By Rachel M. Manne, Esq. and Rachel H. Khedouri , Esq.
In a decision that should give all employers pause about how they are classifying workers, the New Jersey Supreme Court recently ruled that certain workers hired by a residential drywall installation business on a per-job basis should have been employees rather than independent contractors. In East Bay Drywall, LLC v. Dept. of Labor and Workforce Development, 2022 WL 3031731 (N.J. Aug. 2, 2022), the Court applied the Unemployment Compensation Law’s “ABC test”, which considers whether the individuals were under the direction and control of the employer, whether the work was outside the usual course of business of the employer or performed outside of the employer’s places of business, and whether the individuals were customarily engaged in an independently established trade, occupation, profession or business. The ABC test presumes that a worker is an employee and the onus is on the employer to establish that particular workers pass the test. Although all three prongs must be satisfied for a worker to be considered an independent contractor, the East Bay Court concentrated on prong “C” of the test – i.e., whether the worker maintains a business independent and apart from the company – finding it unnecessary to revisit the lower court’s consideration of prongs “A” and “B” given the company’s failure to satisfy “C”.
While the facts are fleshed out further below, the significance of the Court’s decision is this: Even if a worker has formed their own company (whether as an LLC or a similar structure), such corporate structure does not automatically ensure passage of prong C. The ABC test is narrowly interpreted in New Jersey and employers should proceed with caution in classifying workers this way.
Background of the East Bay Case:
In East Bay, an auditor for the Department of Labor and Workforce Development (the “Department”) had conducted a routine audit to determine whether the workers were properly classified as subcontractors or should have been employees for whom East Bay was required to contribute to the State’s unemployment compensation and temporary disability funds. Among the facts considered by the auditor were that East Bay provides the raw materials and remains responsible for the finished product, but the workers provide their own tools and transportation and are self-directed on how to install the drywall and whether and how many laborers to hire. The auditor also reviewed documentation – such as tax returns, business cards, invoices and business insurance certificates – to determine whether the workers constituted independent businesses separate from East Bay. Ultimately, the auditor found that 16 of the entities employed by East Bay were misclassified as contractors; the Commissioner of the Department agreed, ordering East Bay to remit more than $40,000 in unpaid unemployment and temporary disability contributions plus interest and penalties.
The New Jersey Superior Court, Appellate Division, reversed the Commissioner’s decision as to eleven of the entities finding that their provision of insurance certificates was significant evidence that they were independent businesses in satisfaction of prong “C”.
The New Jersey Supreme Court’s holding:
The Supreme Court reversed the Appellate Division’s finding, holding the auditor was correct that all 16 entities should have been classified as employees because there was insufficient evidence to prove the entities’ independence from East Bay. The Court found unpersuasive the company’s testimony that the subcontractors worked for other contractors, would leave a job before it was completed, and were free to accept or decline work. It also found the insurance certificates and business registrations to be insufficient to prove the workers were “truly independent business entities” where they did not establish complex ownership structures or prove that they operated beyond the relationship with East Bay. The Court found it significant that there was no evidence establishing whether the entities maintained independent business locations or advertised as well as several other “hallmarks of independence”, including:
- the duration and strength of the business;
- the number of customers and respective volume of business;
- the number of employees of the entity; and
- the amount of remuneration received from the employer at issue compared to other companies for the same service.
The Supreme Court specifically noted that most of the subcontractors were sole proprietors of their businesses, creating a question as to the true independence of the business. Ultimately, the Supreme Court cautioned against “[a] business practice that requires workers to assume the appearance of an independent business entity — a company in name only” since it “could give rise to an inference that such a practice was intended to obscure the employer’s responsibility to remit its fund contributions as mandated by the State’s employee protections statutes.”
Next Steps for Employers: As we have advised in the past, employers should carefully consider their independent contractors to avoid claims of misclassification. The East Bay decision is a clear reminder that application of the ABC factors is a highly fact-sensitive inquiry and relying on business entity registration, insurance certificates, invoices, or other indicators that workers operate as independent entities may not necessarily be enough to meet the company’s burden to establish that these workers are not employees. Multistate employers should also take note that an “ABC” test is relied upon in many other states – not just New Jersey – so the status of all independent contractors should be reviewed.
Please e-mail the NFC attorney you work with or call us at 973.665.9100 for assistance reviewing your employee classifications in light of this new ruling or any other employment law needs you may have.