On September 18, 2019, California Governor Gavin Newsom signed into law Assembly Bill 5 (“AB 5”). The law takes effect on January 1, 2020 with respect to workers’ rights under the state’s Unemployment Insurance Code, the Labor Code and wage orders of the Industrial Welfare Commission, and on July 1, 2020 for workers’ compensation claims.
AB 5 is a worker-friendly law that is expected to have widespread impact across the state by potentially reclassifying millions of California workers as employees rather than independent contractors or consultants. As announced by the California Legislature when it passed AB 5, the new law is designed to “ensure workers who are currently exploited by being misclassified as independent contractors instead of recognized as employees have the 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.”
Companies need to determine whether their business operations are affected by the new law and, if so, they will need to take various measures, including potentially modifying their contractor arrangements and agreements.
AB 5 FUNDAMENTALS
By way of background, AB 5 codifies and expands the California Supreme Court decision in 2018 in the lawsuit, Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County (“Dynamex”), which established the so-called “ABC” test to determine whether a worker is an employee or an independent contractor. In adopting the ABC test, the California Supreme Court revamped the previous, more lenient test under California law for categorizing workers (known as the “Borello” test) and imposed a more stringent and less discretionary standard for categorizing workers in that state who are covered by the new law. The new legislation will therefore likely result in more workers being classified as “employees” under California state law.
Under the ABC test, a worker is presumed to be an employee unless the hiring company can demonstrate that its relationship with the worker satisfies three conditions: (a) the worker is free from control and direction in the performance of services; (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. Under the new law, the company has the obligation to prove that all three conditions are met.
Of these three conditions, it is the second one – that the worker perform work which is outside the usual course of the hiring company’s business – that arguably presents the greatest potential for a recharacterization of workers. This provision means that companies which have relied on outside contract workers to supplement their employee workforce may be required to treat those contract workers as employees if the main profession of their outside workers corresponds to the company’s principal line of business. As an example, this second condition has led ride-share app-based companies like Uber and Lyft to claim that their outside drivers are not employees because those companies are technology companies, not taxi companies. It is yet to be seen whether those claims will pass scrutiny in California courts.
Whether a worker is classified as an employee or an independent contractor impacts a company’s responsibility for paying Social Security and payroll taxes, unemployment insurance taxes, state employment taxes and workers’ compensation insurance and for complying with various state laws and regulations dealing with wages, hours and working conditions of employees. Penalties for the misclassification of a worker as an independent contractor range from $10,000 to $25,000 per misclassified worker, as well as liability for back wages and overtime, meal and rest break premiums, and other statutory and civil penalties. The law also allows the California Attorney General and the city attorneys of cities with populations of more than 750,000 to seek injunctive relief to force the reclassification of workers.
AB 5 EXEMPTIONS TO THE ABC TEST
The law exempts certain businesses and occupations from the ABC test so long as certain conditions are met, and the majority of AB 5 is devoted to establishing these specific statutory exceptions. Unfortunately, many of the details surrounding the exceptions are yet to be hammered out; however, as a general rule, if the requirements for a statutory exception are met, then the ABC test will not apply. Instead, the more lenient Borello test will apply to determine the classification of a worker. Following is a broad outline of the exceptions.
Specific Occupations. Workers in certain occupations are exempted from the ABC test, such as insurance brokers, physicians, surgeons, dentists, podiatrists, psychologists, veterinarians, lawyers, architects and engineers, among others. Workers in these industries can continue to be categorized by hiring companies as employees or independent contractors in accordance with the more permissive Borello standard.
“Professional Services” Contracts. The ABC test doesn’t apply to a worker who renders services under a contract for “professional services” if a number of conditions are met. Under this exemption, the individual providing services for the hiring entity may include an individual providing services through a sole proprietorship or other business entity. However, this exception narrowly defines “professional services” to include, among others, marketing, HR administration, travel agent services, graphic designers, grant writers and fine artists.
Business-to-Business Contracting Relationships. The ABC test does not apply to business-to-business contracting relationships that satisfy a lengthy list of requirements, including (among others) that (a) both businesses be legal entities (e.g., corporations, partnerships, etc.) and not individual persons, (b) their contract is in writing, and (c) the services are provided directly to the business and not to its customers.
Relationships between Referral Agency and Service Provider. Relationships between a “referral agency” and a business service provider that fall within certain legal parameters are excepted from the ABC test. Under this exception, a “referral agency” is defined as a business that connects clients with service providers that provide graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, among others.
Contractor-Subcontractor Relationship in Construction Industry. The ABC test doesn’t apply to the relationship between a contractor and an individual performing work under a subcontract in the construction industry, provided specified criteria are satisfied.
WHAT YOU SHOULD BE DOING TO PREPARE FOR AB 5
While a full presentation of the steps that are necessary and appropriate to prepare a business for AB 5 goes beyond the scope of this Alert and is very factually specific, following are some of the steps that businesses should be considering.
- Determine Whether the Law Applies to Your Company. As noted above, AB 5 contains many exemptions for businesses, industries and individuals. Each company needs to assess how its business fits into this new classification regime. Certain exemptions are clear while others are not. Moreover, a critical open issue that is currently pending before the California Supreme Court is whether AB 5 will be given retroactive effect. We recommend that you revisit your self-assessment periodically in order to stay in compliance.
- Review Your Contractor Arrangements. Any business that is subject to AB 5 and which uses outside contractors needs to review those arrangements in light of the new law. This applies to all arrangements, whether under a written contract or verbal understanding.
- Consider Revising Your Contracts. A practical way for businesses to support their categorization of workers as contractors is to ensure that (a) they have written contracts with all of them, and (b) those contracts track the requirements of the new law. However, you should bear in mind that, if mishandled, revising your contracts might be interpreted as an implicit acknowledgement that the existing forms were deficient in some way. We encourage you to contact us before undertaking any revisions to enable us to assist in managing that process in a careful and compliant manner.
- Contact Us if You Believe that Your Contractors Should Be Recategorized in Order to Comply with the Law. If, after careful review, you believe that one or more of your contractors may have been miscategorized, we urge you to contact us. As in the case of contract revisions, it is important that a careful and thorough review of the situation be conducted before any step is taken, in order to minimize exposure to possible litigation.
PELG ATTORNEYS CAN HELP
We can assist with the self-assessment of your business at this important time as well as with ongoing monitoring as both your company and the law continue to develop. The interaction between the legal tests and their many conditions and exemptions requires close analysis and a familiarity with the legal concepts involved. For example, certain exemptions require that a service provider hold certain business licenses, which is a determination we can assist with. In addition, the adoption of the law is widely expected to precipitate litigation over the coming months and years from worker advocacy groups, California governmental agencies and affected individuals, which may change its impact on your company. Contact us to talk through your concerns and stay current with your obligations.
For more information about AB 5 or assistance in getting your company AB 5-ready, reach out to your primary contact at our firm or to Paul Ellis at email@example.com or (212) 949-5900 ext. 301.
This Client Alert is for informational purposes only, and is not intended to be legal advice.