Unintended Consequences: Dynamex and California Health Care Employers
By Gregg Fisch, Partner, Sheppard Mullin
By Chris Bell, Partner, Moss Adams LLP
By Chris Parker, Senior Manager, Moss Adams LLP
Original Publish Date: August 6, 2019
The California Supreme Court’s 2018 landmark decision, Dynamex Operations West, Inc. v. Superior Court (Dynamex), redefines the employment relationship between entities and workers in California and creates one of the most stringent standards in the United States for classifying workers as independent contractors.
Applying the changes introduced by Dynamex can present significant complications in many industries. This is especially true for the health care industry due to California’s prohibition of corporate practice of medicine (CPOM) and its associated rules. For example, the state requires hospitals to have physicians available during all hours of hospital operation, while, at the same time, generally prohibiting hospitals from hiring physicians directly.
Due to these complexities, many California health care entities may benefit from examining the potentially sweeping impacts of this new interpretation of the law and determining near- and long-term methods for making necessary changes to their hiring and retention policies. Following is an in-depth overview of the potential implications for health care employers and how those in the health care industry will likely need to respond.
History: The ABC Test
On April 30, 2018, the California Supreme Court (Court) issued its ruling in Dynamex, adopting a new standard in California for classifying workers as employees or independent contractors, known as the ABC Test. The ABC Test requires a hiring entity to demonstrate that all three of the following requirements are met for a worker to be properly classified as an independent contractor:
- The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- The worker performs work that’s outside the usual course of the hiring entity's business;
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
The ABC Test, and the B-prong in particular, creates a challenging new standard for companies when evaluating the proper classification of individual service workers who are retained to provide their services. The ABC Test, or similar formulas, has been adopted in 17 other states, though California’s application is one of the broadest to date.
The Doctor’s Dilemma
Doctors are responsible for treating patients as well as myriad other tasks associated with successfully running a business. Additionally, whether as individual professionals or as part of a medical group, doctors must coordinate their activities with patients, families, hospitals, nurses, and other physicians.
Due to this heavy workload, many doctors work collaboratively—transferring to different locations to fill short-term needs and assisting other physicians when necessary. Historically, these collaborations took place as independent-contractor relationships because of the temporary or uncertain nature of the work and the limited scope of services associated with the clinic or provider’s short-term needs.
Misclassification Risks
However, when medical practice groups create new business relationships with medical professionals and treat them as independent contractors, the practice group runs the risk of violating the B-prong of the Dynamex ABC Test. The potential risk arises because the medical professional likely will perform work that is within the medical group’s regular course of business.
If this is the case, the individual professional might be misclassified under California law, which could expose the contracting entity to potential civil lawsuits, unemployment claims, and possible employment tax withholding requirements as well as possibly subjecting the entity to additional scrutiny by regulators.
The Hospital’s Dilemma
Hospitals have their own dilemma when it comes to worker classification. Hospitals need to contract with doctors to provide coverage for hospital patients. However, California, like many other states, vigorously prohibits nonprofessional entities—which is what hospitals are typically classified as—from practicing medicine, pursuant to what is commonly known as the CPOM doctrine.
The legal consequence stemming from the CPOM prohibition is hospitals generally cannot directly hire doctors. Instead, they often contract with medical practice groups or professional corporations to provide physician services during their hours of operation.
Service Provider Overlaps
Out of necessity, a hospital needs to dictate the hours when a physician is onsite so the hospital is certain there are physicians available to address patient needs. From an outsider’s perspective, the spectrum of services provided by a hospital, versus a physician, may overlap in many areas.
This view may cause confusion regarding which services are done by each entity in the usual course of business. A factfinder, or a non-health care professional, for example, may not see the distinction in these practices, which introduces the question of how each entity would be treated by a reviewing court or administrative body.
Misclassification Risks
Due to the structure of the hospital business and the nature of the hospital’s service offering as a health care facilitator, a court could determine the hospital is violating all three prongs of the ABC Test in relation to any health care professionals it contracts.
If the court concludes that the hospital is misclassifying its workers as independent contractors, the hospital may face multiple misclassification risks, such as a doctor or other service provider suing the hospital for employment taxes, employee benefit payments, and back wages.
Determining Exposure
It is important for all involved in these hiring decisions to determine their potential exposure. Entering into an employment relationship between a doctor and a hospital will almost certainly result in a CPOM violation, and consequences for the doctor and hospital, respectively, could include the following:
- Civil or criminal penalties
- Loss of license
- Invalidation of contracts
- False claims allegations
Penalties
If an entity classifies a worker as an independent contractor when, according to the ABC Test, the worker should be an employee, there could be significant liability exposure in a number of areas. In these instances, the misclassifying entity could be found to owe the following:
- Social Security and payroll taxes
- Unemployment insurance taxes
- State employment taxes
- Associated penalties and interest for each unpaid tax
- Worker’s compensation benefits to any misclassified worker
- Additional penalties for incorrect tax reporting at both state and federal level
Administrative Actions or Civil Lawsuits
Most significantly from an economic standpoint, the entity also may be subject to unexpected monetary damages, various penalties, and civil and administrative actions in which claims are asserted for failing to comply with the litany of potentially applicable federal and state wage-and-hour laws. In administrative or civil actions, individuals claiming to be misclassified may seek to obtain the following:
- Overtime payments
- Premium pay for violation of meal period and rest break requirements
- Penalties for failure to comply with wage statement obligations
These civil actions also may be brought as putative class actions, which would likely be even more costly for the entity.
Reducing Risk of Misclassification
Taking heightened exposure potentiality into account, hiring entities can benefit from determining how to decrease the risk of misclassifying workers. Here are a couple steps an entity can take to decrease risk.
Review the Relationship
An entity must closely review the relationship with each individual it classifies as an independent contractor or where the entity plans to provide a Form 1099 to report remuneration. If any of these individuals perform work within the scope of that regularly performed by the hiring entity, the individual is not likely to be properly classified as an independent contractor.
Example
For an entity in the health care industry, if a worker’s job is to provide or support medical care services, they likely will not be classifiable as an independent contractor because the services they provide are within the hiring entity’s existing scope. If that’s the case, the entity should consider reclassifying each worker who falls within these parameters as an employee and treat future workers hired for these positions as employees.
Contract with a Corporation
A hospital or a medical practice may decrease its misclassification risk by contracting with a professional corporation, instead of contracting directly with workers. However, this approach still leaves the entity open to further scrutiny regarding misclassifying the individuals actually providing the services at issue, including as joint employers of the workers.
Regardless of approach, the true relationship between and among the parties can be retroactively analyzed by a tribunal. Using an intermediary may be deemed a subterfuge in an effort to contract around the ABC Test, which could result in harsher penalties. The hiring entity must determine if it is actually contracting at arms’ length with a legitimate entity serving as an employer to what would otherwise be its own employees. If a hiring entity fails to take this step, it may face the risk of later being found to have violated applicable employment laws.
Retroactive Application
Although Dynamex provides an extensive analysis of the ABC Test in California, the Court did not address whether the test applies to services provided, or contracts that were completed, before the Dynamex decision was issued. This retroactive analysis may become an issue for California health care entities that have historically classified providers as contractors instead of employees. It may also introduce additional retroactive exposure within the applicable statute of limitations if the Court determines the ABC Test was always the law in California.
As of this writing, the Ninth Circuit has requested the California Supreme Court make a determination regarding retroactivity of its Dynamex decision.
Future Legislation
Pending legislation in California may impact the effects of the Dynamex decision.
California Assembly Bill 5
California Assembly Bill 5 (AB-5) attempts to codify the ABC Test set forth in Dynamex while providing certain exemptions from the requirements. For example, AB-5 states that the former worker classification standard, the Borello test, would continue to apply instead of Dynamex in limited circumstances. This application could raise additional misclassification risks but likely to a lower extent than those raised by the ABC Test.
AB-5 could also exempt physicians or surgeons licensed by the State of California—but not other types of health care workers—from the ABC Test and the classification requirements established in Dynamex. However, this bill still has a long journey to go before passage and, even if the law is ultimately enacted, the final version could be different from its current form.
Additional Insight
A number of additional cases in which Dynamex is being interpreted and applied are continuing to move through state and federal court systems. These cases will likely provide more clarity on the application of the worker classification rules. That means it’s important to continue monitoring these ongoing legislative and judicial matters and their potential effects on how the ABC Test will impact the health care industry.
We’re Here to Help
To learn more about the Dynamex ruling or how it may affect you or your health care entity, contact a professional.
Gregg Fisch is a partner at Sheppard Mullin law firm. He specializes in labor and employment law and has extensive experience in all aspects of litigation. Gregg regularly consults clients on wage-and-hour issues; disability, family, medical leave laws; workplace violence prevention; and the discipline and termination processes. He can be reached at gfisch@sheppardmullin.com or (310) 228-3721.
Chris Parker is a senior manager at Moss Adams. After working for California’s Franchise Tax Board (FTB) for more than a decade, he joined the firm to lead the state and local tax controversy practice. Chris can be reached at chris.parker@mossadams.com or (916) 503-8266.
Chris Bell has practiced public accounting since 2005. He’s a partner at Moss Adams and national practice leader for the firm’s medical group practice. Chris is also the firm’s health care tax leader. He can be reached at chris.bell@mossadams.com or (916) 503-8164.
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