A federal judge has rejected a proposed $100 million settlement between Uber Technologies Inc. and drivers in two states, reopening the debate over the car-hailing company’s freelance labor model.
U.S. District Judge Edward Chen in San Francisco ruled Thursday that the settlement in April of two class-action suits in California and Massachusetts isn’t fair, accurate or reasonable for drivers.
The ruling sends attorneys for both sides back to the drawing board in a case viewed as a pivotal moment for more companies that depend on a pool of freelance workers to drive taxis, clean houses, run errands or perform other menial tasks. The parties are ordered to meet to figure out next steps and appear in court on Sept. 15.
In response to the judge’s ruling, Uber said it was reviewing its options. “The settlement, mutually agreed by both sides, was fair and reasonable,” said a spokesman. “We’re disappointed in this decision.”
The suits representing about 385,000 current and former drivers contend Uber should treat them as employees, rather than contractors, and seek protections including reimbursement for expenses and gasoline.
Drivers were also frustrated that they received little warning before the ride-hailing firm deactivated its app from their smartphones and were given little or no explanation for any termination.
The proposed settlement called for Uber to revise some of those practices and pay $84 million to drivers and another $16 million in the event the company goes public. For Uber, a settlement would ward off a serious legal threat to its business model that has helped persuade investors to value the company at $68 billion. A $100 million payment is relatively minor compared with the more than $13 billion in equity and debt Uber has raised from investors and the potentially billions of dollars in costs incurred if it had to pay health benefits and auto expenses.
In recent months, dozens of drivers filed objections to the agreement, saying it shortchanged them or denied them the opportunity to let a jury decide on key questions like their legal status.
“The monetary terms were minuscule as opposed to what [the drivers] could have gotten at trial, and it was leaving the drivers’ employment status undecided,” said Veena Dubal, an associate professor of law at the University of California, Hastings, who filed a legal memorandum representing drivers who objected to the deal.
In his ruling, Judge Chen acknowledged that both the drivers and Uber have strong arguments on the employment question. However, his objection hinged on the $1 million in the settlement dedicated to claims related to a California law that allows plaintiffs to pursue labor code violations on behalf of the state and split the award. The drivers’ attorneys had estimated the value of those claims at $1 billion, though plaintiffs are generally awarded only a fraction of the potential maximum.
Thursday’s ruling could result in drivers receiving little or no recompense from Uber, however. Shannon Liss-Riordan, the attorney representing the drivers, expressed concerns in interviews earlier this year that Uber could hold out for an appeals court ruling that would scotch a key victory for drivers.
Before the April settlement, the Ninth Circuit Court of Appeals had agreed to review Judge Chen’s decision declaring the arbitration clause in Uber’s driver agreement unenforceable. That decision had allowed the cases to proceed in court rather than in arbitration.
Those appeals were stayed, but a similar one is proceeding in a separate case against Uber, and in June, the panel signaled that it was sympathetic to Uber’s position.
If the court declares that Uber’s arbitration clause holds, Uber may choose not to renegotiate the current settlement and instead take the chance of going to trial with a much smaller class of drivers to be covered by any decision.
“It now seems very likely that the scope of this case may be drastically reduced to about 8,000 drivers,” Ms. Liss-Riordan said on Thursday. “That means that drivers who did not opt out of Uber’s arbitration clause would need to bring individual claims in arbitration if they want to be a part of this.”
The debate over how startups like Uber, rival Lyft Inc. and grocery delivery service Instacart Inc. classify their legions of drivers and deliverymen has roiled Silicon Valley. Founders and investors say reclassifying contractors as employees could drive up their labor costs by at least 20%, upending their pricing models and making their services more expensive.
Uber and other startups say their workers prefer the flexibility of being a freelancer, such as only working a few hours a week or at odd hours. As employees they would likely have more stringent work schedules and other requirements like wearing a uniform and undergoing time-consuming training.
Drivers in the Uber lawsuits have contended that the demands of the job, including being told where to go by an app and stringent vehicle standards, mean Uber should treat them as employees and help pay for expenses like fuel, tolls and additional insurance.
Under the terms of its settlement, Uber would have had to explain its decisions to terminate drivers, and in most cases would have to give warnings before removing drivers from the service. Drivers would also be allowed to post signs in their cars soliciting tips from riders. Judge Chen said Thursday the tipping provision was inadequate to getting drivers greater pay.
Prior to the judge’s ruling, San Francisco-based Uber indicated it had a long-term solution to the debate about driver classification: driverless vehicles. Uber said earlier Thursday it plans to begin testing autonomous vehicles in Pittsburgh as soon as this month, featuring technology that would eventually make human drivers obsolete.
—Rachel Emma Silverman contributed to this article.
Write to Greg Bensinger at greg.bensinger@wsj.com and Lauren Weber at lauren.weber@wsj.com