Summary

On September 18, 2019, Governor Newsom signed California Assembly Bill 5 (AB 5) into law – codifying and expanding the California Supreme Court’s decision in the Dynamex case and the "ABC test" for determining if a worker may be classified as an independent contractor, instead of an employee.

Below is how AB 5 expands the Dynamex ABC test, creates exemptions, and establishes new methods of enforcement.

Before AB 5: Borello and Dynamex

Deciding whether a worker is an independent contractor or an employee has never been up to the worker or the business; rather, there has always been a legal test for classifying workers as independent contractors. Previously, the form of the test depended on the type of claim or worker right at issue – e.g., unpaid wages, breaks, unemployment insurance benefits, workers’ compensation insurance benefits, etc.

Borello 

For nearly 30 years, California courts, the California Labor Commissioner, and the California Employment Development Department have used the multi-factor test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello) to determine whether an individual was an employee for many purposes.

The Borello test has 11 factors, primarily focusing on whether a company has control over the means and manner of performing contracted work, and additional secondary factors, such as who provides work tools and the individual’s opportunity for profit or loss, to determine contractor status.

Dynamex 

In Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County (Dynamex), the California Supreme Court revisited whether Borello was the proper legal test to determine employment for purposes of claims under the California Wage Orders, which cover overtime, meal periods, rest breaks, and other topics. The Court concluded that Borello was not the proper test, ruling that the ABC test should be used to determine whether a worker is properly classified as an employee or an independent contractor.

Under the ABC test, a worker is presumed to be an employee unless the company proves that the worker:

• (A) Is free from the control and direction of the company in performing work, both practically and in the contractual agreement between the parties; and
• (B) Performs work that is outside the usual course of the company’s business; and
• (C) Is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the company.

More simply, to satisfy the ABC test and legally classify a worker as an independent contractor, the company must prove that the worker is free from the company’s control, performs work outside the company's primary business, and is regularly engaged in the trade the worker is hired for, independent of work for the company.

See our prior advisory on the Dynamex decision here.

The Dynamex test introduced two new factors that were never before part of California’s independent contractor analysis. Part (B) – which requires the worker "perform work that is outside the usual course of the hiring entity's business" – is often the most difficult to satisfy and impacts nearly every industry. Part (C) – which requires the worker to be “customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity” – eliminates most workers who perform side jobs (like those in the gig economy) that are relatively minor compared to their main day-to-day work.

See our prior advisory on Dynamex’s impact on the entertainment industry here.

Dynamex did not change any statutes and involved compliance under the wage orders, which was the only issue before the California Supreme Court. So until AB 5, the ABC test did not extend to other employer obligations established under the California Labor Code, such as reimbursement of business expenses and the potential recovery of Private Attorney General Act (PAGA) penalties by employees.

AB 5 changes all of this, and goes further.

What AB 5 Does

AB 5 adds Section 2750.3 to the California Labor Code. Here is what that means.

ABC Test Applies To More Claims 

Beginning on January 1, 2020, under AB 5, the ABC test will be the test used to determine whether a worker providing services in California is an "employee" for purposes of the California Wage Orders, the Labor Code, and the Unemployment Insurance Code.

This means that workers claiming misclassification as independent contractors can and will use the ABC test to make claims that they are employees and are entitled to make claims such as failure to reimburse necessary business expenses (Labor section 2802), failure to provide accurate and complete wage statements (Labor Code section 226), failure to pay unemployment insurance tax, and failure to provide workers compensation insurance.

However, AB 5 does not extend the ABC test to tort claims or claims under the California Government Code, which protects employees against harassment and discrimination.

AB 5 Enforcement 

The California Attorney General and certain city attorneys will be empowered to pursue injunctions against businesses suspected of misclassifying workers. This, along with the ability to base PAGA representative action claims on Labor Code violations, will circumvent some employee arbitration and class action waiver agreements when PAGA claims are made.

AB 5 Exemptions

A host of occupations are carved out of the ABC test. For these occupations, the Borello multi-factor test applies when determining whether a worker must be classified as an employee. Subject to certain licensing and other requirements, here is a list of the general exemptions to AB 5:

• Doctors (physicians, surgeons, dentists, podiatrists, veterinarians, psychologists)
• Professionals (lawyers, architects, engineers)
• Professional services (marketing, human resources administrator, travel agents, graphic designers, grant writers, fine artist)
• Financial services (accountants, securities broker-dealers, investment advisors)
• Insurance brokers
• Real estate agents
• Direct sales (if compensation is based on actual sales and not wholesale purchases or referrals)
• Builders and contractors
• Freelance writers and photographers (if contributes no more than 35 submissions to an outlet in a year)
• Hair stylists and barbers (if licensed and if can set own rates and schedule)
• Estheticians, electrologists, and manicurists (if licensed)
• Tutors (that teach their own curriculum, and that are not public school tutors)
• Commercial fishermen
• AAA-affiliated tow truck drivers

All other occupations are covered under AB 5, so the ABC test applies. These include many occupations that often in the past were treated as independent contractors, such as:

• Health care professionals (occupational therapists, speech therapists, optometrists, nurse practitioners, physician assistants, radiation therapists, licensed professional clinical counselors, marriage and family therapists, licensed clinical social workers, respiratory therapists, audiologists)
• Rideshare, delivery service workers, and other gig economy workers
• Truck drivers
• Janitors & housekeepers
• Health aides
• Performers and other entertainment professionals
• Land surveyors, landscape architects, and geologists
• Campaign workers
• Language interpreters
• Exotic dancers
• Rabbis and other clergy

Effective Dates and Retroactivity 

The issue of AB 5’s retroactivity is not entirely clear. AB 5 states that "specified Labor Code provisions of the bill apply retroactively to existing claims and actions to the maximum extent permitted by law while other provisions apply to work performed on or after January 1, 2020."

The ABC test applies retroactively "with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders" as do all exceptions "to the maximum extent permitted by law." This may add further confusion, since it is an open question whether the Dynamex decision is retroactive.

See our prior client advisory here.

Beginning on January 1, 2020, the ABC test will apply for purposes of the Unemployment Insurance Code and all other provisions of the Labor Code not "relating to the wage orders." Beginning on July 1, 2020, Dynamex and the ABC test will apply for purposes of workers’ compensation.

What’s On the Horizon

Though the battle over AB 5 is done (for now), the war over how to determine who is an employee and who is an independent contractor is far from settled.

State legislatures and industry and worker advocacy groups are expected to remain active in pushing legislation aimed at either expanding or limiting worker rights across the nation. In California, lobbyists are preparing for a battle during the 2020 legislative session, including a "clean up" bill to address other industries that sought but did not get exemptions under AB 5.

Some major gig economy companies have already announced that they have pledged substantial resources to a potential campaign for a California ballot initiative to exempt the industry from AB 5. Worker advocacy groups are gearing up in other states as well, including New York, Washington, and Oregon for similar legislative efforts.

Gig economy companies in California are already feeling the impact of AB 5, even though it is not effective until 2020. Attorneys representing workers recently filed a wage-hour class action citing the ABC test as the legal standard for determining whether drivers for the company should be classified as employees. The San Diego City Attorney filed a lawsuit seeking to force reclassification of drivers as employees under the ABC test.

More of the same types of litigation are no doubt on the horizon.

Practical AB 5 Advice for Employers

All companies should now step back and examine their California independent contractor relationships through the lens of the new framework that AB 5 has created. Companies must satisfy the Dynamex ABC test (or the Borello multi-factor test if for an exempted occupation) or face increased risk of defending against additional claims from individual workers claiming to be employees, class action attorneys representing workers on a class or collective basis, and city and state authorities.

Companies should monitor how narrowly California courts interpret the ABC test – especially what the "usual course of the hiring entity's business" means – in assessing the legal risk. This will likely prove the most problematic of the ABC test factors for most businesses that regularly engage independent contractors.

Deciding what to do is only the first step – how to transition workers from independent contractors to employees is just as important to avoid triggering claims for past misclassification.

Where a business decides not to reclassify, revising the company’s existing independent contractor agreements and policies to more clearly satisfy the ABC test is key. Deciding to replace independent contractors with third-party staffing agencies or labor contractors will require selection of agencies or contractors that comply with the law, uphold the obligations of their agreements, and indemnify their clients for violations of the law, since companies are often found jointly liable for wage and hour violations of their contractors and agencies who provide such workers to their businesses.

See our prior client advisory here.

The time to evaluate and plan for January 1, 2020 is now. And the wisest way to do that is to engage legal counsel to assist with and protect the analysis and communications about it with attorney-client privilege to avoid creating evidence that may be used in a claim down the line.

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