Takeaways

On September 18, 2019, California Governor Gavin Newsom signed into law a bill making it risky for employers (regardless of size) to classify many types of workers as independent contractors.
As employees, these workers will be subject to and protected by California’s workplace rules, including overtime, meal and rest breaks, paid sick leave, paid family leave, payroll withholdings, unemployment insurance, workers’ compensation, and other local and municipal regulations.
Contingent-workforce industries, founded in the Silicon Valley, were unsuccessful in their attempt to thwart the legislation, which is the most aggressive in classifying workers as employees in the country.

California Governor Gavin Newsom signed into law Assembly Bill 5—sweeping legislation that requires most “gig economy” workers to be treated as employees, effective January 1, 2020. The law impacts not only tech giants in the gig economy, but also applies to many traditional contract workers such as truckers, software coders, janitors and exotic dancers, among many others. Multiple industries and occupations secured exemptions to the law, but they still must comply with the traditional tests for independent contractor status.

The law enshrines the holding by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (2018), which established a new litmus for whether a worker was an employee. Prior California law focused on the level of control exercised by the hiring entity and utilized a multifactor test to determine whether the worker had sufficient independence to qualify for independent contractor status. S.G. Borello & Sons, Inc v. Department of Industrial Relations, 48 Cal.3rd 341 (1989).

Background

As described in a 2018 Pillsbury Client Alert, Dynamex broke new ground by announcing the presumption that a worker who performs services is an employee for purposes of claims arising under the wage orders of California’s Industrial Welfare Commission (IWC), unless the new and rigid three-part ABC test is met. But the case did not specify which test would apply in other scenarios, such as unemployment insurance coverage and Labor Code provisions not part of the IWC wage orders.  

In the aftermath of the Dynamex decision, a variety of stakeholders mobilized to seek a legislative solution. Industries and workers which historically relied on a contracted worker model (such as real estate, health care, licensed professionals, broker-dealers, cosmetologists, and commercial fishermen) sought to narrow the ruling or seek a special exemption. Meanwhile, California trial lawyers sought to broaden the ruling so that it would apply to claims outside the wage orders, and also apply retroactively. Technology companies as well as the California Chamber of Commerce argued for retraction of Dynamex to preserve the gig-economy model which they contend has fostered innovation and economic prosperity in the state. They argued that the failure to limit application of the ABC test would cause economic harm. The State of California sought an expansion of the Dynamex holding, since employment carries tax withholding and unemployment insurance obligations which result in more funds being deposited into the state treasury.

Ultimately, the California Legislature sided mainly with employee-rights advocates, weakening the “gig-economy” innovators and echoing the concerns of the Dynamex court for “the harm to misclassified workers who lose significant workplace protections, the unfairness to employers who must compete with companies that misclassify, and the loss to the state of needed revenue from companies that use misclassification to avoid obligations such as payment of payroll taxes, payment of premiums for workers’ compensation, Social Security, unemployment and disability insurance.” (See Assembly Bill 5, Section 1(b), citing Dynamex.) Proponents of AB 5 also argued that the misclassification of workers as independent contractors has played a significant role in the erosion of the middle class and the rise in income inequality.

The ABCs of AB 5

In California, employees are entitled to a variety of benefits and workplace protections, such as unemployment insurance, minimum wages, overtime pay, meal and rest breaks, workers’ compensation, compliant paystubs, expense reimbursement, paid sick leave, and paid family leave. Many of these protections are inapplicable to independent contractors, who have the freedom to run their own business, work for a variety of clients, and set their own schedules.

Whether a worker is properly classified as an independent contractor has traditionally rested on the degree of control exercised by the hiring entity, determined by considering the multifactor test of Borello. AB 5 adds Section 2750.3 to the California Labor Code, which retains emphasis on that “control” element, but adds the two additional and onerous “B & C” factors enumerated by the Dynamex court. Under AB 5, a worker is presumed to be an employee unless the person:

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

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

As a safe harbor, AB 5 explains that if a court refuses to apply the ABC test, or if the statute provides an exception, the Borello test must be utilized. Further, by expanding the definition of employee, the bill expands potential criminal liability for worker misclassification under various California Labor Code and California Unemployment Insurance Code provisions.

The Winning Exemptions

The lobbying efforts of multiple industries and occupations resulted in their specific exemption from coverage of the ABC test. Yet, those exemptions do not mean that workers in those industries are safe from scrutiny as potential employees; receiving the coveted exemption simply means that the historical control test (Borello) remains the appropriate measure.  

Industries and occupations that secured this lower standard of scrutiny include licensed insurance agents, certain licensed health care professionals (e.g., physicians, surgeons, dentists, podiatrists, psychologists, veterinarians), registered securities broker-dealers or investment advisers, direct sales salespersons, a person or organization licensed by the Department of Insurance, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and others performing work under a contract for professional services or a subcontract in the construction industry. Additionally, AB 5 clarifies that the ABC test does not apply to the following individuals holding an active license from the State of California and practicing in that recognized profession: doctors, lawyers, architects, accountants, engineers, or private investigators. The professional service occupations exempted include contracted marketing and human resources professionals, travel agents, graphic designers, fine artists, grant writers, U.S. Treasury agents, payment processing agents, photographers, photojournalists, freelance writers, editors or newspaper cartoonists, manicurists, and estheticians, but these exemptions require that the hiring entity demonstrate that the individual maintains a business location and license, has the ability to set their hours, the individual performs the same work for others or holds themselves out as available to do so, and routinely exercises discretion and independent judgment by setting their own rates and scheduling their own appointments.

With regard to contracted salespersons, the determination as to whether they are an employee or independent contractor is governed by Borello because they are exempt from Dynamex application, provided their pay is based on actual sales rather than wholesale purchases or referrals.

Those industries and occupations who did not receive a clear exemption in AB 5 are attempting to push additional legislative carve outs, for example AB 170 (compliance exception for newspaper deliverers).

What’s Next? – Litigation, Litigation, Litigation (and Some Copycats)

Nearly every industry and notable employer in California has been hit with some sort of wage-hour claim in the past 20 years. Class-action claims are commonplace, and employers have learned the importance of compliance the hard way, in expensive litigation involving overtime classification, overtime calculation, meal and rest break practices, or payroll calculations. AB 5 will undoubtedly accelerate this frenzied trend, encouraging class-action claims by workers who received the benefits of the independent contractor position they sought (flexibility, independence), yet now seek the retroactive statutory protections of employment. AB 5 aids the quest for litigation payoffs by stating that its enactment is not a change in the law, but declaratory of existing law and applying retroactively to existing claims.

Gig economy stalwarts have faced class-action litigation assault for years on the classification issue, notching several minor wins but resting on arguable compliance with the Borello test and worker arbitration agreements to fend off class claims for liability. With the addition of the B and C factors of Dynamex, their business model can be directly assaulted, although some companies have announced that they plan to assert factual arguments regarding the core nature of their business. And, as employee arbitration agreements face heightened scrutiny, previous firewalls may start to show weakness. Gig economy businesses (all of whom were not granted exemptions) say they plan to spend $90 million on a 2020 ballot measure to regulate workers in the gig economy. Before the bill’s signing, Uber’s chief legal officer stated the company believes “California is missing a real opportunity to lead the nation by improving the quality, security and dignity of independent work.” In his signing statement, Gov. Newsom said that he is prepared for more negotiations with labor and business. He specifically stated: “A next step is creating pathways for more workers to form a union, collectively bargain to earn more, and have a stronger voice at work—all while preserving flexibility and innovation.”

Where trial lawyers fail to seek redress for workers, municipalities can venture into the civil litigation arena. AB 5 authorizes the attorney general, city attorneys in large California cities (i.e., cities with a population in excess of 750,000) and local prosecutors to sue companies for injunctive relief to discontinue the misclassification, or for any other remedies available. Where a government litigant joins an action, settlement may become more difficult and the effectiveness of class-action waivers will be questioned.

Finally, the post-Dynamex wave may not be limited to California. While the Golden State remains at the forefront of employment law progressivism, other states, including New York, will likely consider similar action. On the Federal side, multiple 2020 Democratic presidential candidates have expressed support for AB 5, including Elizabeth Warren, Kamala Harris, Pete Buttigieg, Bernie Sanders and Julián Castro.

Recommendations for Employers

  • Conduct an audit to isolate the number of California contractors, and determine whether any fall into an enumerated AB 5 exemption.
  • All independent contractors must continue to meet the “control” test (Borello); ensure compliance on this requirement before assessing whether parts B and C of Dynamex
  • Establish procedures to ensure that the company has adequately considered whether a worker can be safely classified as an independent contractor and educate hiring managers as to the bill’s requirements.
  • Update contractor documentation to reflect appropriate classification test (ABC or Borello).
  • Consult with counsel to ensure contractor classification is consistent with other worker documentation (e.g., Proprietary and Arbitration Agreements should be specially tailored for the contracting relationship, not employment).
  • To the extent a company did not do so after the Dynamex decision, work with counsel to implement a strategy to reclassify California workers who do not meet the new codified test or utilize workers who are employed by a third party to perform this work. Remember, simply paying these workers minimum wage or not allowing overtime is not sufficient. They are now entitled to workers’ compensation coverage, unemployment insurance, reimbursement of business-related costs and similar employee protections.
  • Consider updating and strengthening any arbitration clauses with class-action waivers for contractors. Though the governor vetoed AB 3080—which would have banned arbitration agreements by employers, in September 2018—continue to carefully watch legislative developments aimed at limiting this tactic.