High-stakes California PAGA and class action misclassification lawsuits present real and specific challenges to all direct selling companies.
Over the past year, we have seen a rising tide of both threatened and filed class action and Private Attorneys General Act (“PAGA”) litigation in California against direct sellers alleging that the companies are misclassifying their distributors as independent contractors.
These lawsuits are driven by plaintiffs’ attorneys looking to recruit distributors and offer them the opportunity of a windfall recovery if the suit is successful. The basis of the claims is that independent distributors should have been classified as actual company employees and were misclassified as independent contractors.
Although the distributors are wholly independent, as anyone with knowledge of industry practices knows, the plaintiffs claim their associated companies failed to adhere to things like mandatory work breaks, lunch breaks, overtime pay, etc. Almost half a dozen direct sellers have been sued on such claims, and California plaintiffs’ lawyers have made it clear they intend to sue many more direct sellers. Indeed, we have seen multiple advertisements from plaintiffs’ attorneys seeking clients for additional class action and PAGA misclassification claims to be filed soon.
Here we briefly discuss the mechanics of California distributor-misclassification litigation and recommended action your company can take in light of the litigation.
Class Actions
A direct seller’s highest exposure in distributor misclassification lawsuits typically comes from claims that can be brought as class actions, many of which have a four-year statute of limitations. Accordingly, the potential class consists of California distributors who sold the direct sellers’ products or services during the preceding four years and continuing until the case resolves.
Such claims can be defeated by an arbitration agreement and class action waiver, but the law surrounding such provisions is consistently changing. We highly recommend that direct sellers have legal counsel review their arbitration agreement and class waivers to ensure that the provisions account for the most recent legal precedent.
PAGA Actions
Along with the class claims, California distributor-misclassification litigation also typically involves PAGA claims. Although individual PAGA claims can be compelled to arbitration under a recent Supreme Court decision, non-individual PAGA claims cannot. That means that direct sellers could end up fighting these claims on two fronts against multiple different parties.
1 In arbitration fighting individual distributor claims; and
2 In court fighting the non-individual claims asserted by the individual distributor on behalf of the other distributors in the PAGA group.
And of course, doing so gets very expensive very quickly.
While PAGA damages exposure is typically not as high as class exposure, PAGA exposure is by no means minimal. PAGA claims have a short statute of limitations—one year running back from the submission of a PAGA notice to the California Labor Workforce and Development Agency.
And if the plaintiff successfully proves its PAGA claims, PAGA penalties can be assessed at $100 per alleged employee per pay period for the first violation of any California Labor Code section, and $200 per alleged employee per pay period for each violation thereafter. And the claims may be stacked for each alleged claim. Plaintiffs’ counsel also usually allege that companies are willfully undertaking misclassification of their independent contractors, which can result in even higher potential penalties.
The practical impact of PAGA’s penalty structure is that plaintiffs often come to the table with very high demands. These demands vary and are highly dependent on, among other things, the number of California distributors selling the direct sellers’ products and services.
At present, direct sellers are typically left to defend PAGA claims on the merits in high-stakes, high-cost litigation. And unfortunately, plaintiffs in these lawsuits allege that the “Direct Salesperson Exemption”—which would allow direct sellers to proceed under the more lenient Borello standard and avoid the stringent “ABC” test—does not apply to the modern direct sales model.
If the court determines the stringent ABC test applies, direct sellers must then prove:
A Their distributors are free from the control and direction of the company in connection with the performance of the work, both under the contract for the performance of the work and in fact.
B Their distributors perform work that is outside the usual course of the hiring entity’s business.
C Their distributors are customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
Failing to meet any one of these factors could result in distributors being classified as employees, and the plaintiffs bringing these misclassification claims allege that direct sellers cannot establish at least elements B and/or C.
If, however, the less stringent Borello test applies, the principal test is whether the direct seller “has the right to control the manner and means of accomplishing the result desired,” and the direct seller does “not exercise any degree of control merely by imposing requirements mandated by government regulation.”
In addition, the following factors are considered under the Borello test:
A Whether the one performing services is engaged in a distinct occupation or business.
B The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision.
C The skill required in the particular occupation.
D Whether the principal or the worker supplies the instrumentalities, tools and the place of work for the person doing the work.
E The length of time for which the services are to be performed.
F The method of payment, whether by the time or by the job.
G Whether or not the work is a part of the regular business of the principal.
H Whether or not the parties believe they are creating the relationship of employer-employee.
No single factor is dispositive.
We recommend direct sellers review their distributor-facing agreements with legal counsel to ensure they are in the best position to satisfy the Borello test.
In sum, given recent developments in California distributor misclassification litigation, and the high stakes of such litigation, direct sellers should take a close look at their distributor-facing agreements to assess whether they can satisfy the Borello factors and ensure their arbitration agreement and class action waiver align with current legal precedent.
Winston & Strawn LLP represents dozens of direct selling companies in a wide range of disputes and consulting matters. The firm has successfully defeated class actions alleging pyramid schemes and securities claims, enforced non-compete and non-solicitation agreements against departing distributors, prosecuted individuals violating intellectual property rights, and counseled clients on regulatory compliance issues and publicity crises. The firm also regularly advises direct selling clients undergoing government investigations, including those brought by the FTC.
From the May 2024 issue of Direct Selling News magazine.
