As we reported previously, the California Supreme Court, on April 30, 2018, ruled in the Dynamex v. Superior Court case that to properly classify a worker as an independent contractor, as opposed to a W-2 employee, they must meet the strict new “ABC” test.
Recently the California legislature passed a bill which adopted the Dynamex decision and clarified the issue of who can be and who cannot be an independent contractor. That bill (AB 5) was signed by Governor Newsom and is effective January 1, 2020.
THE “ABC” TEST
The “ABC” test requires a worker meet all three of the established elements to be properly classified as an independent contractor. Failure to meet all 3 elements results in a presumptive finding that the worker is an “employee”: The elements are:
(A) the worker is free from the control and direction of the hirer in connection with the performance of the work; and
(B) the work provided is outside the usual course of the hiring entity’s business; and
(C) the worker is customarily engaged in an independently established trade, occupation, or business.
AB 5 ADOPTS THE “ABC” TEST
But for a few exemptions (described below) AB 5 adopts the rigorous three-factor “ABC” test and proclaims that a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity can meet the “ABC” test.
IMPACT OF AB 5
The Dynamex case dealt specifically with claims pursuant to the Wage Orders which regulate minimum wage, overtime and meal and rest breaks, among other provisions. An unanswered question was what other claims would be covered by the “ABC” test. Now, under AB 5, the “ABC” test will apply not only to claims under the Wage Orders, but also claims brought pursuant to the Labor Code, including PAGA claims, claims for waiting time penalties and business expense reimbursements.
The broad scope of AB 5 will have a significant impact and likely increase the number of claims alleging misclassification of workers as independent contractors.
EXEMPTIONS FROM AB 5
AB 5 contains a list of occupations which have been deemed to be exempt from the “ABC” test. This does not mean that the workers in the enumerated occupations are automatically independent contractors – instead AB 5 provides that any challenge to an independent contractor status as to the exempt occupations would be evaluated under the long-standing Borello standard (generally known as the “right to control test”).
Some of the specified exemptions include:
- Insurance Analysist and Brokers
- Physicians, Surgeons, Dentists, Podiatrists, Psychologists or Veterinarians licensed by the State of California
- A lawyer, architect, engineer, private investigator, or accountant who holds an active license from the State of California
- Securities Brokers or Investment Advisors or their agents and representatives that are registered with the SEC, or the Financial Industry Regulatory Authority or licensed by the State of California
- Direct sales salesperson (as defined in Section 650 of the Unemployment Insurance Code), so long as the conditions for exclusion from employment under that section are met.
In addition, the holding in Dynamex does not apply to a contract for “professional services”. Instead, the determination of independent contractor or employee status shall be governed by the Borello test, if the hiring entity demonstrates that all of the following factors are satisfied:
(A) Maintains a business location separate from the hiring entity (however, this does not prohibit an individual from choosing to perform services at the location of the hiring entity).
(B) Has a business license, and any required professional licenses or permits for the individual to practice in their profession.
(C) Has the ability to set or negotiate their own rates.
(D) Has the ability to set the individual’s own hours.
(E) 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) Customarily and regularly exercises discretion and independent judgment in the performance of the services.
For purposes of this section, among other categories of professions, “Professional Services” means those services which meet any of the following (in addition to meeting additional criteria under each category):
(ii) Human resources
(iii) Travel agent services
(iv) Graphic design
(v) Licensed estheticians, licensed electrologists, licensed manicurists, licensed barbers or licensed cosmetologists (with additional exceptions) who:
(a) Set their own rates, processes their own payments, and is paid directly by clients.
(b) Set their own hours of work and has sole discretion to decide the number of clients and which clients for whom they will provide services.
(c) Has their own book of business and schedules their own appointments.
(d) Maintain their own business license for the services offered to clients.
(e) If the individual is performing services at the location of the hiring entity, then the individual issues a Form 1099 to the salon or business owner from which they rent their business space.
There are many other exemptions from the “ABC” test relating other professionals who are subject to the Business and Professions Code, including a real estate licensee.
Interestingly, while there has been much litigation and media attention about the “gig economy” AB 5 does not include a specific exemption for “gig” economy companies.
LEGISLATIVE PURPOSE OF AB 5
One of the stated purposes of AB 5 is to prevent the state from loss of revenue that “use[s] misclassification to avoid obligations such as payment of payroll taxes, payment of premiums for workers’ compensation, Social Security, unemployment, and disability insurance.” Further, with an employee classification, AB 5 will ensure that workers will be provided with the basic rights and protections, such as minimum wage, workers’ compensation benefits, unemployment insurance, paid sick leave, and paid family leave.
The new law applies to all work performed after January 1, 2020, other than the exceptions detailed above.
Moving forward, hiring entities should consider the following to evaluate the classification of workers:
Audit your independent contractor relationships:
If there are any current independent contractor relationships in existence it would be critical to audit those arrangements to determine whether an exception may be applied.
Reclassify Workers Not Meeting the “ABC” test or not falling within an exemption:
Some workers and the working relationship will not meet the “ABC” text and are not covered by an exemption. In those situations, the worker must be reclassified as an employee.
Even if an “ABC” exemption applies, independent contractor arrangements will still need to satisfy the Borello (right to control) test.
Ensuring proper classification is financially significant to any business because misclassification under California law can be costly. Workers can bring civil claims alleging misclassification and can seek to recover:
- unpaid wages (e.g., usually a claim for overtime);
- meal and rest period premiums (e.g. asserting they were not provided meal and rest breaks);
- unpaid business expenses (seeking the recovery of any expense they incurred in performing the services contracted for); and
- significant penalties (e.g., waiting time, wage statement and potential Private Attorneys General Act penalties.