A California judge just ruled that Uber drivers are employees - here's why it could dramatically change Uber's business model

REUTERS/Stephen Lam

Demonstrators hold signs during a protest organized by the San Francisco Taxi Workers Alliance against ridesharing services Uber and Lyft outside the 8th Annual Crunchies Awards in San Francisco, California February 5, 2015.

Though Uber plans to appeal the ruling, it could potentially strike a huge blow to Uber's business model, at least in California, one of Uber's largest US markets.

Uber and rival Lyft have both faced lawsuits that could dramatically change both companies' business models.

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The lawsuits, which were separately brought on by drivers for the two companies, say drivers should be reclassified as employees as opposed to independent contractors. 

Previously, Uber and Lyft unsuccessfully argued in court that their drivers are independent contractors. The judges in the cases decided the cases would have to be decided by juries.

A ruling in favor of the drivers "could significantly raise their costs beyond the lawsuits and force the companies to pay social security, workers' compensation, and unemployment insurance," Reuters reports. 

Generally, drivers and other independent contractors want full-time pay - or at least predictable pay - but employers have their sights set on maximizing profits.

Employees are expensive for companies. According to the IRS, for common-law employees, employers "must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid" to full-time employees. The same is not necessarily true for an independent contractor.

Benefits are another aspect often extended to employees but not independent contractors. And employers but not independent contractors have the right to control how a worker behaves - how to dress, for example, or specific customer-interaction protocol. You have more labor protections when you're an employee. 

From a company mindset, it's easy to see why a fast-growing company like Uber would favor independent contractors.

But hiring laborers as employees not only makes them happy - it gives company more control over their employees. Companies can enforce a dress code or uniform, for example, with employees, or they can dictate on-duty behavior. In a 2013 lawsuit, a judge ruled that FedEx had misclassified its delivery drivers as contractors when they were really employees, saying that it's "beyond cavil that the pickup and delivery drivers are essential to FedEx's business."

Shannon Liss-Riordan, the same attorney who served on behalf of the 11 FedEx drivers who filed the lawsuit in 2013, is the attorney for the lawsuits drivers have filed against Lyft and Uber.

As independent contractors for Lyft and Uber, drivers pay all their expenses out of pocket: gas, maintenance, insurance, and detailing, just to name a few. 

The drivers, should they win these lawsuits, could be entitled to either hourly wages or a regular salary, as well as reimbursement for the money they've spent on things like gas and insurance as drivers for Uber and Lyft.

In addition, drivers would be able to organize formally. Right now, drivers - especially those unhappy with their working conditions - have informally organized by region or in forums like UberPeople. In August, Southern California Uber drivers aligned with a local Teamsters union.

Lyft has argued that because drivers are in control of how often they work, they are independent contractors. Drivers have contested this classification. They see themselves as employees because they are told how to behave with customers and can be deactivated without notice from Lyft's system.

"Uber's whole business model is built around having other people take the risks as independent contractors. And I don't know if they can change that; it's built into their business model. It's how they're making so much money," Joseph De Wolf Sandoval, an organizer for the California App-Based Drivers Association (CADA) told Business Insider back in October.

The lawsuits, which are both seeking class-action status in San Francisco Federal Court, would apply to drivers only in California. But a ruling in favor of the drivers would set a precedent for Uber and Lyft, as well as other companies that follow the independent-contractor business model.

Here's why.

There has been a rise in on-demand startups recently. You may have heard it called the "1099 economy," so named for the 1099 MISC forms that employers fill out when they hire contractors, as opposed to the W2 forms companies fill out when they hire full-time employees.

Uber and Lyft are chief among these on-demand companies, of course, but there are many others. Postmates and TaskRabbit are delivery services. Washio and FlyCleaners do your laundry on demand. Handy and MyClean are home cleaning startups. The "Uber for X" category goes on, and it's seemingly endless.

The people who work for these companies - not the executives, but the people who do the dirty work of delivering your laundry and dropping off your bag of potato chips - are not usually employees - they're contractors.

Startups use contractors for the simple reason that they are a lot cheaper than employees. When you're an independent contractor, your employer does not have to consider paying into Social Security or withholding taxes. It saves them money.

When home-cleaning startup MyClean switched from an independent-contractor model to one with full-time employees, the startup saw its labor costs go up 40%.

From a financial perspective, it makes sense why companies are clinging to the independent-contractor model. But drivers have a lot to gain from rulings in their favor. These drivers are only asking for reimbursement for their expenses.

But if juries rule against Uber and Lyft, drivers stand to gain more than just lost wages. These lawsuits could change Uber and Lyft's business models entirely, increasing their labor costs.