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California's AB5 Codifies Stricter Rules for Independent Contractors - What Employers Need to Know

September 19, 2019 Articles

On September 18, 2019, California Governor Gavin Newsom signed into law AB5, codifying the ABC test for distinguishing employees from independent contractors and expanding its application beyond California’s Wage Orders. While AB5 does not go into effect until January 1, 2020, it will apply retroactively to certain claims arising under the California Wage Orders. 

Dynamex Codified

AB5 adopts the test articulated in the California Supreme Court’s April 2018 Dynamex decision, which established a presumption that workers are employees unless the hiring entity demonstrates that the worker (a) is free from the control and direction of the hiring entity in connection with the performance of the work, (b) performs work that is outside the usual course of the hiring entity’s business, and (c) is customarily engaged in an independently established trade, occupation, or business. Dynamex had only expressly applied to claims arising under the state Wage Orders, leaving debate over its application to other types of claims. AB5 expands the 3-part test – commonly known as the ABC test – to provisions of the Labor Code and Unemployment Insurance Code.

Specified Exempted Occupations Still Get Borello Test

AB5 exempts specified occupations, industries, and business relationships from the Dynamex test, though it does not automatically deem those exempted workers independent contractors – rather, their status will be assessed under the more flexible multifactor Borello test. The exemptions include the following:

  • Certain professional occupations, including licensed insurance agents, physicians, doctors, lawyers, architects, engineers, private investigators, and accountants; registered securities broker-dealers or investment advisers; direct sales salespersons; and commercial fishermen.
  • Workers operating under certain types of professional services contracts that meet additional sub-criteria, including human resources administrators, marketing professionals, travel agents, graphic designers, fine artists, photographers, writers/journalists, and licensed barbers and cosmetologists. 
  • Construction subcontractors, motor clubs, and real estate and repossession agency licensees that satisfy certain criteria.
  • “Bona fide business-to-business contracting relationships” where a “business service provider” contracts to provide services to another “contracting business,” if the contracting business demonstrates that 12 criteria are all satisfied. This exemption theoretically allows one entity (the contracting business) to use the services of a worker employed by another entity (the business service provider) and have that worker’s relationship with the contracting business be governed by the more flexible Borello test. But the twelve criteria – two of which are Dynamex prongs – make satisfying this exemption difficult. The criteria include that the business service provider is free from the control and direction of the contracting business (Dynamex prong “A”), is customarily engaged in an independently established business of the same nature as that involved in the work performed (Dynamex prong “C”), provides services directly to the contracting business rather than to the contracting business’s customers, maintains a business location separate from the contracting business, actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the contracting business, provides its own tools, vehicles, and equipment to perform the services, and can negotiate its own rates. AB5 does not address to what extent the contracting business is responsible for ensuring the service provider maintains compliance with the 12 criteria or to what extent failure to meet the criteria can have joint-employer implications for the contracting business. 
  • Certain “referral agencies” – businesses that connect clients with service providers in specified industries of dog walking, dog grooming, home cleaning, minor home repair, moving, errands, furniture assembly, animal services, web design, picture hanging, pool cleaning, yard cleanup, graphic design, photography, tutoring, and event planning – can have Borello apply instead of Dynamex if they can establish all of 10 requirements, which are similar to the above-mentioned business-to-business-contractor factors.

Despite fierce opposition, “gig economy” technology businesses such as Lyft, Uber, and Door Dash, which rely on independent contractors for driving and delivery services (and are expected to be most impacted by the new law), are not expressly exempted. 

Retroactive as to Wage Order Claims and Exemptions

Importantly, AB5 declares that it does not constitute a change in, but rather is declaratory of, existing law with regard to violations of the Labor Code relating to Wage Orders (such as meal and rest breaks, overtime, and minimum wage), thus giving retroactive effect to those types of claims – which effectively have a 4-year statute of limitations under California’s Unfair Competition Law. To the extent that AB5’s exemptions serve to relieve an employer from liability, they apply retroactively to existing claims and actions.

Notably, AB5 does not permit an employer to reclassify an individual who was an employee on January 1, 2019 to an independent contractor due to the bill’s enactment. In other words, employers are not to use the codified Dynamex test and/or its exemptions as justification to switch workers already classified as employees to independent contractors. 

Enforcement by City Attorneys

In addition to remedies available to workers, AB5 will empower city attorneys in large cities such as San Francisco, San Jose, and Los Angeles to enforce AB5’s new worker-classification standards by bringing an action for injunctive relief to prevent the continued misclassification of employees.

What’s Next

Uber, Lyft, and DoorDash have jointly committed $90 million to financing a 2020 ballot initiative to overturn the law. Their initiative would preserve the contractor status of their workers while offering some employee protections such as minimum earnings and access to health care plans. The companies’ offers to give drivers greater benefits have thus far been rejected as insufficient, but Governor Newsom has said that, even after signing the bill, he will continue trying to negotiate a compromise that could create a third worker category somewhere between employee and contractor.

In the meantime, with AB5’s passage, entities that rely upon independent contractors – especially drivers and other gig-based workers – will need to take a hard look at those classifications under the ABC test. That review may reveal the need to reclassify workers as employees, or alternatively, to implement structural or policy changes to bolster compliance. For example, hiring entities may start requiring independent contractors to present evidence of an independently established corporation with its own clientele. Entities with workers that fall into any of the exempted categories still need to examine their classification under the Borello test factors. 

Given the law’s retroactivity, it is likely to open a new floodgate for putative class action and PAGA lawsuits. If not doing so already, employers should consider implementing arbitration agreements with class action waivers. Employers should also evaluate an effective communication strategy if and when they decide to reclassify workers under the new law – which may require different, but of course consistent, messages for employees, contractors, business partners, and the public.

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