On September 18, 2019, California governor Gavin Newsom signed into law a contentious piece of legislation—AB5—that could potentially reclassify millions of independent contractors as employees and dramatically reshape the future of independent workforces in California and beyond.
As its nickname, the “gig worker bill”, suggests much of the discussion around AB5 has focused on its effects on the Ubers and Lyfts of the world. But it is actually far, far bigger than that, with the potential to touch nearly all companies in California—and even some outside of California—that use independent contractors (see below for some notable industry exemptions).
While the immediacy is most keenly felt in California, if “as California goes, so goes the nation” holds true then the door is wide open for other states to follow suit and enact similar laws that make it ever more difficult to classify workers as independent contractors (ICs). In addition, because of how the law is written, its reach may even extend to companies outside of California if those companies contract with independent contractors who cross into California—even on a limited basis.
The state of panic has been palpable, but before the dread of restructuring an entire workforce sets in, there are some proactive steps that can be taken to function in a post-AB5 economy.
AB5 codifies the landmark April 2018 decision in the Dynamex case. With this decision, California’s Supreme Court determined that the rigorous, three-pronged “ABC Test” must be used to determine worker classification in wage-order claims.
Under the ABC Test a worker is presumed to be an employee—and the burden to demonstrate their independent contractor status is placed squarely on the shoulders of the hiring company. To do this successfully a company must demonstrate (the emphasis is on “demonstrate” as scrupulous documentation is critical) that the worker satisfies all 3 criteria of the test (1 or 2 doesn’t cut it).
A worker can only be classified as an independent contractor if:
(a) the worker is free from control and direction in the performance of services; and
(b) the worker is performing work outside the usual course of the business of the hiring company; and
(c) the worker is customarily engaged in an independently established trade, occupation, or business.
This definition of an independent contractor is much narrower than that of the multi-factor Borello test—the standard previously used in California, which made it far easier to classify workers as independent contractors.
AB5 makes the ABC Test the law in California, but it also expands its application beyond wage-order claims to all provisions under the state Labor and Unemployment Insurance codes.
This is really the (multi-) billion-dollar question, one that will take some time to be answered as there is a significant gap between what a law dictates and how it is interpreted by the courts.
A variety of California agencies oversee worker classification as it pertains to claims made by individuals. However, those individual claims can trigger larger agency audits of hiring companies’ classification practices—and those audits will now look to the ABC Test to determine improper classification.
We can almost certainly expect to see enforcement duked out in some lengthy legal battles. AB5 enables the California attorney general, city attorneys, and local prosecutors to sue companies over violations. If this occurs it would require a judge’s order to force companies to reclassify their workers; and large entities with deep pockets like Uber and Lyft would likely fight their cases for years. In addition, expect years of lobbying efforts for industry-related exemptions at the legislative level.
This is where the issue of interpretation comes into play, in the wake of the Dynamex ruling, so far the Supreme Court of California has yet to apply all 3 prongs of the ABC test in any single case. The point here is that the interpretation of AB5 will be just as critical as the legislation itself. And right now, that interpretation is an unknown.
Certainly, compliantly structuring, implementing and documenting independent contractor relationships will be more challenging under the ABC Test, but it is possible that courts will interpret AB5 in a way that permits some companies to classify workers as ICs.
Prior to its passage, AB5 was the subject of major lobbying efforts on both sides of the issue. The result is that over 50 professions or types of businesses are exempt from the bill. Exemptions include doctors, dentists, insurance agents, lawyers, accounts, real estate agents, hairstylists, and a variety of creative professionals.
However, AB5 also exempts business-to-business contractors that meet 12 specific requirements and referral agencies that meet 10 specific requirements. This keeps the door open for establishing a sound business-to-business relationship between hiring companies/ referral agencies and independent contractors, but also requires a deliberately planned strategy to achieve compliance with all of the various requirements.
To be clear, exemption from AB5 does not mean that workers can automatically be classified as independent contractors by virtue of waving some kind of classification magic wand. Rather, it means the former Borello test will be used to determine their classification for both wage-order and non-wage-order claims. So structuring and documenting the independent contractor arrangement to comply with the multi-factor test is crucial for exempt businesses.
Very likely, yes. In recent years, 20 states have already implemented the ABC Test in one form or another, although primarily in relation to unemployment insurance or workers’ compensation claims. The passage of AB5 could certainly hasten the ABC Test trend and expand it not only to other states but to other claim types. Because California’s economy is larger than any other US state, legal and political developments there tend to have a ripple effect both across other states and at the federal level.
Since it is certainly possible similar bills will begin to pop up elsewhere, businesses operating outside of California should be proactive in shoring up the appropriate independent contractor processes and relationships now. Though it will take some time for any new legislation to actually be passed, that legislation could be applied retroactively so the sooner a company’s ducks are in a row, the better.
Planning, not panic, is the most helpful here. There’s no doubt that AB5 will have a meaningful impact, both inside and outside California. But again, how the law will be interpreted and applied remains to be seen. Certainly, fear of non-compliance is justified, but there are some proactive steps to take.
If you operate in California, it’s a good idea to start acting now. If you operate outside of California, you have more time, but taking the necessary steps now could save you some sleepless nights later.
The fallout from AB5 is not limited to companies utilizing independent contractor workforces. Two very significant issues will quickly be felt by all California residents: