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Labor Code section 3701.9, was added in 2012 as part of SB 863. This provision prohibits temporary services employers (TSE’s) and leasing employers (LE’s) from self-insuring their workers’ compensation liability. These entities that were self-insured in 2012 when SB 863 was passed had to become insured by January 1, 2015.

The concern addressed by section 3701.9 is that a self-insured staffing company may grow rapidly during a calendar year without a concomitant increase in its workers’ compensation self-insurance deposit. Self-insured employers do not pay insurance premiums; instead, they post a security deposit each year. A self-insured employer would not have to increase the security deposit for its increased payroll until the following year, unlike a typical employer with workers’ compensation insurance, which is required to pay an increased premium on newly hired employees as soon as they are hired. When a self-insured employer’s security deposit is insufficient, the obligation for the loss falls on the Self-Insurers’ Security Fund (Fund) (§§ 3742, 3743) and other self-insured employers may be charged a pro rata share of the funding necessary to meet the obligations of an insolvent self-insurer.

Kimco is a TSE. Kimco provides staffing solutions to various industries, including financial, healthcare and technical/engineering. Kimco has an internal staff in California of 137 employees, an average weekly workforce of more than 4,500 employees, and has filled approximately 300,000 staffing positions in California. KimstaffHR is an LE. KimstaffHR’s corporate office employs 17 individuals in California. In addition, KimstaffHR has more than 2,000 client-based employees who provide services to more than 100 businesses in the state. Since 2003, Kimco and KimstaffHR have participated in the California workers’ compensation self-insurance program.

Kimco filed suit in 2013 against the State of California seeking to have Labor Code section 3701.9 declared unconstitutional claiming a violation of equal protection under the Fourteenth Amendment to the United States Constitution and deprivation of equal protection under the California Constitution (Cal. Const., art. 1, § 7). The gravamen of the complaint is that section 3701.9, which eliminated the right of TSE’s and LE’s to self-insure, is invalid because it singles out these employers and prohibits them from participating in California’s workers’ compensation self-insurance program. In doing so it claims section 3701.9 “treats similarly situated entities differently and arbitrarily, and irrationally distinguishes between them.”

When a statute is challenged on equal protection grounds, a court’s initial inquiry is twofold. It first must determine whether the state has adopted a classification that affects two or more similarly situated groups in an unequal manner. If a challenged statute affects similarly situated groups unequally, the court must then decide whether to apply the strict scrutiny or rational basis test in analyzing the statute’s constitutionality.

The State supported its demurrer to the complaint with a request for judicial notice of a complaint filed in 2011 by the Fund against Mainstay Business Solutions (Mainstay) and other defendants in the Sacramento Superior Court (the Mainstay complaint) as an illustration of the “rational basis” for section 3701.9. In that action, the Fund alleged that Mainstay obtained a certificate of consent to self-insure from the Department, and that Mainstay and another defendant established a “payroll mill” and assumed the role of a ” ‘paper’ employer for payroll and workers’ compensation purposes.” The scheme enabled the codefendants in that action to avoid their statutory obligation to purchase workers’ compensation insurance for their employees. The Fund further alleged that Mainstay now was insolvent, and the Fund had been forced to assume the workers’ compensation liabilities of about 700 injured California employees whose employers had contracted with Mainstay “to provide temporary or leased employees.” Based thereon, the State argued a rational basis exists for section 3701.9’s differentiating between worksite employers who manage their own workforce and those employers who are only nominal employers providing payroll and other services to worksite employers.

The trial court sustained the demurrer and dismissed the complaint. The Court of Appeal affirmed in the published case of Kimco Staffing Services v State of California.

TSE’s and LE’s can change the scope of their workers’ compensation risk dramatically during the course of a year, by taking on new clients and adding employees to their payroll. While a TSE’s or LE’s payroll may grow rapidly during a calendar year, the company’s self-insurance deposit would not be adjusted until the subsequent year. (§ 3701, subd. (c).) The potential for a rapid increase in the number of employees, coupled with the delay in adjusting the amount of the self-insurance security deposit, is a rational basis for excluding TSE’s and LE’s from the workers’ compensation self-insurance program.