by Avi Jerushalmy

The New Jersey Supreme Court recently issued a unanimous opinion stating that workers previously classified as independent contractors were actually employees of a drywall installation business. The court also found that whether the workers could “join the ranks of the unemployed” when the relationship with the company ends directly affects independent contractor status in New Jersey.

Facts

East Bay Drywall LLC stopped reporting wages to the New Jersey Department of Labor and Workforce Development (NJDOL) in 2013. As a result, the NJDOL sent an auditor to analyze the status of workers the company hired between 2013 and 2016. The agency interviewed leadership and requested documentation to determine whether the workers’ subcontracting businesses were each independent entities, or if they should have been considered employees, subject to salary requirements.

The auditor determined that 16 subcontractors should have been classified as employees, and as a result ordered payment of unpaid unemployment and disability contributions, as well as interest and penalties for the years in question. To determine this, the auditor used the ABC test. Under this test, all three prongs of the following criteria must be satisfied to establish nonemployee status:

• The individual has been and will continue to be free from control or direction over the performance of work performed, both under contract of service and in fact; and
• The work is either outside the usual course of the business for which such service is performed, or the work is performed outside of all the places of business of the enterprise for which such service is performed; and
• The individual is customarily engaged in an independently established trade, occupation, profession, or business.

In a previous case, the New Jersey Supreme Court held that the ABC test (which is derived from the New Jersey Unemployment Compensation Act) governs whether a worker should be classified as an employee or an independent contractor under the New Jersey Wage Payment Law and the New Jersey Wage and Hour Law.

East Bay contested the auditor’s results and requested a hearing with the Office of Administrative Law (OAL). The agency found that three of the workers in question were employees, but that the other 13 were independent contractors. It also found that all 16 workers satisfied the first two prongs of the test, but 13 of them met the third prong as well because “each existed independently from their relationship with East Bay” and therefore should be considered independent contractors. The other three failed the third prong.

The NJDOL commissioner, however—who has final say over the proceedings—agreed with the auditor that all 16 of the workers failed the third prong and should be considered employees. He reinstated the auditor’s findings and order of payment.

The Appellate Division found that, under the ABC test, only five of the 16 subcontractors weren’t viable independent businesses, failing the third prong. As a result, it reversed the commissioner’s finding and decided payment for the eleven subcontractors should be recalculated.

New Jersey Supreme Court’s Decision

On appeal, the supreme court found insufficient evidence to support the claim that any of the 16 workers were independent entities under the ABC test, rendering them all employees. It agreed with the commissioner’s finding with respect to the third prong of the test. This was supported by a lack of records showing their independent contractor status. The suit was given to the NJDOL for calculation of appropriate back-owed contributions.

The court stated that the third prong of the ABC test rests on the question of whether the subcontractors would “join the ranks of the unemployed” when the relationship with the company ends. Logically, if the workers are truly independent and operating separately from East Bay, they wouldn’t be unemployed if they no longer worked the company.

The court determined that the information East Bay provided to prove the subcontractors’ independence was insufficient. The information included a certificate of insurance and business registration information. They didn’t prove, however, whether the businesses truly operated separately from East Bay, which as we’ve discussed, is a core principle of the third prong.

East Bay didn’t present evidence to address the true independence of the workers. The court noted, “At best, this information indicates the entities might have operated independently of East Bay. . . . At worst, this information shows the entities were a business in name only. In any event, a business might be duly registered but entirely dependent upon one contractor.” Important factors include the duration of the existence of the worker’s business, the number of customers and volume of business, the number of employees of the business, and the amount paid to the worker from other businesses.

The court, however, didn’t need to analyze the first and second prongs because an individual must only fail one prong to be classified as an employee in this test. The third prong is the point that leads to most employment reclassifications. East Bay Drywall, LLC. v. Department of Labor and Workforce Development.

Bottom Line

This decision is relevant as further evidence that the judicial system in New Jersey will rigidly apply the ABC test in reclassification of workers as employees. The court made it clear that the third prong of the test is a difficult hurdle for a company to clear. To successfully classify workers as independent contractors, you must set forth concrete evidence of an entity’s independence beyond the existence of the subcontracting business.

For more information regarding this decision and best practices for hiring independent contractors to avoid claims and litigation, please contact John C. Petrella, chair of Genova Burns LLC’s employment law and litigation practice group, at jpetrella@genovaburns.com or Peter F. Berk, chair of the firm’s wage and hour practice group, at pberk@genovaburns.com or 973-533-0777.