California Passes AB 5: The Lawful Use of Independent Contractors in California is Drastically Limited

Caroline Powell Donelan and Caitlin I. Sanders

Just last year, the California Supreme Court in Dynamex Operations West v. Superior Court (2018) 4 Cal. 5th 903 (“Dynamex”) abruptly replaced the longstanding test in California for determining whether a worker is an independent contractor (versus an employee) with a more stringent “ABC” test for purposes of the California Industrial Welfare Commission (“IWC”) Wage Orders.

Under the “ABC” test, a worker is presumed to be an employee unless the hiring entity can prove that the worker is (A) free from control; (B) providing services unrelated to the hiring entity’s business; and (C) holding him or herself out as an independent business. More on the landmark decision in Dynamex can be found here.

Last week, California Governor Newsom signed into law Assembly Bill (“AB”) 5, which codifies and expands the “ABC” test set forth in Dynamex, making it even more difficult for employers to properly classify workers as independent contractors in California.

What are the basic provisions of AB 5?

AB 5 adopts the “ABC” test set forth in Dynamex. Specifically, the bill provides that, for purposes of the California Labor Code, Unemployment Insurance Code, and the IWC Wage Orders, a worker is considered an employee unless the hiring entity demonstrates that all of the following conditions are satisfied:

A. The worker is free from the control and direction of the hiring entity in connection with the performance of the work;

B. The worker performs work that is outside the hiring entity’s usual course of business; and

C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Notably, AB 5 goes well beyond the scope of Dynamex, which applied the ABC test solely for purposes of the California IWC Wage Orders. AB 5 imposes the ABC test for purposes of the California IWC Wage Orders as well as the Labor Code and Unemployment Insurance Code.

AB 5 also provides that, if a court determines that the ABC test cannot be applied in a particular context, the determination of whether a worker is an employee or independent contractor is governed by the predecessor test set forth in the California Supreme Court’s S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal. 3d 341 (“Borello”) decision. In brief, the Borello test is a multifactor approach which looks primarily at whether the hiring entity had a “right to control” the manner in which the worker performed the contracted service, along with eight other “secondary” factors.

What occupations and business relationships are excepted from the ABC test?

AB 5 lists numerous occupations and business relationships to which the ABC test does not govern the determination of whether a worker is an employee or independent contractor. With respect to these exceptions, the determination is governed generally by the Borello test.

The primary categories of exceptions are the following:

  1. Specific Occupations: The Borello test applies to the following specific occupations: insurance brokers, physicians, dentists, psychologists, lawyers, architects, engineers, private investigators, accountants, veterinarians, securities broker-dealers, investments advisors, certain direct salespersons, commercial fisherman, and newspaper carriers.
  2. Professional Service Providers: The Borello test governs the relationship between a hiring entity and an individual providing certain professional services such as marketing, human resources, photography, graphic design, freelance writing, manicurist, and cosmetology services. To fall within this exception, however, the hiring entity must establish that the professional service provider satisfies six (6) factors, including that the service provider maintains a separate business location, has a business license, can set or negotiate their rates and hours, and exercises discretion and independent judgment. Licensed manicurists and cosmetologists must satisfy additional criteria to fall within this exception.
  3. Business Service Providers: The Borello test governs a bona fide “business-to-business contracting relationship,” provided that a total of twelve (12) criteria are established. To fall within this exception, the hiring entity must be able to establish, for example, that the contract with the business service provider is in writing. The business service provider must also provide services directly to the contracting business rather than customers of the contracting business. Importantly, this exception is limited to business entities—whether an individual working for a business service provider is an employee of the hiring entity is governed by the ABC test.
  4. Real Estate Licensees and Repossession Agencies: The determination of whether real estate licensees and individuals who perform services for repossession agencies are employees or independent contractors is governed by the applicable section of the California Business and Professions Code.
  5. Construction Industry Subcontractors: Provided that seven criteria are met, the relationship between a contractor and an individual performing services pursuant to a subcontract in the construction industry is generally governed by the Borello test.
  6. Referral Agencies: Relationships between referral agencies and specified service providers (e.g., tutoring, event planning, dog walking and grooming, and yard cleanup services) are governed by the Borello test. This exception, however, does not apply to an individual worker who performs services for a client through a referral agency, and presumably, the relationship is governed by the ABC test.

When does AB 5 go into effect?

With limited exceptions, AB 5 applies to work performed on or after January 1, 2020.

Do the provisions of AB 5 apply retroactively?

Yes, No, and Maybe. While the language of AB 5 is anything but clear, it appears to permit imposition of retroactive and prospective liability as follows:

  • Dynamex and the ABC test applies retroactively with regard to claims for violations of “Wage Order” provisions of the California Labor Code.
  • Dynamex and the ABC test applies prospectively (on or after January 1, 2020) with regard to claims for violations of the California Unemployment Insurance Code and all “non-Wage Order” provisions of the California Labor Code.
  • To the extent any of the exceptions to AB 5 would relieve an employer from liability, then they apply retroactively to the “maximum extent permitted by law.”
  • Dynamex and the ABC test apply prospectively (on or after July 1, 2020) for purposes of California workers’ compensation requirements.

Given the gaping holes in the text of AB 5, it is almost certain that the courts will ultimately have to weigh in on the extent of retroactive application of AB 5.

Stay tuned…

What should California employers do now that AB 5 has become law?

AB 5 changes the test—the one on which employers have been relying for decades—to determine whether a worker is an employer or independent contractor, and complying with the new law will undoubtedly be a significant challenge for service recipients in both the short- and long-term. California employers do not have long to get in compliance (AB 5 applies to work performed after January 1, 2020), and we expect to see an influx of new litigation in connection with the passage of this new law.

Time is of the essence, and it is imperative that employers that use independent contractors as part of their businesses meet with legal counsel to reexamine their workforce and evaluate all options available to them in light of AB 5.

 

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