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Today California Governor Gavin Newsom signed a landmark bill making it more difficult for companies to engage independent contractors. (See our previous coverage HERE.) Assembly Bill 5 “will help reduce worker misclassification — workers being wrongly classified as ‘independent contractors’ rather than employees, which erodes basic worker protections like the minimum wage, paid sick days and health insurance benefits,” Newsom wrote in a statement.

Assembly Bill 5

Under the new law, effective January 1, 2020, workers will be presumed employees — not independent contractors — under the California Labor Code if, for example, the hiring entity exerts control over how they perform their work or if the work is part of the company’s regular business. This standard is the codification of the ABC test applied in the California Supreme Court’s April 2018 Dynamex v. Superior Court decision. (Read more about the case HERE.)

Before Dynamex, courts applied a flexible, multifactor test (adopted by the California Supreme Court in S. G. Borello & Sons, Inc. v. Department of Industrial Relations) to determine whether workers should be classified as employees or independent contractors. For nearly 30 years, California court, state agencies and businesses relied on the Borello test. But, the legal landscape for independent contractors changed greatly when the California Supreme Court adopted the ABC test last spring.

Under the ABC test, and as codified in Section 2750.3 of the California Labor Code, a worker is presumed to be an employee unless a hiring entity can establish three conditions:

  1. That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  2. That the worker performs work that is outside the usual course of the hiring entity’s business; and
  3. That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Dynamex applied the ABC Test to the wage orders of the Industrial Welfare Commission. But the reach of AB 5 is broader — the ABC test will be used to determine a worker’s classification status under all provisions of the California Labor Code and Unemployment Code, in addition to the wage orders.

AB 5’s Exceptions

The law contains a number of exceptions that exclude particular occupations from coverage. If an exception applies, the legislation specifies which standard (usually the Borello test) governs. For example, individuals or entities that might be exempt from coverage include: direct sellers, certain licensed medical professionals (e.g., physicians, psychologists, veterinarians, etc.), certain hairstylists and barbers who rent booths at salons or provide natural hair braiding, commercial fishermen, insurance agents, investment advisers, certain licensed professionals, marketers, real estate agents, certain health care professionals, certain beauty professionals, certain subcontractors in the construction industry, certain repossession agencies, and certain service providers and individuals providing “professional services.”

Relatedly, AB 5 also creates exceptions for certain business relationships. For example, where a business entity (the “contracting business”) contracts to provide services with another business (the “business service provider”), whether the business service provider is an employee will be determined by the Borello test (not the ABC test) if the contracting business can satisfy 12 criteria. See Proposed Labor Code section 2750.3(e)(2)(A)-(L). While this “business-to-business” exception covers sole proprietors, it does not apply to “an individual worker.” AB 5 recognizes a similar exception where a business service provider provides services to clients through a referral agency.

Lawmakers incorporated precise definitions for several exceptions (e.g., individuals providing “professional services”), so companies should carefully review the text of the law to determine whether an exception applies.

Differences Between Dynamex and AB 5

  • Extended Application

As mentioned, while Dynamex was limited to causes of action for alleged violations of the California wage orders, AB 5 makes the ABC test applicable to all provisions of the California Labor Code (not just those provided for in the wage orders) and the Unemployment Code.

  • Injunctive Relief

The final version of AB 5 includes a new provision authorizing the Attorney General and certain public officials to bring civil actions for injunctive relief against alleged employers “to prevent the continued misclassification of employees as independent contractors.”  Thus, under AB 5, government officials may seek an order compelling alleged employers to reclassify their independent contractors as employees.

Does the ABC Test Apply Retroactively?

Until recently, none of the versions of AB 5 addressed an important looming question: will AB 5 apply retroactively? The Ninth Circuit even recently indicated its intent to certify that question to the California Supreme Court. (More HERE.) The final version of AB 5 addresses retroactivity, although not without opening the door to some new questions. Under AB 5, the ABC test will apply retroactively “with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.”

For Labor Code provisions covered by the wage orders (e.g., provisions governing meal and rest breaks, overtime, etc.) the legislature answered the retroactivity question in the affirmative. But for Labor Code provisions not explicitly covered by the wage orders, a new question emerges: do these provisions “relat[e] to wage orders” such that they will receive retroactive application?

Other States Could Follow California’s Lead

While AB 5 does not technically impact workers outside of California, other states may shortly follow and pass similar legislation of their own. In New York, for example, a group of labor advocates has formed a coalition seeking to enact legislation that adopts the ABC test in New York and would apply to rideshare drivers, nail salon workers, and certain bike delivery workers. Andrew Cuomo, Governor of New York, indicated that he does not want to “lag California in anything,” referring to the misclassification issue. AB 5 now presents other states with the opportunity to examine legislation governing worker classification.

What’s Next?

AB 5 will become effective in January 2020 with one exception: on the final day of California’s legislative session, lawmakers adopted a bill that will give certain newspaper publishers a one-year extension to comply with AB 5.

Even with the passage of AB 5, the worker classification issue is far from resolved. Several high profile gig economy companies pledge to support a ballot initiative for the 2020 election that, if adopted, would give gig economy workers additional benefits while maintaining their classification as independent contractors. We will continue to track this issue as it makes its way through legislation and the courts.

Key Takeaways

While the significance of AB 5 should not be understated, it is important to take a step back and understand that the new law does not automatically re-classify all workers as employees. Instead, it codifies an existing California Supreme Court decision imposing a more stringent standard on companies to defend classification decisions if challenged.

Now that AB 5 is in final form, companies in California that rely on independent contractors should first determine whether they fall into any of AB 5’s enumerated exemptions. If not, now is the time to invest in evaluating whether a business’s engagement with workers passes muster under the ABC test, and how to maximize the chances of satisfying the test. If a company continues to use independent contractors after January 2020, it should be prepared to defend that choice in litigation.

Contact your Baker McKenzie lawyer to develop your compliance plan.