Can Uber Disrupt the Law?

Thanks to a California labor ruling, the company just glimpsed its doomsday scenario. Here’s where the fight over its business model goes next.

Uber CEO Travis Kalanick
Uber CEO Travis Kalanick, pictured in Beijing on Dec. 17, 2014, should be worried.

Photo by Kim Kyung Hoon/Reuters

Rarely does a single worker inspire existential angst in a $50 billion company the way Barbara Ann Berwick has for Uber. On Wednesday, it came out that the California Labor Commission had determined earlier this month that Berwick, a former Uber driver, should be classified as an employee of the company rather than an independent contractor. The commission awarded Berwick some $4,000 in unpaid expenses. Uber immediately appealed. The “1099 economy” shuddered.

In the fast-growing world of on-demand, “Uber-but-for” services, the threat that workers who currently operate as independent contractors could be deemed employees is real and powerful. Since operators for companies like Uber, Lyft, and TaskRabbit are independent contractors, they tend to shoulder the bulk of the costs. Uber drivers pay for expenses like gas, insurance, and routine car maintenance out of their own pockets—significantly reducing the earnings they take home. When workers are employees, however, the company becomes responsible for bearing those costs. What’s more, employees are afforded a whole host of benefits and labor protections that independent contractors aren’t. An employee-based labor force is much more expensive than a contractor-based one—and even for ultra-wealthy companies like Uber, much less economically viable. Because of this, Uber insists that it is simply a technology platform facilitating rides between passengers and drivers, not an employer of those drivers.

The California Labor Commission felt otherwise. Uber, the commission observed, is “involved in every aspect of the operation.” Uber sets strict standards for what vehicles its drivers can register (nothing more than 10 years old) and the approval ratings from riders they can maintain (no lower than 4.6 out of 5 stars). More importantly, the actual work done by Berwick was “integral to Defendants’ business,” the commission wrote in its ruling. “Plaintiff did the actual transporting of those passengers. Without drivers such as Plaintiff, Defendants’ business would not exist.”

The Berwick ruling applies only to one employee in one state. But it presages trouble for Uber and its on-demand peers. Imagine briefly if all of Uber’s drivers in the United States—more than 160,000 as of December—were deemed employees and awarded unpaid expenses. Uber would be looking at hundreds of millions of dollars, if not billions, in fees. The low-cost, thin-margin model that lets Uber keep prices low for riders might no longer be sustainable. Uber as we know it could cease to exist.

That’s the doomsday scenario, and it’s still far off. Uber’s appeal is heading to San Francisco Superior Court for what’s known as de novo review—literally “from the new”—where the company will get its best shot at a reversal. “It’s not like in a typical court of appeals where they’re just reviewing what the underlying court did,” says Tamara Devitt, a labor and employment attorney at Haynes and Boone in Palo Alto, California. “They basically start from scratch. So once it’s appealed, it’s almost as though [the labor commission ruling] didn’t exist.” The case could linger at the trial court level for months or longer. “There’s a right to discovery and all that good stuff,” Devitt says. Any ruling that comes out of the trial court level could be appealed again to the California Courts of Appeal, and from there—if it got that far—to the Supreme Court of California. That could help explain why Uber has tried to downplay the labor commission’s ruling, stressing in multiple statements that the decision “is nonbinding.”

At the same time, the fierce debate over Uber’s employment model is unlikely to stall out while Berwick’s case percolates through the California court system. Uber suffered a major loss in March when a U.S. district judge declined to decide whether Uber drivers were employees and said the question would have to be resolved by a jury. That case, which is being brought by Boston-based employment lawyer Shannon Liss-Riordan, is scheduled for a hearing in early August to determine whether it can proceed as a class-action suit. Liss-Riordan expects that Berwick’s ruling could be helpful to her case. “The fact that the California Labor Commission—who’s in charge of enforcing California wage laws—looked at Uber and decided it was an employer is significant,” she says. In another sign that sentiment on employment definitions may be shifting, FedEx last week agreed to pay $228 million to settle a longstanding case over its use of independent contractors.

Berwick’s decision may also prompt other Uber drivers in California to file similar complaints, which the labor commission is free to adjudicate on. “I expect we’ll see a flood of Uber employees filing claims in the Department of Labor Standards Enforcement, and more decisions like this one,” says Rebecca Smith, deputy director of the National Employment Law Project. Liss-Riordan thinks some may already be in the pipeline.

Uber disagrees. “The vast majority—about 73 percent—of our partners prefer the flexible nature of the platform as opposed to a steady 9-to-5 job,” writes Molly Spaeth, a spokeswoman for the company, pointing to a workforce study Uber released in January. “The fact that partners are independent contractors means they can drive when they want for however long they want while tapping into a flexible income opportunity.”

The trends Uber sees among its drivers are reflected across America. What no one seems to know, however, is whether that bodes well or ill for the economy. In April, a study from the U.S. Government Accountability Office estimated that the nation’s so-called contingent workforce—a group that includes temporary part-time workers and independent contractors like Uber drivers—had grown from 35.3 percent of the employed in 2006 to 40.4 percent as of 2010. Those contingent workers tended to earn 10.6 percent less per hour than standard workers and were far less likely to have benefits like retirement plans and health insurance. Contingent workers were also more likely to be living below the poverty line and receiving government support than other employees.

With the trends toward contingent work and 1099 companies being what they are, Uber isn’t the only firm that’s due for some growing pains. There are contractor-based startups to clean your house, install your light bulbs, do your laundry, and deliver your groceries. So far, most of these companies have coasted legally on a loose middleman defense—that they’re really just software platforms connecting two sides of a market, that they don’t actually own anything or employ anyone. As Fusion’s Kevin Roose wrote in January, “in the new economy, the hot asset is assetlessness.

The problem is that the faster these companies grow—the quicker their valuations soar into multibillion-dollar “unicorn” territory, dragging more contingent workers along—the swifter they also draw regulatory and legislative scrutiny. “Today’s ruling from the California labor regulators demonstrates why federal policymakers need to re-examine the 20th century definitions and employment classifications we’re attempting to apply to a 21st century workforce,” Sen. Mark Warner, a Democrat from Virginia, said in a statement Wednesday. “We have a responsibility to provide clarity and predictability instead of allowing inconsistency and confusion as these issues are litigated on a case-by-case and state-by-state basis.”

All of a sudden, a lot of powerful people are paying attention to how Uber does business. The very fact of the company’s immense success makes it impossible to keep employment scuffles under the radar. And the law is a lot tougher to disrupt than the taxi industry.