State Slams Costco With Six-Figure Misclassification Penalty

State regulators in California have imposed a substantial misclassification penalty on a global employer. It’s yet another reminder for HR pros: Treating workers as independent contractors when they should be classified as employees can be a very expensive mistake.

States Ramp Up Scrutiny of Worker Misclassification

In recent weeks, state regulators have sharpened their scrutiny of worker classification, making it clear that mislabeling workers carries a higher risk. First among recent notable examples is the New Jersey case involving Lyft — the ridesharing service agreed to pay more than $19 million for misclassifying more than 100,000 of its drivers as independent contractors rather than employees.

On the heels of that case came an announcement from California’s attorney general of a $10 million judgment against a provider of in-home caregiving services that was similarly accused of misclassifying workers as independent contractors instead of employees.

Now comes yet another substantial penalty in a misclassification case, again involving California and a big-name employer. This time, it’s membership warehouse club Costco that is facing payment of a heavy misclassification penalty.

Near the end of October, the state’s Department of Industrial Relations announced that the state’s labor commissioner cited Costco and two affiliated entities for misclassifying 58 delivery drivers as independent contractors rather than employees.

State’s Misclassification Investigation Begins

The state began an investigation in July 2022, after two former trucking workers filed complaints that alleged both misclassification and wage theft.

In addition to Costco, the targets of the state’s investigation included delivery contractor Ryder Last Mile Inc. and trucking subcontractor Mega Nice Trucking.

The state’s investigation determined that drivers who worked directly under Mega Nice Trucking were wrongly misclassified as independent contractors instead of employees.

The state said the drivers were deprived of protections that are afforded to employees but not independent contractors — like an hourly minimum wage, overtime, and meal breaks.

Different Name, Same Misclassification Problem

The state added that although the drivers were “reclassified” as employees in 2023, they continued to be treated like independent contractors – receiving a flat daily rate and being denied overtime and meal breaks. Mega Nice Trucking admitted to misclassifying the drivers, the state said. Investigators also discovered falsified payroll records.

The state jointly cited Costco, Ryder Last Mile and Mega Nice Trucking for a total of $868,128. Of that total, $662,978 is slotted to go directly to the affected drivers.

All three employers have appealed the citations that the state has issued.

An important wrinkle in this case – and one that separates it from the other recent examples – is the involvement of multiple employers. HR pros must remember that using subcontractors doesn’t relieve them of the responsibility to follow applicable wage laws.

Beware of Joint Employer Status

As California Labor Commissioner Lilia Garcia-Bower stated in the release announcing the alleged violations, “[c]ompanies that exert control over workers cannot evade responsibility by hiding behind layers of subcontracting.”

In this case, the state said Costco and Ryder Last Mile were both responsible for the alleged violations because they:

• Scheduled deliveries
• Mandated the wearing of uniforms
• Enforced specified protocols, and
• Closely monitored the drivers’ performance.

This meant the two entities were joint employers, the state said. And that meant both were responsible for compliance with legal requirements.

Two Key Takeaways

This case highlights HR’s need to know the answers to two important questions.

Question #1: How do I determine whether a worker should be classified as an independent contractor or an employee?

The federal Department of Labor has issued guidance on the proper classification of workers and has advised that the question comes down to “looking at the economic realities of the worker’s relationship with the employer.”

The DOL also identifies factors that should be considered in determining whether a worker is an independent contractor or an employee. These factors include:

• The worker’s opportunity for profit or loss
• Relative investments by the worker and employer
• The degree of permanence of the relationship
• The nature and degree of control exercised by the employer
• Whether the work is integral to the employer’s business, and
• The level of skill and initiative needed for the work.

Indicators of employee status focus on the degree of employer control and how integral the work is to the business. Here are some indicators of employee status:

• The worker maintains an ongoing relationship with the same employer.
• Their work is “critical, necessary, or central to the company’s business.”
• The employer oversees scheduling, performance, and work methods.
• The employer supplies tools, equipment and workspace.

Question #2: Are we a joint employer?

Remember: Using a contractor or subcontractor does not necessarily relieve employers of their responsibility to comply with applicable wage-related laws – including laws addressing the proper classification of workers.

While there is no quick-and-fast rule to apply, the question to ask is this:  How much control does the employer exercise with respect to the worker’s essential terms and conditions of employment? It’s important to consider day-to-day supervision, job assignments and how the work is performed.

And remember: If the requisite level of control is exercised, it does not matter that a worker is directly employed by a different entity. For example, in this case, California cited Costco even though the drivers were working directly under Mega Nice Trucking.