California Court of Appeal Rules Payroll Company Not an “Employer”

On December 16, 2010, the California Court of Appeal found that a payroll company was not an “employer” for the purposes of wage liability, under either California law or the FLSA “economic realities” test. While acknowledging that California law slightly differs from federal law, the court held that, under either standard, the key determination is whether the payroll company exercised control over the plaintiff’s wages, hours, or working conditions. In this case, despite documents labeling the payroll company as the plaintiff’s “employer,” and despite the payroll company’s actions in paying wages, issuing W-2s and withholding taxes, the plaintiff failed to raise a triable issue that the payroll company was his employer.

The Facts

The Plaintiff, John Futrell, filed a class action complaint against a production company, Reactor, Inc., and a payroll service, Payday, that Reactor used to pay its employees. Futrell alleged that Reactor and Payday were joint employers, and that each was liable for failing to pay Futrell double-time wages for hours worked in excess of 12 hours per day. The trial court granted Payday’s motion for summary adjudication on the grounds that Payday had not been Futrell’s employer, because Payday did not control Futrell’s work, did not set his wages, did not supervise his work, and did not determine his hours or conditions of employment.

The Court Finds that a Payroll Company Was Not An Employer

In reviewing Payday’s motion asserting that it was not Futrell’s employer, the court noted the distinction between California law as stated by the California Supreme Court in Martinez v. Combs (2010) and federal law as stated in the “economic realities” test. Accordingly, the court addressed Futrell’s FLSA claims separately from his claims arising under the California Labor Code.

A. California Law: Three Definitions of Employer

The court followed Martinez when analyzing the definition of “employer” for the purposes of wage and overtime claims under California Labor Code Sections 510 and 1194. In Martinez, the California Supreme Court rejected the federal “economic realities” test and, in its place, adopted three alternative definitions of what it means to be an employer under California law: (a) to exercise control over wages, hours or working conditions or (b) to suffer or permit to work or (c) to engage, thereby creating a common law employment relationship.

In analyzing these three tests, the court disregarded documentary evidence that identified Payday as Futrell’s “employer,” noting that such labels should be ignored in the face of evidence of the parties’ actual conduct. In applying the three tests, the court found that Payday exercised no control over hours or working conditions, and that issuing a paycheck did not constitute control over wages. Payday did not suffer or permit work, because it lacked the power to cause Futrell to work or to prevent him from working. Finally, there was no common law employment relationship because Payday did not direct or supervise Futrell, did not hire him, did not set his pay, and he did not perform services directly for Payday’s benefit. Accordingly, under California law, Payday was not Futrell’s employer.

B. The Federal “Economic Realities” Test

In analyzing the FLSA claims, the court noted that “[a]lthough the FLSA applies a slightly different test than California law, the predominant factor remains the control an alleged employer has over an employee.” As Payday did not exercise meaningful control of Futrell, it was not his employer.

The court also rejected Futrell’s argument that Payday should be estopped from denying its employer status because it had made representations in contracts and to the IRS that it was Futrell’s employer. The court found that estoppel principles do not apply “in the absence of evidence showing Futrell somehow did an act in detrimental reliance on any statement by Payday.”

What Futrell Means for Employers

The Court of Appeal’s conclusion in Futrell is consistent with common sense: a payroll service is not an individual’s employer by virtue of issuing paychecks and other ancillary documents to the individual. But if a payroll company engages in any other conduct that suggests an exercise of control over some aspect of the individual’s work, then that payroll company may be treated as an employer under either California or federal law. Therefore, it is imperative that payroll companies are vigilant against activities beyond those minimally necessary associated with payroll processing, to ensure that they are not saddled with the obligations attendant to being an employer. It also is important that employers utilizing payroll services realize that they—not the payroll service—may be responsible for the correct payment of overtime.

For more information, please contact the Seyfarth attorney with whom you work, or any Labor and Employment attorney on our website.