California Supreme Court Limits Liability for Payroll Service Providers

On February 7, 2019, the California Supreme Court unanimously held in Goonewardene v. ADP, Inc., S238941 that a payroll service provider cannot be held liable for errors it makes in issuing paychecks to workers of companies it contracts with. According to the Court, employees are not third-party beneficiaries of a contract between their employer and an independent payroll service provider. The Court also held that payroll service providers do not owe a duty of care to employees to ensure the Labor Code and wage orders are followed.

Facts and Lower Court Decisions

The Plaintiff filed the underlying suit in April 2012, alleging that her former employer violated the Labor Code and applicable wage orders.

After the trial court sustained several demurrers from her employer, Plaintiff amended her complaint to add her employer and ADP, LLC—a payroll company that provides payroll services to her employer. The Plaintiff alleged ADP engaged in unfair business practices under California’s Unfair Competition Law by failing to provide her with adequate documentation and records regarding her compensation. Before the Court ruled on ADP’s demurrer to the Plaintiff’s complaint, the Plaintiff amended her complaint to add claims of wrongful termination, breach of contract, unfair business practices, false advertising, negligence, and negligent misrepresentation against her employer and ADP. After some motion practice, the trial court sustained ADP’s demurrer to the underlying pleading with prejudice (meaning the Plaintiff would have no additional opportunity to amend her complaint).

The court of appeal held that the trial court erred in sustaining ADP’s demurrer with prejudice. Specifically, the court of appeal held that the Plaintiff could proceed with claims for breach of contract, negligent misrepresentation, and negligence against ADP based on allegations that ADP negligently performed payroll services for the Plaintiff’s benefit. In concluding that the Plaintiff’s breach of contract claim could proceed, the court of appeal held that the Plaintiff could be a third-party beneficiary of the contract between ADP and the Plaintiff’s employer.

ADP sought review of the court of appeal decision allowing the breach of contract, negligence, and negligent misrepresentation claims to proceed.

The Supreme Court’s Decision

The California Supreme Court held that as a matter of law, the Plaintiff could not be considered a third-party beneficiary of the contract between her employer and ADP. Therefore, the Plaintiff could not maintain a breach of contract claim against ADP. Moreover, the Court held that the Plaintiff could not maintain a negligence or negligent misrepresentation claim against ADP.

In considering the breach of contract claim, the Court noted that the court of appeals erroneously characterized the Plaintiff as a creditor beneficiary of the contract between her employer and ADP. The Court held that ADP agreed only to assist the employer by calculating the wages the employer owes the Plaintiff under applicable labor statutes and wage orders, and making and delivering paychecks to the Plaintiff.

The Court then turned to whether the Plaintiff could bring a breach of contract claim under California’s third-party beneficiary doctrine. In conducting this analysis, the Court looked to three factors: (1) whether the third party would benefit from the contract, (2) whether a motivating purpose of the contract was to benefit the third-party, and (3) whether allowing the third-party to bring its breach of contract claim against the contracting party is consistent with the objective of the contract. The Court held that the motivating purpose of the contract was not meant to benefit the Plaintiff. Indeed, the purpose of contract between ADP and the employer was simply to help the employer comply with California law in paying wages. The Court then held that allowing the Plaintiff to sue would be inconsistent with the contract. This is because if ADP breached the contract with the Plaintiff’s employer, the employer could bring its own suit against ADP.

Next, the Court considered whether to recognize a cause of action for negligence in these circumstances. In considering whether to impose tort liability in favor of a third party for a contracting party’s negligent performance of a contract, the Court considered several non-exclusive factors: (1) the extent the transaction was meant to effect the plaintiff; (2) the foreseeability of harm; (3) the degree of certainty that the plaintiff suffered the injury; (4) the closeness of the connection between the defendant’s conduct and the injury; (5) the moral blame attached to the defendant’s conduct; and (6) the policy of preventing future harm.

The Court gave five reasons why it declined to create a negligence cause of action for employees against their employer’s payroll service providers. First, the Court noted that employees already have a remedy through various labor statutes or wage orders against their employer. Second, creating a negligence cause of action would not deter negligent conduct by payroll service providers as they are already contractually bound to provide adequate services to employers. Third, the Court leaned on its discussion holding that an employee is not a third-party beneficiary, and emphasized that a payroll service provider does not have a special duty of care with an employee. Fourth, the Court raised the specter that creating a duty of care between a payroll service provider and employee may hamper a payroll service provider’s ability to fulfill its contract with an employer. Fifth, the Court noted that the “imposition of a tort duty of care on a payroll company is likely to add an unnecessary and potentially burdensome complication to California’s increasing volume of wage-and-hour litigation.”

For the same reasons the Court rejected a duty of care for payroll service providers in favor of employees, it also rejected creating a cause of action for negligent misrepresentation.

What Employers Should Know

Goonewardene signals that the Court may be skeptical of holding contractors liable under the third-party beneficiary doctrine in suits by the employees of parties to which they have service agreements.  This case also is significant as the Court explicitly signaled that it is hesitant to expand the labyrinth of wage-and-hour law compliance. Should you have any questions about this opinion, contact your Payne & Fears LLP attorney.