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Swanson Hay Co. v. State of Washington Employment Security Department

Court of Appeals of Washington, Division 3

October 31, 2017


          SIDDOWAY, J.

         The common law, the Washington legislature, and the United States Congress have defined whether two parties stand in an employment as opposed to an independent contractor relationship in different ways, depending on the context. This case illustrates that it can be clearer to ask not whether someone is an independent contractor, but to ask instead whether the contractor is independent for a given purpose: e.g., for the purpose of the doctrine of respondeat superior, for federal payroll tax purposes, for state worker's compensation, or for other state law purposes. At issue here is employment security-the context in which, in Washington, the relationship is more likely than any other to be viewed as employment.

         The three motor carriers in this consolidated appeal challenge assessments of unemployment insurance taxes on amounts they paid for services provided by "owner-operators, " meaning individuals who own trucking equipment, lease it to a carrier, and then use that equipment under contract to haul freight for that carrier. The carriers did not meet their burden of demonstrating that the owner-operators' services qualify for the narrow exemption from unemployment insurance tax liability for payments to sufficiently independent enterprises. We find no federal preemption of the tax's application to the owner-operators' services and no basis on which the agency's final order was arbitrary or capricious. We affirm.


          Washington's Employment Security Act

         Title IX of the Social Security Act of 1935 for the first time imposed a federal excise tax on employers on wages paid, for the purpose of creating an unemployment benefit fund. Steward Machine Co. v. Davis, 301 U.S. 548, 574, 57 S.Ct. 883, 81 L.Ed. 1279 (1937). The tax began with the year 1936 and was payable for the first time on January 31, 1937. Id. An employer could claim a 90 percent credit against the tax for contributions paid to an unemployment fund under a state law, provided the state law had been certified to the United States Secretary of the Treasury as meeting criteria designed in part "to give assurance that the state unemployment compensation law [is] one in substance as well as name." Id. at 575. The tax and largely offsetting credit were described by supporters as "the states and the nation joining in a cooperative endeavor to avert a common evil": the problem of unemployment that the nation had suffered at unprecedented levels during the years 1929 to 1936. Id. at 587, 586.

          Before Congress considered adoption of the act, most states held back from adopting state unemployment compensation laws despite the ravages of the Great Depression. Id. at 588. This was not for "lack of sympathetic interest, " but "through alarm lest in laying such a toll upon their industries, they would place themselves in a position of economic disadvantage as compared with neighbors or competitors." Id. "The federal Act, from the nature of its ninety per cent credit device, [was] obviously an invitation to the states to enter the field of unemployment insurance." Standard Dredging Corp. v. Murphy, 319 U.S. 306, 310, 63 S.Ct. 1067, 87 L.Ed. 1416 (1943) (citing Buckstaff Bath House Co. v. McKinley, 308 U.S. 358, 363, 60 S.Ct. 279, 84 L.Ed. 322 (1939)). Most states accepted the invitation and adopted state unemployment compensation laws. See Benjamin S. Asia, Employment Relation: Common-Law Concept and Legislative Definition, 55 YALE L. J. 76, 83-85, nn.24-34 (1945) (discussing laws adopted by 31 states and the District of Columbia).

         Criteria by which the Social Security Board would certify state laws were limited to what was "basic and essential" to provide reasonable protection to the unemployed, with "[a] wide range of judgment... given to the several states as to the particular type of statute to be spread upon their books." Steward, 301 U.S. at 593. But to assist state legislatures, the Social Security Board published draft laws in 1936 and 1937 as examples meeting the federal requirements.[1] Following a recommendation by the Committee on Legal Affairs of the Interstate Conference of Unemployment Compensation Agencies that "employment" for purposes of the state laws should be broadly defined, using a pioneering 1935 Wisconsin law as a model, a draft bill published by the Social Security Board in January 1937 tracked Wisconsin's expansive definition of employment. Asia, supra at 83, n.21. It broadly defined employment to mean "service, including service in interstate commerce, performed for wages or under any contract of hire, written or oral, express or implied . ..." Draft Bill, 1937 ed., § 2(i)(1) at 7. To narrowly exempt payments to individuals engaged in an independent enterprise, it employed a three-part measure of independence, often referred to as the "ABC" definition, that included a freedom from control ("A") requirement, an independent business character or location ("B") requirement, and an independently established enterprise ("C") requirement. The "C" requirement was described as "at once the most radical departure from common-law criteria and the most relevant of the three tests to the purposes of the unemployment compensation program." Asia, supra at 87.

         In March 1937, the Washington Legislature enacted an unemployment compensation act substantially based on the Social Security Board's draft bills, to take effect immediately. Laws OF 1937, ch. 162 § 24, at 617. Tracking language in the draft bills, its preamble described "economic insecurity due to unemployment" as the "greatest hazard of our economic life." Id., § 2, at 574, presently codified at RCW 50.01.010. It authorized taxation to create resources from which to provide benefits for persons "unemployed through no fault of their own" by applying "the insurance principle of sharing the risks, and by the systematic accumulation of funds during periods of employment to provide benefits for periods of unemployment." Id. at 575.

         Section 19(g)(1) of the 1937 Washington legislation tracked Wisconsin's and the Social Security Board's definition of employment. Its "ABC" definition of exempt independent enterprises, which was virtually identical to the Social Security Board's 1937 draft bill, [2] provided:

Services performed by an individual for remuneration shall be deemed to be employment subject to this act unless and until it is shown to the satisfaction of the director that:
(i) Such individual has been and will continue to be free from control or direction over the performance of such service, both under his contract of service and in fact; and
(ii) Such service is either outside the usual course of the business for which such service is performed, or that such service is performed outside of all the places of business of the enterprises for which such service is performed; and
(iii) Such individual is customarily engaged in an independently established trade, occupation, profession or business, of the same nature as that involved in the contract of service.

Laws OF 1937, ch. 162, § 19(g)(5). As later observed by our Supreme Court, because the requirements were stated in the conjunctive, a failure to satisfy any one of them rendered the exemption unavailable. Penick v. Emp't Sec. Dep't, 82 Wn.App. 30, 42, 917 P.2d 136(1996).

         In 1945, the Washington legislature repealed all acts relating to unemployment compensation and enacted a new unemployment compensation act, presently codified as amended in Title 50 RCW. LAWS OF 1945, ch. 35 §§ 1-192, at 76-151. The breadth of "employment" covered by the act was made even clearer by the addition of language describing "personal service, of whatever nature, " etc., as "unlimited by the relationship of master and servant as known to the common law or any other legal relationship." Id. at § 11.

         Appellants and the assessments

         In proceedings below, the appellant-carriers, Swanson Hay, Co. (Swanson), System-TWT Transport (System), and Hatfield Enterprizes, Inc. (Hatfield), appealed unemployment taxes assessed by the Employment Security Department (Department) on the carriers' payments for services to owner-operators. They participated in evidentiary or summary judgment proceedings before an administrative law judge (ALJ) and filed petitions for review of the ALJ's adverse determinations by the Department's commissioner (Commissioner). The Commissioner entered modified findings and conclusions but affirmed determinations adverse to the carriers.

         There are some differences in the three carriers' operations and audit history. System was identified for audit through the work of an "underground economy unit" of the Department and was originally assessed $264, 057.40 in taxes for the period beginning in the second quarter of 2007 and including years 2008 and 2009. 1 AR(ST) at 4, [3] ¶ 7; 3 AR(ST) at 185-86, 183, 222-23; 2 AR(ST) at 350. During that time frame, System treated roughly 380 company drivers as employees, reporting and paying unemployment insurance taxes. 2 AR(ST) at 320, ¶ 5; Br. of Appellant System at 5. But it contracted with more than 250 owner-operators that it treated as exempt from operation of the tax. Id. It engaged in several appeals of its assessment, contesting both the amount and liability for the tax, but ultimately stipulated to an assessment value of $58, 300.99 should its challenge to liability fail. 1 AR(ST) at 5, ¶ 11; 2 AR(ST) at 350-51.

         Swanson and Hatfield are smaller operators. Swanson was originally found by the Department to have misclassified 12 contractors as not in employment and was assessed $36, 070.32 for the period 2009, 2010, and the first two quarters of 2011. 2 AR(SH) at 235, ¶¶ 4.1, 4.5. On appeal, the Department agreed to modify the assessment to treat only 11 of the contractors as misclassified. 2 AR(SH) at 235, ¶ 4.7. The order and notice of assessment was later remanded to reduce the assessment to account for the contractor treated as exempt. Id. at 280.

         Hatfield was found by the Department to have misclassified 15 contractors as not in employment and was assessed taxes and penalties of $13, 616.53 for eight calendar quarters falling within the period January 2009 through June 2011. 4 AR(H) at 1140, ¶ 4.1. On appeal, the ALJ ordered that the assessment be reduced to 30 percent of that amount to account for the fact that the Department relied on payment amounts approximately 70 percent of which were for equipment rather than driving services. Id. at 1144, ¶ 5.8. The reduction was affirmed by the Commissioner. Id. at 1201.

         Differences in the carriers and their procedural histories are mostly inconsequential on appeal. They are discussed where relevant.



         Judicial review of agency action is governed by the Administrative Procedure Act (APA), Title 34 RCW. Tapper v. Emp't Sec. Dep't, 122 Wn.2d 397, 402, 858 P.2d 494 (1993). We apply the standards of the APA directly to the record before the agency and in employment security appeals we review the decision of the Commissioner, not the underlying decision of the ALJ or the decision of the superior court. Id.; Verizon Nw., Inc., v. Emp't Sec. Dep't, 164 Wn.2d 909, 915, 194 P.3d 255 (2008). The Commissioner's decision is deemed prima facie correct and the burden of demonstrating otherwise is on the party attacking it. RCW 50.32.150.

         The APA authorizes courts to grant relief from an agency order in an adjudicative proceeding in nine instances, five of which were relied on in petitions for judicial review filed by one or more of the carriers:

■ The order or the statute on which it is based is in violation of constitutional provisions;
■ The agency engaged in unlawful procedure or decision-making process, or failed to follow a prescribed procedure;
■ The agency erroneously interpreted or applied the law;
■ The agency did not decide all issues requiring resolution by the agency; and
■ The order is arbitrary or capricious.

RCW 34.05.570(3)(a), (c), (d), (f), and (i). Clerk's Papers (CP) at 4, 24, 98, 318.

         Errors of law are reviewed de novo. Inland Empire Distrib. Sys., Inc. v. Utils. & Transp. Comm 'n, 112 Wn.2d 278, 282, 770 P.2d 624 (1989). An agency's decision is arbitrary and capricious if it is "willfully unreasonable, without consideration and in disregard of facts or circumstances." W. Ports Transp., Inc. v. Emp't Sec. Dep't, 110 Wn.App. 440, 450, 41 P.3d 510 (2002).

         Issue One: Federal Preemption

         System makes a threshold argument that even if the Employment Security Act (ESA)[4], would otherwise apply to its payments for the services of owner-operators, the Department's assessments are preempted by federal law. Hatfield joins in all of System's arguments. Br. of Appellant Hatfield at 9. The Department responds that Division One of this court already held that the ESA is not federally preempted in Western Ports, 110 Wn.App. at 457.

         In its final decisions in the System and Hatfield appeals, the Commissioner, "mindful of [his] limited authority as a quasi-judicial body" discussed case law from other jurisdictions dealing with the federal preemption issue but ultimately concluded that his was not the appropriate forum to decide the constitutional issue, except insofar as he would apply Western Ports. E.g., 4 AR(H) at 1191. He correctly observed that the Commissioner's Review Office, being an office within the executive branch, lacks the authority or jurisdiction to determine whether the laws it administers are constitutional; only the courts have that power. Id. (citing RCW 50.12.010 and .020; Bare v. Gorton, 84 Wn.2d 380, 383, 526 P.2d 379 (1974)). At the same time, he recognized that on judicial review, the superior and appellate courts may consider and rule on the constitutionality of an agency order. Id. (citing RCW 34.05.570(3)(a)). He found that the record had been adequately developed at the administrative level to enable judicial review. Id. at 1192.

         To assess the relevance of Western Ports, we begin by identifying the preemption arguments that System advances. It first relies on an express preemption provision that System argues was not considered in Western Ports. Its second argument relies on language from federal leasing regulations that were considered in Western Ports and found not to preempt state law, but System argues we should reject Western Ports' conclusion in light of later, persuasive authority.

         A. Express Preemption

         In 1994, seeking to preempt state trucking regulation, Congress adopted the Federal Aviation Administration Authorization Act of 1994 (FAAAA), Pub. L. No. 103-305, § 601, 108 Stat. 1605-06; see also ICC Termination Act of 1995, Pub. L. No. 104-88, § 14501, 109 Stat. 899. Its express rule of preemption, which is subject to exceptions and exclusions not relevant here, provides:

[A] State, political subdivision of a State, or political authority of 2 or more States may not enact or enforce a law, regulation, or other provision having the force and effect of law related to a price, route, or service of any motor carrier ... or any motor private carrier, broker, or freight forwarder with respect to the transportation of property.

49 U.S.C. § 14501(c)(1).

         In adopting the preemptive language "related to a price, route, or service, " Congress copied language of the preemptive clause of the Airline Deregulation Act of 1978 (ADA), Pub. L. No 95-504, 92 Stat. 1705, in order to ensure application of the broad interpretation of that preemption provision adopted by the United States Supreme Court in Morales v. Trans World Airlines, Inc., 504 U.S. 374, 112 S.Ct. 2031, 119 L.Ed.2d 157 (1992). The Supreme Court held in Morales that the "related to" preemption provided by the ADA preempted all "[s]tate enforcement actions having a connection with, or reference to airline 'rates, routes, or services.'" Id. at 384 (alteration in original) (quoting 49 U.S.C. App. § 1305(a)(1)). It rejected states' arguments that their laws of general applicability were immune from preemption. Pointing to its earlier holding in an ERISA[5] case (ERISA also employs the same preemptive language), the Court held that "' [a] state law may "relate to" a benefit plan, and thereby be pre-empted, even if the law is not specifically designed to affect such plans, or the effect is only indirect.'" Id. at 386 (alteration in original) (quoting Ingersoil-Rand Co. v. McClendon, 498 U.S. 133, 139, HI S.Ct. 478, 112 L.Ed.2d 474 (1990)). In a critical limitation on its holding, the Court recognized that'" [s]ome state actions may affect [airline fares] in too tenuous, remote, or peripheral a manner' to have pre-emptive effect." Id. at 390 (alterations in original) (quoting Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 100 n.21, 103 S.Ct. 2890, 77 L.Ed.2d 490 (1983)).

         The carriers in this case argue that imposing unemployment insurance taxation on their use of owner-operators has a significant impact rather than a tenuous, remote, or peripheral impact on their prices, routes, and services. They contend that it "effective[ly] eliminat[es]... the owner/operator business model" that has been long relied upon for "a flexible supply of equipment in an industry with erratic demand." Br. of Appellant System at 1-2.

         1. Western Ports did not address express preemption

         With System's first challenge in mind, we turn to Western Ports. It arose not from a Department audit, but from an application for unemployment benefits by Rick Marshall, an owner-operator whose independent contractor agreement with Western Ports, a trucking firm, had been terminated by the firm. The Department denied Mr. Marshall's application for benefits based on Western Port's contention that he was an independent contractor exempt from coverage under RCW 50.04.140. The principal focus of this court's decision on appeal was whether Western Ports proved the first, "freedom from control" requirement for the exemption. W. Ports, 110 Wn.App. at 452-59.

         But Western Ports also argued that federal transportation law preempted state employment security law because it both permitted and heavily regulated owner-operator lease arrangements like Mr. Marshall's. Id. at 454. This court analyzed that argument as an issue of implied "field" preemption-one of three ways federal law can be found to preempt state law, the other two being express preemption or where state law would conflict with federal law. Estate of Becker v. Avco Corp., 187 Wn.2d 615, 622, 387 P.3d 1066 (2017). Field preemption can be found from federal regulation so pervasive it supports the inference that Congress left no room for state supplementation, where the federal interest is so dominant it can be assumed to be exclusive, or where the federal objective and regulation reveals the same purpose as the state purpose. Pac. Gas & Elec. Co. v. State Energy Res. Conservation & Dev. Comm 'n, 461 U.S. 190, 204, 103 S.Ct. 1713, 75 L.Ed.2d 752 (1983).

         In analyzing the field preemption argument, Western Ports considered 49 U.S.C. § 14102, which authorizes the Secretary of the federal Department of Transportation to regulate the leasing of motor vehicles used in interstate commerce, and the detailed federal leasing regulations adopted thereunder. 110 Wn.App. at 454-57, 455 n.2. It "decline[d] to infer" from them that Congress intended to supplant state law, given that "[n]owhere ... has Congress even mentioned state employment law" and federal transportation law and state unemployment insurance law "have very different policy objectives." Id. at 457. Only once in Western Ports did the court mention the FAAAA's express preemption provision, and that was to point out that when Congress wanted to preempt state law, it did so "expressly, clearly, and understandably." Id.

         Western Ports contains no analysis of whether imposing state unemployment insurance taxes on Western Port's payment for owner-operator services related to its prices, routes, or services. While the decision is relevant and persuasive as to other issues presented in this appeal, it simply did not address the first, express preemption issue that is raised by these carriers.[6]

         2. The carriers' express preemption argument proceeds on a theory that Title 50's broad definition of "employment" will be applied in other contexts, a legal premise we reject

         The carriers largely rely on a series of state and federal court decisions that have found a portion of Massachusetts's independent contractor statute to be preempted by the FAAAA as applied to motor carriers' payment for owner-operator services. The carriers' briefs even echo language from one of those decisions, Sanchez v. Lasership, Inc., 937 F.Supp.2d 730, 736 (E.D. Va. 2013), which characterized the Massachusetts law as "an unprecedented change in independent contractor law that dictates an end to independent contractor carriers in Massachusetts and imposes an anticompetitive, government-driven mandate that motor carriers change their business models to avoid liability under the statute."

         The Massachusetts law-chapter 149, section 148B of the Massachusetts General Laws-is different from Washington law in important respects. It mandates "employee" classification for purposes of multiple state laws, more significantly affecting motor carriers. The mandated classification applies at a minimum to chapters 149 and 151 of the Massachusetts General Laws, which deal with workmen's compensation and minimum fair wages. Schwann v. FedEx Ground Package Sys., Inc., 813 F.3d 429, 433 (1st Cir. 2016). Under those laws, an "employer" must provide benefits to employees that include days off, parental leave, work-break benefits, a minimum wage, and reimbursement of all out-of-pocket expenses incurred for the benefit of the employer regardless of what the parties' agreement would otherwise provide. Id.

         By contrast, chapter 50.04 RCW defines employment and identifies its exemptions solely for unemployment insurance tax purposes. As observed in Western Ports, "an individual may be both an independent contractor for some purposes, and engaged in 'employment' for purposes of Washington's exceedingly broad definition of covered employment." 110 Wn.App. at 458.

          System asks us to reject that conclusion of Western Ports and the Department's position that Title 50's definitions and exemptions apply only to unemployment insurance taxes, calling them "unrealistic." Br. of Appellant System at 25. It cites to evidence that the Department participated in an underground economy task force "whose thrust was to subject carriers to state regulation for a variety of other agency purposes, " and to an Obama administration employee misclassification initiative. Br. of Appellant System at 25 n.35. Our own reading supports the carriers' contention that there is advocacy from some quarters for extending the narrow "ABC" criteria for independent contractor status in the unemployment compensation context to other worker protections. See, e.g., Jennifer Pinsof, A New Take on an Old Problem: Employee Misclassification in the Modern Gig-Economy, 22 MICH. TELECOMM. & TECH. L. REV. 341 (2016); Anna Deknatel & Lauren Hoff-Downing, ABC on the Books and in the Courts: An Analysis of Recent Independent Contractor and Misclassification Statutes, 18 U. Pa. J.L. & Soc. Change 53 (2015). But there is opposition advocacy as well, as evidenced by the participation in this appeal of American Trucking Associations, Inc. as amicus curiae in support of System.

         The scope of Title 50's broad definition of "employment" presents an issue of law for this court, not an issue for political speculation. Under the law as it presently stands, the definition and exemptions apply only to the imposition of unemployment insurance taxes.[7] We reject as legally unsupported the argument that assessment of the tax on carriers' payments for owner-operator services will dictate the end to an historic business model and force carriers to begin purchasing all of their trucking equipment.[8]

          3. Federal law does not expressly preempt the assessments

         Whether federal law preempts state law fundamentally is a question of congressional intent. English v. Gen. Elec. Co., 496 U.S. 72, 78-79, 110 S.Ct. 2270, 110 L.Ed.2d 65 (1990). When "federal law is said to bar state action in fields of traditional state regulation ... [courts] have worked on the 'assumption that the historic police powers of the States were not to be superseded by the Federal Act unless that was the clear and manifest purpose of Congress.'" NY State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645, 655, 115 S.Ct. 1671, 131 L.Ed.2d 695 (1995) (quoting Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230, 67 S.Ct. 1146, 91 L.Ed. 1447(1947)).

         Laws of general applicability are usually not preempted merely because they increase a carrier's overall costs. Dilts v. Penske Logistics, LLC, 769 F.3d 637, 646 (9th Cir. 2014). "[G]enerally applicable background regulations that are several steps removed from prices, routes, or services, such as prevailing wage laws or safety regulations, are not preempted, even if employers must factor those provisions into their decisions about the prices that they set, the routes that they use, or the services that they provide." Id. Such laws are not preempted "even if they raise the overall cost of doing business or require a carrier to re-direct or reroute some equipment." Id. (citing Californians for Safe & Competitive Dump Truck Transp. v. Mendonca, 152 F.3d 1184, 1189 (9th Cir. 1998)). Laws of general applicability may be preempted where they have such "acute, albeit indirect, economic effects" that states essentially dictate the prices, routes, or services that the federal law intended the market to control. See Travelers Ins., 514 U.S. at 668.

         The relevant evidence presented and found by the ALJ is that the ongoing cost of doing business to which the Hatfield will be subjected by the application of Title 50 is a quarterly tax rate that has so far not exceeded 1.14 percent. 1 AR(H) at 79. The record does not reveal the agreed tax rate that led to System's stipulated liability of $58, 300.99 for owner-operators over an almost three-year period. But the highest unemployment tax rate presently imposed in ...

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