AB 5 Becomes Law: California Limits the use of Independent Contractors by Employers

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Ervin Cohen & Jessup LLPOn September 18, 2019, Governor Newsom signed Assembly Bill 5, thereby establishing a law that purports to prevent the misclassification of employees as independent contractors and provide “basic rights and protections they deserve under the law, including a minimum wage, workers’ compensation if they are injured on the job, unemployment insurance, paid sick leave, and paid family leave.”  California businesses and employers would argue that AB 5 appears to be nothing more than shameless effort to collect more payroll taxes by prohibiting a wide variety of independent contractor relationships and, as a result of the lobbying efforts of trade unions and various industries, is a confusing mess of tests, rules and exceptions which will serve as a basis for litigation for the foreseeable future.

AB 5 was prompted by a California Supreme Court case that focused on the gig economy and the Court’s desire for a simplified test to address the question of whether a worker is an employee or independent contractor.  In Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903, the Court replaced the 11-factor test for determining employee vs. independent contractor status established by the Court’s own decision in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341, with the simple and far more rigorous ABC test.  The decision created problems for everyone except plaintiff’s lawyers.  Industries built on an independent contractor model of business, such as hospitals where physicians are independent contractors, were now apparently operating illegally.  Further, the Dynamex ABC test applied only to claims made under the California Industrial Welfare Commission’s Wage Orders, which meant that the Borello test would still be applied to all other claims, such as those brought under the Labor Code or the Unemployment Insurance Code.  As a result, it was possible that a worker could be held to be an employee for some purposes and independent contractor for other purposes in the same lawsuit.

To clear up this problem, AB 5 states that, for purposes of the Labor Code, the Unemployment Insurance Code, and the Wage Orders, a person providing services shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all of the following conditions are satisfied (the ABC test):

(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.

(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.

Any exceptions to the terms “employee,” “employer,” “employ,” or “independent contractor,” and any extensions of employer status or liability, that are a part of the Labor Code, the Unemployment Insurance Code, or in a Wage Order, shall remain in effect.  Further, if a court of law rules that the ABC test cannot be applied in a particular context based on grounds other than an express exception to employment status, then the determination of employee or independent contractor status shall be governed by the Borello test.

In addition, AB 5 requires that the Borello test will still apply to the following occupations:

(1) A person or organization who is licensed by the Department of Insurance.

(2) A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California, performing professional or medical services provided to or by a health care entity.

(3) An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant.

(4) A securities broker-dealer or investment adviser or their agents and representatives that are registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the State of California.

(5) A direct sales salesperson as described in Section 650 of the Unemployment Insurance Code, so long as the conditions for exclusion from employment under that section are met (primarily paid by sales rather than by hour, and pursuant to a written contract that must state that the person is not an employee for state tax purposes).

(6) A commercial fisherman working on an American vessel with a valid commercial fishing license (which exception is set to expire on January 1, 2023, unless extended by the Legislature).

(7) Real estate licensees licensed by the State of California.

(8) Licensed repossession agencies.

(9) A newspaper distributor working under contract with a newspaper publisher, and a newspaper carrier working under contract either with a newspaper publisher or newspaper distributor (added by Assembly Bill 170 at the eleventh hour, this provision will remain effective only until January 1, 2021, unless it is extended by the Legislature).

The Borello test will also apply to “professional services” contractors, if the hiring entity demonstrates that all of the following factors are satisfied:

(A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity, although the individual may choose to perform services at the location of the hiring entity.

(B) The individual has a business license by July 1, 2020, in addition to any required professional licenses or permits for the individual to practice in his or her profession.

(C) The individual has the ability to set or negotiate his or her own rates for the services performed.

(D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours.

(E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work.

(F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.

The definition of “Professional services” contractors, however, is limited to: marketing, provided that the contracted work is original and creative in character and depends on invention, imagination, or talent or is work that is an essential part of or necessarily incident to the contracted work; administrators of human resources, provided that the contracted work is predominantly intellectual and varied in character and is such that the result accomplished cannot be standardized in a given period of time; certain travel agent services; graphic designers; grant writers; fine artists; enrolled agents licensed by the United States Department of the Treasury to practice before the Internal Revenue Service; payment processing agents through an independent sales organization; still photographers or photojournalists who do not provide content submissions (each “submission” being defined as items pertaining to a specific event or subject, provided for in a contract that defines the scope of the work, and accepted and published or posted for sale) to the putative employer more than 35 times per year (which exception does not apply to an individual who works on motion pictures, including projects for theatrical, television, internet streaming, commercial productions, broadcast news, music videos, and live shows, whether distributed live or recorded for later broadcast); freelance writers, editors, or newspaper cartoonists who do not provide content submissions to the putative employer more than 35 times per year; and licensed estheticians, licensed electrologists, licensed manicurists (which exception will expire on January 1, 2022), licensed barbers, or licensed cosmetologists, provided these individuals set their own rates and process their own payments which must be made directly by clients, set their own hours of work and have sole discretion to decide which clients to see and how many, have their own book of business and schedule their own appointments, maintain their own business license for the services offered to clients, and issue a Form 1099 to the salon or business owner when performing services at the location of the hiring entity from which they rent their business space.

AB 5 further provides that the holding in Dynamex will not apply to bona fide business-to-business contracting relationships between sole proprietorships, partnerships, limited liability companies, limited liability partnerships, or corporations, and excluding individuals performing services (who will still be subject to the ABC test).  In such business-to-business contract relationships, the determination of employee or independent contractor status of the business services provider shall be governed by Borello, if the contracting business demonstrates that all of the following criteria are satisfied:

(A) The business service provider is free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

(B) The business service provider is providing services directly to the contracting business rather than to customers of the contracting business.

(C) The contract with the business service provider is in writing.

(D) If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration.

(E) The business service provider maintains a business location that is separate from the business or work location of the contracting business.

(F) The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed.

(G) The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity.

(H) The business service provider advertises and holds itself out to the public as available to provide the same or similar services.

(I) The business service provider provides its own tools, vehicles, and equipment to perform the services.

(J) The business service provider can negotiate its own rates.

(K) The business service provider can set its own hours and location of work.

(L) The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required.

AB 5 also establishes that Dynamex will not apply to the relationship between a contractor and an individual performing work pursuant to a subcontract in the construction industry, and instead the determination of whether the individual is an employee of the contractor shall be governed by Labor Code 2750.5 and by Borello, if the contractor demonstrates that all the following criteria are satisfied:

(1) The subcontract is in writing.

(2) The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license.

(3) If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration.

(4) The subcontractor maintains a business location that is separate from the business or work location of the contractor.

(5) The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services.

(6) The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided.

(7) The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

(8) The licensing requirement set forth in section (2) shall not apply to a subcontractor providing construction trucking services for which a contractor’s license is not required, provided that all of the following criteria are satisfied:

(i) The subcontractor is a business entity formed as a sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation.

(ii) For work performed after January 1, 2020, the subcontractor is registered with the Department of Industrial Relations as a public works contractor pursuant to Section 1725.5, regardless of whether the subcontract involves public work.

(iii) The subcontractor utilizes its own employees to perform the construction trucking services, unless the subcontractor is a sole proprietor who operates their own truck to perform the entire subcontract and holds a valid motor carrier permit issued by the Department of Motor Vehicles.

(iv) The subcontractor negotiates and contracts with, and is compensated directly by, the licensed contractor.

(v) For work performed after January 1, 2020, any business entity that provides construction trucking services to a licensed contractor utilizing more than one truck shall be deemed the employer for all drivers of those trucks.

(vi) This construction trucking services exception shall only apply to work performed before January 1, 2022.

There is also an exception to the Dynamex ABC test for the relationship between a referral agency (which is limited to an agency that connects clients with service providers who provide graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, or yard cleanup) and a service provider (which must not be an individual but rather must be a sole proprietor, partnership, limited liability company, limited liability partnership, or corporation providing services to clients through the referral agency).  Specifically, the determination of whether the service provider is an employee of the referral agency shall be governed by Borello, if the referral agency demonstrates that all of the following criteria are satisfied:

(A) The service provider is free from the control and direction of the referral agency in connection with the performance of the work for the client, both as a matter of contract and in fact.

(B) If the work for the client is performed in a jurisdiction that requires the service provider to have a business license or business tax registration, the service provider has the required business license or business tax registration.

(C) If the work for the client requires the service provider to hold a state contractor’s license, the service provider has the required contractor’s license.

(D) The service provider delivers services to the client under service provider’s name, rather than under the name of the referral agency.

(E) The service provider provides its own tools and supplies to perform the services.

(F) The service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed for the client.

(G) The service provider maintains a clientele without any restrictions from the referral agency and is free to seek work elsewhere, including through a competing agency.

(H) The service provider sets its own hours and terms of work and is free to accept or reject clients and contracts.

(I) The service provider sets its own rates for services performed, without deduction by the referral agency.

(J) The service provider is not penalized in any form for rejecting clients or contracts. This subparagraph does not apply if the service provider accepts a client or contract and then fails to fulfill any of its contractual obligations.

Finally, AB 5 does not apply the ABC test to the relationship between a motor club 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 and, instead, requires that the determination of whether such an individual is an employee of the motor club shall be governed by Borello, if the motor club demonstrates that the third party is a separate and independent business from the motor club.

Employers should take note that, except as applied to unemployment insurance claims, AB 5 will be applied retroactively; AB 5 declares that it is not a change, but is rather declaratory of existing law with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.  In addition, while the exceptions that would relieve an employer from liability will also be applied retroactively to existing claims and actions “to the maximum extent permitted by law”, this is the only purpose for which the exceptions can be used.  The new law states that it cannot be used as a basis to permit an employer to reclassify an individual who was an employee on January 1, 2019, to an independent contractor.

There will undoubtedly be further amendments to the law created by AB 5.  Indeed, there is already an effort to create a ballot initiative to address the impact on on-demand companies like Uber, Lyft, Door Dash, and Postmates.  It is unlikely, however, that there will be any significant change to the ABC test which is at the core of AB 5.  California businesses should therefore take immediate steps to examine their independent contractor business relationships in light of the law and make appropriate changes.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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