The California Legislature passed a closely watched bill on September 11, 2019 that, if signed into law, will make it harder for California businesses to classify workers as independent contractors. Assembly Bill (AB) 5, which codifies and expands the California Supreme Court's 2018 holding in Dynamex Operations West v. Superior Court of Los Angeles, 4 Cal. 5th 903 (2018) (Dynamex) and applies the "ABC" test to most independent contractor questions, is heading to California Governor Gavin Newsom, who is expected to sign.

AB 5 overview

If signed into law, AB 5 will represent a tectonic shift in how businesses classify workers as independent contractors. For years, California businesses have relied on the multi-factor test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989) (Borello) to classify workers as independent contractors. Under the Borello test, the most significant factor is whether the person to whom the service is rendered (i.e., the business) has control or the right to control the worker both as to the work done and the manner and means in which it is performed. Additional factors include whether the person performing the services is engaged in an occupation or business distinct from the hiring company, and whether the work performed is part of the regular business of the hiring company.

In 2018, the California Supreme Court held in Dynamex that the more rigorous "ABC" test should apply to independent contractor questions arising under the California Industrial Wage Commission Wage Orders. AB 5 takes Dynamex a step further by codifying the rule for Wage Orders and retroactively applying the "ABC" test to claims arising under the California Labor Code and Unemployment Insurance Code as well.

The ABC test presumes a worker is an employee unless the hiring entity can establish the following three elements:  

  1. The person 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. The person performs work that is "outside the usual course of the hiring entity's business"; and
  3. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

The "B" prong will present a significant hurdle for many California companies as many independent contractors perform services that are, at least in part, within the "usual course" of the hiring entity. How that phrase will be interpreted by California courts and regulators after AB 5 is signed into law remains to be seen.

Are there exemptions?

AB 5 exempts from the ABC test (and instead clarifies the Borello multi-factor test applies) the following categories of workers: licensed insurance companies, physicians, surgeons, dentists, podiatrists, psychologists, veterinarians, lawyers, architects, engineers, private investigators, accountants, securities broker-dealers and investment advisers, those providing "professional services" pursuant to a written contract (marketing, HR, travel agent, graphic design, writer, esthetician, barber), licensed real estate agents, licensed repossession agents, certain "bona fide business-to-business" contracts, construction subcontractors, and referral agencies.

Takeaways for employers

  • The stakes could not be higher. If signed into law, AB 5 will take effect January 1, 2020. On its face, it applies retroactively. Thus, although there may be legal challenges as to the legality of such retroactivity, California employers should examine their potential exposure starting now. Misclassified workers will be given the ability to sue for misclassification and seek the recovery of unpaid wages (e.g., overtime), meal and rest period premiums, unpaid business expenses, and significant penalties (e.g., waiting time, wage statement, and potential penalties under the California Private Attorney General Act (PAGA)). In addition to those remedies, AB 5 also gives the California Attorney General and certain City Attorneys the authority to seek injunctive relief against offending employers to prevent the continued misclassification of employees.
  • Act now. California employers should undertake an immediate risk assessment of their current workforce to determine how many contractors the company uses, how much it would cost to reclassify workers, and how much risk the company can tolerate in the event of a misclassification claim. California employers should also look critically at their existing independent contractor arrangements, determine whether any exemptions may apply, and decide whether to restructure those relationships as soon as possible.

The Dentons Employment and Labor team is well situated to help companies of all sizes audit their workforce, revise existing relationships to align with AB 5, and think through creative strategies that can both ensure compliance and increase market share. To learn more about AB 5, please reach out to one of the key contacts listed.

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