For the past year or so, I have been speaking and writing about the California Secure Choice Law authorizing the State’s mandatory payroll deduction IRA program named CalSavers (“Program”).  When implemented, the Program will require private employers who don’t otherwise offer employees a retirement plan to automatically enroll their employees and withhold and contribute to the Program a percentage of the employees’ pay to be invested in an individual retirement account for the employee.  Employees can elect to opt out but must be automatically enrolled first.  In particular, I have stressed that there is still an open issue as to whether the statute creating the Program is preempted by ERISA due to the way the statute was enacted and amended.  And, I have pointed out that it is likely going to require litigation to settle the matter.

On May 31, my prediction came true when the Howard Jarvis Taxpayer’s Association (“HJTA”) and two of its employees sued the Program and the Chair of its Board, State Treasurer, John Chiang, in Federal District Court.  As predicted, the suit maintains that the statute creating the Program is void as preempted by ERISA.  The suit also seeks to enjoin the State from spending any further money on the Program.

State Sailed Legislation Through Rough Water Without Safe Harbor

The issue of ERISA preemption exists because of the history of the Secure Choice Law as well as Federal regulatory developments between the Obama and Trump administrations.  The statute creating the Secure Choice Board was enacted in 2016 and the Program’s implementation was contingent upon the Board reporting to the Governor and State legislature that the U.S. Department of Labor (“DOL”) had issued a safe harbor regulation stating that state run mandated employer payroll deduction IRA plans were not subject to ERISA and that the Program met such safe harbor’s requirements.  In August of 2016, the DOL issued the safe harbor.  In November, Trump won the election and took office in 2017.  In May of 2017, Congress repealed the safe harbor regulation under the Congressional Review Act, providing it shall have no force or effect and Trump signed it.

Also in May of 2017, the Secure Choice Board received a legal opinion from a private law firm stating that even without the Obama administration’s 2016 safe harbor, the Program would not create one or more ERISA plans (see  The legal opinion relied on interpretive guidance by the DOL from 1975 (“1975 Safe Harbor”), finding that a payroll deduction IRA plan is not an ERISA plan where:  1) there are no employer contributions to the plan; 2) the only employer involvement is publicizing the program without endorsing it; collecting employee contributions through payroll deductions and remitting them to the IRA sponsor; 3) employee participation is “completely voluntary”; and 4) the employer receives no compensation from the IRA sponsor.

The opinion summarizes how when the 2016 safe harbor was issued, the DOL stated it was necessary because the 1975 Safe Harbor would not cover a program using auto enrollment.  The DOL analyzed that if an employer voluntarily adopted auto enrollment, it may exercise undue influence over an employee’s decision to participate.  This would prevent the employee’s participation from being completely voluntary because it is not “employee initiated”.  Therefore, the employer has established an ERISA plan.  The opinion then states that where an employer is offering the Program because it is required by State law, the employer is not voluntarily acting to establish a plan, or coercing employees to participate.  Therefore, the employee’s participation through auto enrollment with an opt out should be considered “completely voluntary”.

The Program requires covered employers of a certain size to automatically enroll employees into CalSavers and contribute a percentage of the employees’ pay.  However, the employee may opt out of participation in the Program.  In the first year of implementation, covered employers are those with 100 or more employees.  In the second year, the number drops to 50 or more employees and in the third year it drops to 5 or more employees.  The Board will decide when the Program is ready to be implemented and is aiming for 2019.

If the HJTA lawsuit is successful it would be the end of the Program.  Of course, the Program could appeal the initial decision.  And given that other states, such as Oregon, have similar laws, the issue could eventually wind up before the U.S. Supreme Court to decide.  Of course, this will take time.

Currently, the anticipation of CalSavers becoming effective serves as a great opportunity for the California retirement plan industry to market the value of employers adopting other types of retirement plans that would exempt them from the mandate (such as 401k or SEP-IRA plans), and the flexibility of design they offer to meet an employer’s needs.

The California Supreme Court recently decided an important decision on the issue of when a worker is properly classified as an independent contractor or employee for purposes of California wage orders.  On April 30, the Court decided in Dynamex Operations West, Inc. v. Superior Court, that drivers for a delivery service were employees “for purposes of California wage orders, which impose obligations relating to the minimum wages, maximum hours, and a limited number of very basic working conditions (such as minimally required meal and rest breaks) of California employees.”

The Court held that when classifying workers for purposes of California wage orders, employers must start with the presumption that the worker is an employee and to classify a worker as an independent contractor the worker must pass a three-pronged ABC test.   Failing any prong means the worker is an employee.  The Court said to be classified as an independent contractor the employer must show: “(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact, (B) that the worker performs work that is outside the usual course of the hiring entity’s business, and (C) that the worker is customarily engaged in an independently established trade, occupation, or business, the worker should be considered an employee and the hiring business an employer under the suffer or permit to work standard in wage orders”.

Clearly this test leans toward employee status.  Prongs B and C are very difficult to meet for a business that substantially uses independent contractors.  For example, drivers for a delivery company, taxi company or private ride requesting company would generally fail these prongs.

Aaron Silva, a partner in Murphy Austin’s Labor & Employment practice group and host of the Murphy Austin HR LegalCast said of the decision, “Importantly, this new case is not a “universal” independent contractor test.  The Court even says it is possible for someone to be an independent contractor for purposes of one law, like workers’ compensation, but not another, like the wage orders.  Regardless, businesses need to be cautious when deciding whether to retain someone as an independent contractor rather than an employee, because the consequences can be severe.”

So what does this mean for employee benefits governed by ERISA?  First, the case says it is limited to wage orders.  Second, ERISA preempts state law.  Therefore, the Dynamex decision would not govern whether a worker is an employee as defined under ERISA.  In fact, the United States Supreme Court has said that one should apply the common law test of agency surrounding the right to control the manner and means by which the work is accomplished to determine if a worker is an employee for ERISA purposes.  Nationwide Mutual Insurance Co. v. Darden, 112 S. Ct. 1344 (1992).  The United States Court of Appeals for the Ninth Circuit, of which California is a part, adopted the common law test for ERISA from Darden in Burrey v. Pacific Gas & Electric, 159 F3d 388 (Ninth Cir. 1998).

Additionally, a worker that is re-classified for California wage order purposes as an employee most likely will not be retroactively eligible for ERISA covered benefits plans because the plan document likely has “Microsoft” language in its eligibility provisions.  This is language resulting from another Ninth Circuit case, Vizcaino v. Microsoft Corp., 120 F.3d 1006 (Ninth Cir. 1997).  In that case, the IRS, on audit, reclassified certain workers from independent contractor to employees based on the common law test and Microsoft agreed with the reclassification.  The workers then sued for retroactive benefits and the court held they were entitled to them.  Since the Microsoft case, most plans contain language stating that workers who agree they are independent contractors will not be retroactively eligible for plan benefits if a government agency determines they were misclassified and retroactively classifies them as employees.  This Microsoft language is in virtually all pre-approved retirement plans.  However, the language of the plan should always be checked, especially if it is an individually designed plan.  Additionally insured health plans that don’t have a “wrap” plan document, probably won’t have Microsoft language.

Thus, it is possible, especially in this gig economy, for a worker to be eligible for minimum wages, break periods, and overtime and not be eligible to participate in the employer’s 401(k) plan.  Therefore, employers should really consider all factors when deciding whether to attempt to classify workers as independent contractors.