California Employment Law and the Dangers of Retroactivity

Wide-reaching – and sometimes unexpected – changes in employment law are important to all businesses in the US, because they must continually ensure their compliance with fast-evolving and hyper-technical legal requirements. These challenges are compounded for larger companies with a national footprint, given that employment law requirements may differ in each state.

California is a perfect example, where its Supreme Court frequently announces law unique to that state and applies its rulings retroactively. This compels organisations to constantly partner with legal counsel to anticipate upcoming decisions or  risk significant class action and representative PAGA lawsuits for past and future conduct.

This month, we have the fortune to hear from Seyfarth Shaw partner Paul J. Leaf. In this featured article, he draws upon his wealth of experience in California employment law to explain the pitfalls of and defences to retroactively applying new California Supreme Court rulings, while also delving into ongoing developments in California employment law.

What are some hot issues in California employment law?

Practicing in one of the most employee-friendly states, there is never a dull moment when advising my business clients about California employment law. I work on a wide range of employment issues, often on the following repeat matters: (1) independent contractor misclassification claims; (2) protecting my clients from the retroactive application of new California employment law that invalidates how they previously operated; and (3) strategising about how to deal with PAGA claims, including by updating arbitration agreements.

What is California’s ABC test, and is it being applied retroactively?

In 1989, the California Supreme Court announced that SG Borello & Sons, Inc v Department of Industrial Relations, 48 Cal. 3d 342 (1989) controls whether workers are independent contractors or employees. Under this nine-factor test, no single factor automatically establishes employee status. Indeed, even if multiple factors indicate employee status, a worker can still be deemed an independent contractor.

Despite businesses relying on Borello for nearly 30 years to structure their workforces, in Dynamex v Superior Court, 4 Cal. 5th 903 (2018), the California Supreme Court adopted a three-factor test to replace Borello for certain claims. The ABC test significantly expands the scope of employment, because if the hiring entity fails to establish any factor, the worker is deemed an employee.

After Dynamex, the ABC test became effective immediately. Businesses thus had to scramble to assess whether their existing independent contractor relationships – even if lawful under Borello – could pass the ABC test.

If a hiring entity was unsure whether it could satisfy the ABC test, it had to pivot to an employee model, modify its own business practices, or risk a misclassification lawsuit. The cost of such a lawsuit can be staggering, because misclassifying a worker as an independent contractor gives rise to a litany of derivative claims that may be actionable through class action and PAGA lawsuits, including willful misclassification, unpaid minimum wages and overtime, improper meal and rest breaks, failure to reimburse business expenses, inaccurate wage statements and untimely payment of wages. Willful misclassification alone can give rise to $25,000 in penalties for each worker misclassified as an independent contractor.

Practicing in one of the most employee-friendly states, there is never a dull moment when advising my business clients about California employment law.

What’s more, in Vazquez v Jan-Pro Franchising Int’l, Inc, 10 Cal. 5th 944 (2021), the California Supreme Court ruled that the ABC test applies retroactively. Thus, even if hiring entities had properly utilised workers as independent contractors while Borello controlled, the backwards application of the ABC test created four years of potential class action liability and one year of potential PAGA liability during that Borello period.

Are other key California court decisions relating to employment law being applied retroactively?

Yes, because the California Supreme Court regularly applies its decisions retroactively, including when it announces new law. Based on statutes of limitations, such retroactive decisions generate four years of potential class action liability and one year of potential PAGA liability, often across multiple claims. This is because a single claim for unpaid wages gives rise to derivative claims, including penalties for inaccurate wage statements, penalties for untimely payment of wages and attorneys’ fees. Consider a few examples.

For approximately 70 years, businesses in California relied on a federal doctrine holding that up to 10 minutes of work time each day need not be compensated if the time was difficult to track. This de minimis doctrine was endorsed by the US Supreme Court and then applied to California claims by the Ninth Circuit and the California Division of Labor Standards Enforcement (DLSE) – the state agency charged with enforcing California’s wage and hour laws. Further, a California Court of Appeal applied the federal de minimis doctrine in an employee compensation case. No California court had deemed the federal de minimis doctrine inapplicable under California law.

But in Troester v Starbucks Corp, 5 Cal. 5th 829 (2018), the California Supreme Court rejected the federal de minimis doctrine. Troester is being applied retroactively.

In 1990, 2011 and 2013, the California Court of Appeal held that an eight-hour sleep period could be excluded by written agreement from hours worked in a 24-hour shift. The DLSE agreed that such sleep time need not be compensated. No California court had reached a contrary conclusion.

But in Mendiola v CPS Sec. Sols., Inc, 60 Cal. 4th 833 (2015), the California Supreme Court first announced that sleep time during an on-call shift can be compensable. Mendiola was made retroactive.

Since at least 2012, multiple federal courts concluded that premium pay – the hour of compensation owed to employees for an improper meal or rest break – is paid at an employee’s base hourly wage, not the potentially higher (and more difficult to calculate) regular rate of pay. In 2019, the first California Court of Appeal to consider this issue agreed.

But in Ferra v Loews Hollywood Hotel, LLC, 11 Cal. 5th 858 (2021), the California Supreme Court held that premium pay must be paid at the regular rate of pay. Ferra was made retroactive.

Starting in 2012, three California Courts of Appeal held that premium pay is not a wage that can trigger penalties for inaccurate wage statements or untimely payment of wages. At least seven federal courts applying California law agreed.

But in Naranjo v Spectrum Sec. Servs., Inc, 13 Cal. 5th 93 (2022), the California Supreme Court parted ways with these authorities. The California Supreme Court has not barred retroactive application of Naranjo.

The California Supreme Court regularly applies its decisions retroactively, including when it announces new law.

What is your strategy to protect clients from the retroactive application of new California law?

Among other strategies, I establish a defence that shields my clients from retroactive penalties, because those penalties – as opposed to any unpaid wages – are usually the greatest source of potential liability.

When the California Supreme Court applies new law retroactively, the resulting owed wages are often small, but the derivative penalties stemming from those unpaid wages can be crippling. For example, with one employee, a single unpaid penny in wages can trigger up to $4,000 in penalties for inaccurate wage statements, up to 30 days’ worth of compensation for not timely paying the missing wages at separation (for an employee earning the $15 California minimum wage, these penalties max out at $3,600) and attorneys’ fees. That is $7,600 in penalties, plus attorneys’ fees, for one unpaid penny in wages. Multiply that by hundreds or thousands of employees, including employees earning above the minimum wage who trigger higher waiting time penalties, and companies are quickly facing significant liability.

Under California law, an employer has a good faith dispute defence against these wage statement and waiting time penalties (among other wage-related penalties) if it reasonably believed it was following the law at the time and the law later changed, or if the law was unclear during the pertinent period.

The mere fact that the California Supreme Court chooses to decide a case should necessarily establish the good faith dispute defence. After all, the California Supreme Court often takes up cases to resolve a split of authority among federal or lower state courts. Other times, federal appellate courts find it so difficult to forecast how the California Supreme Court will decide an issue of state law that they ask the California Supreme Court to decide the issue for them.

Yet, as in all of the retroactively applied California Supreme Court cases discussed above, that Court often does not address whether a good faith dispute defence applies. As a result, companies must hire lawyers to litigate whether they are subject to penalties, and many companies are compelled to settle cases at inflated prices due to the spectre of massive penalties.

When the California Supreme Court applies new law retroactively, the resulting owed wages are often small, but the derivative penalties stemming from those unpaid wages can be crippling.

Should the California Supreme Court change how it applies employment decisions retroactively and prospectively?

Yes. Starting with prospective application, final California Supreme Court decisions are effective immediately. If a new decision entitles employees to additional wages, the employees should begin accruing those wages right away.

But the California Supreme Court should provide a grace period before derivative penalties stemming from those wages can kick in. After all, some businesses have giant workforces with complicated personnel software controlled by third parties, which makes instant changes impossible. Smaller businesses may not have the resources to immediately figure out how to comply with new law. It is unfair to penalise well-intentioned, diligent employers that are willing to pay the new wages but simply need time to comply.

Employers have advance notice of new laws passed by the legislature well before they become effective, which gives employers time to make changes and avoid penalties. The same should be true of new rules coming out of the California Supreme Court. Retroactively applying new law without the California Supreme Court specifying whether a good faith dispute defence exists essentially requires employers to predict the future or to constantly engage lawyers. Aside from a decision by the California Supreme Court, there is no official authority employers can consult to derive a definitive understanding of what California employment law requires and that will shield against future penalties if the law changes.

As shown by Troester and Mendiola, employers cannot unreservedly rely on what the DLSE says about California law, because the California Supreme Court may ignore that agency’s interpretations and then retroactively apply contrary law without specifying whether the good faith dispute defence governs. Nor can employers unreservedly rely on opinions from the California Courts of Appeal or federal courts, because as shown by Ferra and Naranjo, the California Supreme Court can disagree with those courts and then retroactively apply contrary law without addressing the good faith dispute defence.

The lack of a reliable self-help guide short of a California Supreme Court opinion leaves businesses having to constantly engage lawyers to anticipate forthcoming legal changes. But employment lawyers – even judges – cannot always predict how the California Supreme Court will decide an issue.

For instance, Ferra shows that even when lawyers parse a statute and follow how the California Court of Appeal and multiple federal courts interpreted that statute, the California Supreme Court may disagree, make its decision retroactive without addressing the good faith dispute defence, and open employers who followed their lawyers’ advice and published court opinions to years of potential liability for unpaid compensation and penalties.

The lack of a reliable self-help guide short of a California Supreme Court opinion leaves businesses having to constantly engage lawyers to anticipate forthcoming legal changes.

In Ferra, the California Supreme Court held that premium pay must be paid at the “regular rate of pay”. That phrase is a term of art with a long-established meaning that is often used in statutes and Wage Orders to distinguish from the only other compensation metric available: an employee’s base hourly wage.

The Ferra holding was not obvious beforehand because the statute and Wage Orders that require premium pay do not say it must be given at the regular rate of pay; a different term is used. Several district courts and the California Court of Appeal agreed that premium pay is given at the base hourly wage, because if the legislature intended premium pay to be given at the regular rate of pay, it easily could have said so, as it did elsewhere in statutes for different types of compensation.

The California Supreme Court can resolve this retroactivity problem when it announces new law by opining then whether the good faith dispute defence is available. Sometimes these legal changes may be obvious and employers will be penalised. But when legal changes are not foreseeable, penalties are unfair and no employer should have to spend money fighting over the good faith dispute defence or be forced to accept inflated settlements.

What is the Private Attorney General Act and what is the significance of the US Supreme Court allowing individual PAGA claims to be arbitrated?

PAGA is a California statute that authorises employees to file lawsuits to recover civil penalties on behalf of themselves, other employees and the State of California for violations of the California Labor Code. A major reason that PAGA lawsuits have often been filed is a line of cases beginning with the California Supreme Court in Iskanian v CLS Transp. Los Angeles, LLC, 59 Cal. 4th 348 (2014), which holds that PAGA claims cannot be waived or compelled to individual arbitration.

But in Viking River Cruises, Inc v Moriana, 142 S. Ct. 1906 (2022), the US Supreme Court held that (1) a plaintiff’s individual PAGA claim can be compelled to arbitration and (2) as a matter of state law standing under the PAGA statute, a representative PAGA claim brought on behalf of other employees must be dismissed once the plaintiff’s individual PAGA claim has been compelled to arbitration. These holdings are significant because they allow businesses to avoid class actions and representative PAGA claims while remaining in arbitration.

When legal changes are not foreseeable, penalties are unfair and no employer should have to spend money fighting over the good faith dispute defence or be forced to accept inflated settlements.

Businesses still face real PAGA risk, however.

First, the California Supreme Court has granted review of Adolph v Uber to consider the second holding of Viking River. The California Supreme Court could decide this statutory standing issue in a way that permits a representative PAGA claim brought on behalf of other employees to proceed in court, irrespective of whether the plaintiff is arbitrating her individual PAGA claim.

Still, some employers can get around Adolph and receive the full benefits of Viking River. For some businesses, all of their employees have signed an arbitration agreement with a PAGA waiver. This means that even if the PAGA standing portion of Viking River is undone by Adolph, and trial courts retain jurisdiction over representative PAGA claims after the plaintiffs have been compelled to arbitrate their individual PAGA claims, there will be no one available to participate in those representative PAGA actions. This conclusion derives from executed waivers, not standing, which makes Adolph irrelevant. To secure a dismissal, businesses must make this argument when courts intend to stay a representative PAGA claim until Adolph is decided. If a court nevertheless stays the case, the employer has great settlement leverage.

Second, if this approach is followed, an employer can face a flood of individual arbitrations, assuming opposing counsel has access to a meaningful percentage of the workforce. Because California law requires employers to pay all expenses unique to mandatory arbitration, employers face significant arbitration costs not present in court, such as filing fees and arbitrator fees.

To minimise these risks, employers can add mass arbitration protections to their arbitration agreements, including a process to arbitrate a few test cases while the rest of the portfolio is stayed and no arbitration fees are incurred.

What other trends do you see on the horizon for California employment law?

There are many future developments that employers should watch, including the following:

Based on current trends, the California Supreme Court could make it unlawful for employers to round employee time punches. It already barred rounding of employee meal period time punches in Donohue v AMN Servs., LLC, 11 Cal. 5th 58 (2021). And more recently, the California Court of Appeal in Camp v Home Depot USA, Inc, 2022 WL 13874360 (Cal. App. Oct. 24, 2022), held that if employers have captured the exact amount of time employee have worked, rounding is unlawful, even if it benefitted the employees overall.

Under California Assembly Bill 51, employers may not require employees as a condition of employment to execute arbitration agreements covering claims under the California Fair Employment and Housing Act or the California Labor Code. In Chamber of Commerce of the US v Bonta, the Ninth Circuit will determine whether AB 51 is preempted by the FAA.

Though PAGA claims need not meet class action procedural requirements, some courts hold that PAGA claims must nevertheless satisfy a similar standard of manageability. The California Supreme Court recently granted review in Estrada v Royalty Carpet Mills, Inc, 76 Cal. App. 5th 685 (2022) to resolve a split of authority concerning whether trial courts may strike or limit PAGA claims as unmanageable.

On a personal level, what drew you to employment law in particular?

I was initially a commercial litigator at Kirkland & Ellis LLP, learning from incredibly bright attorneys on ‘bet the company’ cases. But the ‘one and done’ nature of such litigation made it difficult for me to partner with clients so I could help steer their day-to-day business operations. After friends practicing employment law confirmed that working in this area would allow me to more deeply integrate with my clients, I joined Seyfarth Shaw in 2015.

Being an employment lawyer has delivered on all fronts. I regularly work with the same clients on multiple cases, which gives me a significant understanding of their businesses. I then use lessons learned from litigation and attempt to predict future legal precedent to modify my clients’ policies and practices to minimise their liability. I love the challenge of finding creative legal solutions that meet my clients’ business preferences.

My deep interest in employment law and desire to achieve great results for my clients make it easy to work very hard and passionately at my job. I was thus very proud to be recognised last year by the National Hispanic Bar Association as one of the top lawyers under 40 across the US.

Can you share anything about your plans for 2023?

Given my interest in policy, I want to argue a case before the California Supreme Court that defines a far-reaching part of California employment law. On a personal level, I want to dedicate more time to international travel with my wife and parents, publishing op-eds about US foreign policy (I have written extensively about China’s rise and other international security issues in the Indo-Pacific region), playing pickleball, and putting more miles on my Peloton tread.

 

Paul J. Leaf, Partner

Seyfarth Shaw LLP

2029 Century Park East, Suite 3500, Los Angeles, California 90067-3021, USA

Tel: +1 213-270-9724

Fax: +1 310-551-8449

E: pleaf@seyfarth.com

 

Paul J. Leaf is a partner in the Los Angeles office of Seyfarth Shaw LLP. He represents businesses in employment and commercial disputes, with a focus on wage and hour class actions and representative PAGA actions. Paul also defends companies against claims of discrimination, harassment, retaliation, breach of fiduciary duty, wrongful termination, non-compete and non-solicitation. Paul enjoys leveraging lessons learned from litigation and anticipating future legal developments to draft forward-looking personnel policies for his clients in order to prevent lawsuits altogether.

Seyfarth Shaw LLP provides advisory, litigation, and transactional legal services to clients worldwide. With approximately 900 lawyers across 17 offices, Seyfarth Shaw and its employment group consistently earn top spots in national rankings of law firms.

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