcontractors as independent contractors, the Supreme Court cited the public policy underpinning the New Jersey Unemployment Compensation Law (N.J.S.A. 43:21-2) and the Report of Governor Murphy’s Task Force on Employee Misclassification.
Lastly, the Court cautioned against businesses engaging in “subterfuge” by making subcontractors appear to be independent businesses to avoid employee classification.
Although East Bay lost its case, the Supreme Court did not foreclose the opportunity to satisfy the C prong by presenting a certificate of insurance and business registration information. The Court stated that a certificate of insurance and business registration information might indicate independence from the employer. However, in this case, East Bay could not show to the satisfaction of the Court that the subcontractors advertised, maintained independent locations or had employees.
Lessons For Employers
The East Bay Drywall, LLC v. Department of Labor & Workforce Development decision is a reminder to New Jersey employers that the DOL and New Jersey courts will presume a worker is an employee unless the employer can prove otherwise.
East Bay Drywall obligates employers to prove their contractors have a functioning independent business. Even then, hiring a worker with a formal independent corporate structure is not dispositive proof of a worker’s independent contractor status.
To be viewed as an independent contractor, the contractor’s business must be capable of continuing once he or she completes the particular work/project.
Other evidence the DOL will want to see to support the classification of independent contractor:
- Does the contractor have other employers?
- How much money was the contractor paid by those other employers?
- How many customers does the contractor have?
- Is there a customer list?
- Does he have commercial space separate from the employer’s?
- Does he own his own tools, vehicles, etc.?
- Does he have business cards, advertise in local media?
- Whether he maintains different business and email addresses from the employer?
This decision demonstrates how difficult it is for employers to justify a worker’s independent contractor status. It also highlights the need for employers to document the support for a worker’s classification and be ready to produce it in response to DOL inquiries.
This difficulty is only compounded by the fact most of the evidence that would support the classification of a worker as an independent contactor is, by and large, in the hands of the worker.
Consequently, businesses that use independent contractors will do themselves a favor by collecting supporting evidence of the contractors’ “independence.”
It should be noted that the DOL asked the Supreme Court to find that East Bay’s job sites constituted East Bay’s “places of business,” under prong B of the ABC test. However, the Court did not find it necessary to reach that issue considering its decision on prong “C”.
In a footnote, the Court suggested that the DOL enact regulations to clarify the scope of the “B” prong because of the prevalence of remote work today.
Today, You Don’t Want to Get Caught Misclassifying Employees
The misclassification of employees as independent contractors can have costly consequences for businesses. Misclassifying a worker violates New Jersey’s wage and hour laws. Penalties could include fines of up to $1,000 plus a penalty of 20 percent of wages owed. They can also file criminal charges against the person responsible for the misclassification. Penalties could include fines of up to $10,000 and up to 18 months in jail. Lastly, employers might have to repay wages owed, plus liquidated damages of 200 percent of the unpaid wages. They are also liable for the worker’s attorney’s fees.
We also note the DOL audit starting the dispute in East Bay Drywall was triggered when East Bay stopped reporting wages as a registered employer. Employers should be very careful with worker classifications in this environment. Businesses should consult legal counsel before to changing worker classifications.
New Jersey has now established the Office of Strategic Enforcement and Compliance to enforce proper worker classification. Employers should expect an increase in the DOL’s review of contractor relationships.
New Jersey Business Lawyers
The business lawyers at Schiller, Pittenger and Galvin, P.C., have counselled business clients on New Jersey’s wage and hour laws for decades. If you have questions or concerns regarding the classification of your workers, contact the New Jersey wage and hour attorneys at the firm in their Scotch Plains office at 908-490-0444 or email them here.