Employee or Independent Contractor in California?

If you are a proprietor of a business in California and need to determine whether a worker is an employee or independent contractor?

If so, the basic test is whether you as the principal have the right to direct and control the manner and means by which the work is performed:

"When the principal has the "right of control," the worker will be an employee even if the principal never actually exercises the control. If the principal does not have the right of direction and control, the worker will generally be an independent contractor. If it is not clear from the face of the relationship whether the worker or the principal has the "right of control," reference is made to a list of secondary factors that are evidence of the existence or nonexistence of the right of control."

California Division of Labor Standards Enforcement (DLSE) and Employment Development Department (EDD) are mainly concerned whether you as the principal are in compliance with California's wage, hour and workers' compensation laws.

In California, the Franchise Tax Board (FTB), Division of Workers' Compensation (DWC) and the Contractors State Licensing Board (CSLB) also have their own regulations pertaining to this issue.

In addition, the IRS uses factors divided according to the degree of control as it relates to behavior, finances, and the relationship between the parties. (http://www.irs.gov/pub/irs-utl/emporind.pdf)

The potential liabilities and penalties are significant if you misclassify an employee as an independent contractor. As such, if you are in the position of making this determination, please contact a qualified attorney to help make this assessment for your business.

Trade Secret Exception and California Non-Competes

According to California Business & Professions Code Section 16600:

"Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, orbusiness of any kind is to that extent void."

What this means for a California employer is that California protects its citizens by allowing them to pursue employment of their choice.

But, is this law entirely one-sided?

No, according to California law, an exception is around the protection of trade secrets used by an employee to compete with the former employer.

In California, trade secret means information, including a formula, pattern, compilation, program, device, method, technique, or process, that:

(1) Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; and

(2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

However, the employer must take certain steps to keep the valuable trade secrets confidential. Think about it, what would you do if you were an employer in this case? You would probably keep the info password protected and/or place the hard-copy info in a safe locked environment. What else? You might want to stamp everything as confidential. An additional step would be the process of emphasizing and re-enforcing the confidential nature of the valuable info. For instance, you could have an attorney draft a confidential agreement describing and explaining the policy behind keeping your trade secrets confidential, then have the employees sign the agreement at the start of their employment.

This is a complicated area of law, if you are an employer who has made a lot of effort and gone through a lengthy process to derive at certain valuable information and you have taken reasonable steps to keep this information non-public, please educate yourself and consult with an attorney to protect this information to avoid future hurdles and legal battles. 

Should you have an LLC Operating Agreement in California?

Absolutely. For one, in California, all LLC’s are required under state law to have a Limited Liability Company Operating Agreement (see code 17050).

"(a)In order to form a limited liability company, one or more persons shall execute and file articles of organization with, and on a form prescribed by, the Secretary of State and, either before or after the filing of articles of organization, the members shall have entered into an operating agreement. The person or persons who execute and file the articles of organization may, but need not, be members of the limited liability company..."

Aside from this requirement, consider the following critical issues which can be addressed with a well-written operating agreement:


-Liability Protection: can help prove that the LLC is a separate legal entity.
-Management: Sets forth who manages the entity and outlines duties and responsibilities of managers and members.
-Distributions: Sets forth how profits will be divided among the members of the entity.

-Dissolution: Sets forth the process for dissolving the company and distribution of assets after the dissolution.

Do consider having a proper operating agreement drafted for your LLC either before or after the filing of articles of organization.

No limited liability when signing a pre-formation contract

The title says it all, if you are the owner of an LLC/Corp, do NOT sign a contract before the entity is legally formed. If you do, you are signing the contract in your principal capacity and have unlimited  personal liability related to the contract. 

In other words, pre-formation contracts limit your limited liability.

Assuming you have signed a pre-formation contract, try to have the creditor(s) sign a novation replacing the entity in your place.