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Employee can’t recover unpaid wages from ADP, employer’s third-party payroll processing provider

By Ronald Miller, J.D.

Under California’s third-party beneficiary doctrine, an employee may not bring a breach of contract suit for unpaid wages against an independent payroll service contracted to handle an employer’s payroll functions.

Allegations in an amended complaint were not sufficient, under California’s third party beneficiary doctrine, to support a cause of action by an employee against ADP, her employer’s payroll service provider, for ADP’s alleged breach of its contract with the employer, ruled a unanimous California Supreme Court. Providing a benefit to employees with regard to the wages they receive is ordinarily not a motivating purpose of the contracting parties under such circumstances. Accordingly, the employee was not viewed as a third party beneficiary who may maintain a suit against the payroll company for an alleged breach of contract between the employer and ADP with regard to unpaid wages (Goonewardene v. ADP, LLC, February 7, 2019, Cantil-Salauye, T.).

Payroll company included in suit for unpaid wages. In April 2012, the employee filed a complaint against her employer for wrongful discharge, breach of contract, violations of California Labor Code, and related causes of action. She alleged that the employer failed to pay her the wages she was due under the Labor Code and applicable wage orders and wrongfully terminated her employment when she complained. In an amended complaint, she included a cause of action against ADP, the company providing payroll services to her employer. She later amended her complaint to add wrongful termination and breach of contract, among other claims, against the payroll company. Ultimately, the trial court entered a final order sustaining the payroll company’s demurrer on all causes of action and dismissed the employee’s action against ADP.

Appeals court. On appeal, the court of appeal reviewed whether the trial court erred in sustaining the demurrer without leave to amend. It first concluded that the employee’s causes of action against ADP resting on the theory that it could properly be viewed as a joint employer were without merit. However, it went on to find that the employee’s amended complaint adequately pleaded claims against ADP for breach of contract, negligent misrepresentation, and negligence, based on allegations that it performed payroll services for the employee’s benefit in an inaccurate and negligent manner. The appellate court determined that the employee could properly be found to be a third-party beneficiary of the contract between the employer and the payroll company.

Third-party beneficiary theory. ADP sought review of the appeals court decision to the extent it held that the employee’s suit could advance as to the employee’s causes of action for breach of contract, negligent misrepresentation, and negligence. The California Supreme Court reviewed the validity of the appeals court’s decision regarding these three causes of action.

The state high court first turned to the appeals court’s conclusion that the employee may maintain a cause of action for breach of contract. In California, it is well established that under some circumstances a third party may bring an action for breach of contract based upon an alleged breach of contract entered into by other parties (Civil Code Section 1559). The issue was whether, under the circumstances at issue here, the employee was entitled to bring an action against ADP for breach of its contract with the employer under the common law third party beneficiary doctrine.

“Purpose” of the contract. For a third-party action to go forward, courts examine the express provisions of the contract at issue, as well as all the relevant circumstances under which the contract was agreed to, in order to determine not only (1) whether the third party would in fact benefit from the contract, but also (2) whether a motivating purpose of the contracting parties was to provide a benefit to the third party, and (3) whether permitting a third party to bring its own breach of contract against a contracting party is consistent with the objectives of the contract and the reasonable expectations of the contracting parties. All three elements must be satisfied.

The amended complaint did not claim that the employee was privy to the unwritten contract allegedly entered between ADP and the employer, and the general allegation that the contract was for the benefit of the employer and employees left unclear in what sense the contract was intended to benefit the employees.

Creditor beneficiary. In concluding that the employee may maintain a breach of contract action against ADP on third-party benefit theory, the appeals court relied on allegations that, under the parties’ contract, ADP agreed to “take over” all of the employer’s ordinary payroll tasks, including calculating the wages the employer was obligated to pay each employee, and issuing paychecks and pay stubs that reflect the correct wages. Thus, the appeals court found that ADP’s obligations in this regard rendered each employee a creditor beneficiary of the contract, under the theory that ADP’s role was to “discharge” the employer’s wage obligations to its employees.

Employer-provided funds. However, the state high court concluded that the appeals court erred in characterizing the employee as a creditor beneficiary of the contract. Instead, as in most employer/payroll company agreements, ADP simply agreed to assist the employer by calculating the amount of wages that the employer owed to each employee in light of the applicable labor statutes and wage order, and providing the ministerial services of making out paychecks and delivering the required pay information to each employee.

In the absence of an allegation to the contrary, the high court found it was reasonable to infer that the employees’ wages were paid by funds provided by the employer, rather than ADP. Accordingly, the court concluded that the employee was not properly viewed as a creditor beneficiary of the parties’ contract within the meaning of the third-party beneficiary doctrine.

When an employer hires a payroll company, providing a benefit to employees with regard to the wages they receive is ordinarily not a motivating purpose of the transaction. Instead, the relevant motivating purpose is to provide a benefit to the employer, with regard to cost and efficiency of the task performed and the avoidance of potential penalties. The judgment of the appeals court was reversed to the extent that it held the trial court had erred in dismissing cause of action for breach of contract, negligence, and negligent misrepresentation without leave to amend.