Could Employee Classification Issues Uberwhelm the Uber Business Model?

Arguments were held last week in connection with motions pending in a federal lawsuit [O’Connor v. Uber, 13–3826, U.S. District Court, N.D. Cal.- San Francisco] that could put an ugly dent into the virtual fender of Uber, the app-based transportation network and quasi-taxi service operating in virtually every American metropolitan area and in 54 foreign countries. While Uber has maneuvered around many of the claims spelled out in the original complaint filed on behalf of a purported class of Uber’s drivers, two important issues remain. Both relate to whether the drivers should be dealt with as employees, rather than as independent contractors. If the plaintiffs prevail with the remaining issues, Uber will, among other things, have to provide workers’ compensation coverage for its drivers and reimburse them for a good portion of their expenses.

The Threat From Within

As the case currently stands, any decision as to employee classification will not be binding beyond California’s borders. While the Uber has generally managed to fend off claims and aspersions cast against it by scads of angry/envious competitors, regulators, taxing authorities, taxi and limousine commissions, and occasionally even customers from around the globe, it is ironic that the firm must defend this employee misclassification charge in its own back yard—Uber was founded in and around Silicon Valley in 2009. So much for home court advantage. Also particularly troubling for Uber is the fact that, unlike most of the other attacks on its core business model, this lawsuit was spawned from within its very ranks.

Uber’s Business Model

As many of you know, Uber is essentially a smartphone app connecting passengers to drivers with vehicles for hire. Unlike traditional taxis, however, all hiring and payment goes through Uber—not the driver. After a one-time app download, would-be passengers choose the kind of car service they desire, input their location and, in some cases, their desired destination. The app alerts the customer when a car has been confirmed. The driver’s identity and license plate number are identified and the app shows the route the driver will take and the estimated time of the driver’s arrival. Customers tell the driver where they want to go, if that hasn’t already been plugged into the system. Uber emails a receipt to the customer after the transaction is completed. Both the customer and the driver rate each other—an incentive to be both a good rider and a careful, courteous driver.

Uber sets fares for each service in each city based on its own formula and data. Unlike standard taxi services, however, the fare can vary from time to time. For example, when demand is high—New Year’s Eve, for example—potential riders are alerted of “Surge Pricing,” which Uber maintains is an incentive for getting more drivers onto the streets during these high demand periods. Unlike traditional taxi service, tips are included in the price paid by the customer to Uber. That’s one of the issues at the heart of the federal lawsuit. Plaintiffs claim that while the passenger is told the tip is included in the fare, not all the tip is turned over; some of it is kept by Uber.

By early December 2014, Uber’s information technology had boosted the firm’s business valuation to more than $40 billion, according to two prominent hedge funds [see Wall Street Journal article] (http://blogs.wsj.com/digits/2014/12/05/ubers-investor-club-adds-two-hedge-funds-qatars-sovereign-wealth-fund/?mod=WSJ_Opinion_LatestHeadlines). Of course, that valuation could be significantly reduced if Uber’s drivers are deemed to be employees rather than independent contractors. Uber would be required to pay for, among other things, unemployment insurance, workers’ compensation coverage, and an employer’s share of Social Security taxes.

Are Uber’s Drivers Employees?

The issue is one of control. Generally speaking, employment status under California law is governed by a multi-factor test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal. 3d 341, 769 P.2d 399, 256 Cal. Rptr. 543, 54 Cal. Comp. Cases 80. The factors include:

1. Whether the one performing services is engaged in a distinct occupation or business;
2. 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;
3. The skill required in the particular occupation;
4. Whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work;
5. The length of time for which the services are to be performed;
6. The method of payment, whether by the time or by the job;
7. Whether or not the work is a part of the regular business of the principal; and
8. Whether or not the parties believe they are creating the relationship of employer-employee.

Under Borello, these factors generally cannot be applied mechanically as separate tests; they are intertwined and their weight depends often on particular combinations.

FedEx Misclassification Litigation

A recent case involving FedEx illustrates the interplay between and among these factors. In Alexander v. FedEx Ground Package Sys., Inc., 765 F.3d 981 (9th Cir. 2014), FedEx contended its FedEx Ground drivers were independent contractors and not employees. FedEx had contracted with drivers to deliver packages to its customers under the terms of an operating agreement (“OA”). The OA designated the relationship as that of principal and independent contractor. FedEx did not expressly dictate working hours; it did, however, “structure” drivers’ workloads to ensure that they worked between 9.5 and 11 hours each working day.

The court held that while some portions of the OA tended to point to an independent contract status, on the whole, FedEx exerted sufficient control over the drivers to make them employees. For example, the drivers were required to wear FedEx uniforms, drive FedEx-approved vehicles, and groom themselves according to FedEx’s appearance standards. The court stressed that FedEx told its drivers what packages to deliver, on what days, and at what times. Although drivers could operate multiple delivery routes and hire third parties to help perform their work, they could do so only with FedEx’s consent. The court determinend that the drivers, in all reality, had little autonomy; FedEx told them what color of socks they were to wear.

What About Uber’s Drivers? Are They Employees?

For Uber’s drivers, the issue isn’t nearly so clear. As in Alexander, the service agreement designates the drivers as independent contractors and not as employees. That, of course, will not control (it is a factor on Uber’s side, however). There are a number of important differences between the FedEx scenario and that of Uber. Among them are the fact that:

• Virtually all Uber drivers do not rely upon Uber as their primary source of income—many are black car drivers already;
• Uber drivers are free to work for others;
• Uber does not set the drivers’ hours, directly or indirectly;
• Uber offers no uniforms or other branding to the drivers beyond a sign identifying them as an approved Uber driver;
• FedEx required the driver to be available every day FedEx was open—not the case with Uber;

Dominant Rule: Taxi Drivers Are Employees If Cab Company Supplies Can

While the dominant legal rule is to designate taxi drivers as employees when the cab company leases or otherwise supplies the cab to the driver [see Larson’s Workers’ Compensation Law, § 61.01, et seq.], that is not Uber’s arrangement. As far as I can determine, all Uber drivers own their vehicles or lease them from third parties, not from Uber. It only supplies the driver with an iPhone and the aforementioned sign. Uber maintains it isn’t a transportation company, that instead it’s merely a software platform. In a hearing last week, the judge is said to have “smirked” at that argument. Smirks aside, there are significant differences between Uber and FedEx.

Likely Verdict: I Think It’s A Toss-Up

The Uber plaintiffs—there is similar litigation against Lyft, an Uber competitor—don’t have nearly the strong case as the FedEx drivers. FedEx is much more than software. It has warehouses all around the nation (and the world) that facilitate the movement of packages and freight. It has a jet fleet that rivals some of the largest airlines. Uber has no such complimentary network of bricks and mortar and doesn’t need it. Perhaps the analogy fails me here, but does anyone seriously contend that sellers on Ebay are Ebay employees?

There are those who argue that Uber’s methods are merely a new approach to the old taxi mechanism: the radio dispatch. I’m not so sure. What I’m more sure of—Uber and other alternative business models are generating huge levels of revenue and valuation. State, federal and local governments have never been able to resist the temptation to tax the goose that lays the eggs (she did all the work). While I think Uber has a much stronger argument than did FedEx, I wouldn’t lay odds in Uber’s fight. One thing is sure: all parties, including those entities whose web sites end in “dot gov,” have huge interests at stake.