Your Independent Contractor is Probably Your Employee After All

On September 18, 2019, California Governor Gavin Newsom signed Assembly Bill 5 (“AB 5”) into law.  The bill sets a new standard for classifying workers throughout California, and its ramifications are sure to be felt across companies of all sizes who have used independent contractors as part of their business model.  All California business owners, therefore, should become familiar with AB 5 and how it impacts their business.  The gist of the bill?  Those workers you thought were independent contractors are probably employees.


AB 5 takes effect January 1, 2020. In short, a person providing labor or services for remuneration shall be considered an employee, rather than an independent contractor, unless all of the criteria in the three-part “ABC” test are met. There are several exceptions to the law that are discussed in detail in this article.


The ABC Test


AB 5 codifies a new legal standard to determine whether a worker should be classified as an employee.  In so doing, the bill explicitly approves of a three-part ABC test first set out in an influential California Supreme Court decision from 2018 called Dynamex Operations West, Inc. v. Superior Court of Los Angeles (“Dynamex”).  In Dynamex, the court created a legal presumption that a person who provides labor or services to a hiring entity is an employee, not an independent contractor.  To overcome this presumption and justify independent contractor status, the hiring entity must prove that all three parts of the ABC test are met:


(A) 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;

(B) The person performs work that is outside the usual course of the hiring entity’s business; and

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


After Dynamex was announced, there was subsequent litigation in lower courts and discussion in the public realm about the extent of the ABC test’s application.  The California Supreme Court had left a lot of question marks about when to apply the ABC test.  AB 5 eliminates a lot of that uncertainty by expanding the application of the ABC test from the Industrial Welfare Commission Wage Orders to the California Labor Code and Unemployment Insurance Code.  As the ABC test has a very high threshold for a business to meet, many workers who were historically treated as independent contractors will now be deemed employees by courts and government agencies – with all the accompanying rights for the worker (and obligations for the employer).


Certain portions of the law will be applied retroactively to existing claims, while the law otherwise applies to work performed on or after January 1, 2020.  AB 5 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.


Who is Excluded from the ABC Test?


It’s not all bad news for businesses, as there is some saving grace in the form of seven detailed exceptions.  Under these seven exceptions, the ABC test does not apply; instead, more lenient standards apply to the determination of whether a worker is an independent contractor or employee.


The first category of exceptions applies to the following specialized occupations: insurance brokers; physicians, surgeons, dentists, podiatrists, psychologists, and veterinarians; licensed lawyers, architects, engineers, private investigators, and accountants; registered securities broker-dealers, investment advisers, and their agents; direct sales salespersons; and commercial fishermen.  Again, it is important to recognize that, just because a worker qualifies for one of these occupations does not automatically mean they are an independent contractor; rather, it just means the classification analysis is conducted under the more lenient standard of S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal. 3d 342 (“Borello”).  Borello, which had previously been widely applied in employment law before the ABC test of Dynamex, created a multi-factored test to determine if a worker is an independent contractor.  Those factors included whether the hirer has the right to control the manner and means of the work, whether the hirer has the right to hire and fire the worker, whether the hirer or the worker provides the tools and instrumentalities necessary for work, and the degree of skill required to perform the work.


The second category of exceptions applies to contracts for “professional services,” so long as the provider of the professional services meets certain requirements, including maintaining a business location, sets or negotiates their own rates and hours, and regularly exercises discretion and independent judgment.  “Professional services” are defined as: marketing; administrator of human resources; travel agent services; graphic design; grant writer; fine artist; services by an enrolled agent licensed to practice before the IRS; services by a still photographer or photojournalist; services by a freelance writer, editor, or newspaper cartoonist; and services by a licensed esthetician, electrologist, manicurist, barber, or cosmetologist.  There are a number of detailed requirements for each of these types of professional services.  If a working relationship qualifies as a contract for professional services, then the Borello standard applies.


The third category of exceptions applies to real estate licensees and repossession agencies. If satisfied, the Business and Professions Code applies.


The fourth category of exceptions applies to a “bona fide business-to-business contracting relationship.”  To qualify as a bona fide B2B relationship, the relationship must be between two validly formed business entities and satisfy twelve separate criteria, including: a written agreement; the services provider must have a separate business location; the services provider must be customarily engaged in providing those same services to other businesses besides the contracting business; and the services provider must provide services directly to the contracting business rather than to customers of the contracting business.  If all twelve criteria are satisfied, the Borello standard applies to the classification determination of employee or independent contractor status of the services provider.


The fifth category of exceptions applies to the relationship between a contractor and an individual performing work pursuant to a subcontract in the construction industry, provided seven specific criteria are met.  If satisfied, the classification determination is governed by Section 2750.5 and the Borello standard.


The sixth category of exceptions applies to the relationship between a referral agency and a service provider, provided ten specific criteria are met.  If satisfied, the classification determination is governed by the Borello standard.


Finally, the seventh category of exceptions applies to the relationship between a motor club (like AAA) and an individual performing services pursuant to a contract between the motor club and a third party to provide motor club services utilizing the employees and vehicles of the third party.  If satisfied, the classification determination of the individual is governed by the Borello standard.


The Future of Employment Law


There will undoubtedly be litigation over the effectiveness and scope of AB 5.  There has been vigorous opposition to the bill, including perhaps most notably from large tech companies like Uber and Lyft.  If their efforts are successful, there may even be a statewide ballot initiative in 2020.  Thus, the legal standard may change as the law is interpreted and modified.


Nonetheless, it is clear the overall trend in California is moving towards a scheme of classifying individual workers as employees, rather than independent contractors.  Many workers’ groups are hopeful this new legislation will send ripple effects throughout the rest of the country.  Thus, this has been hailed as a landmark victory for workers everywhere, not just in California.


For now, every business operating in California needs to appreciate the significance of a worker being classified as an “employee.”  Employees have legal rights which an employer must honor.  For example, non-exempt employees are entitled to payment of a minimum wage, meal and rest breaks, payment for overtime, sick leave, and a number of other rights.  On top of basic legal obligations, some employers offer other perks or benefits to its employees.  If a business is not careful in granting those benefits, it could end up giving two weeks of vacation to a worker the business thought was an independent contractor!


The bottom line is that businesses failing to properly classify their workers as employees run the risk of liability for employment law violations.  While this has always been the case, the enactment of AB 5 emphatically expands that risk.  Of course, the more independent contractors a business utilizes, the greater the potential liability.  A business would be wise to confer with their legal counsel on the issues raised by AB 5.


ADLI is dedicated to helping businesses of all sizes understand their obligations and options under the law, in order to ensure the well-being of both the business and its people.  To learn more about the labor and employment practice at ADLI, click here.


Written by Ben Jakovljevic.