How Will California's AB 5 Affect My Business?

Following the California Supreme Court decision in Dynamex Operations v. Superior Court, 4 Cal. 5th 903 (2018), which identified the "ABC Test" for worker classification for the purposes of California's wage and hour determinations under the IWC Wage Orders, and now with the passage and signing into law of Assembly Bill 5 (Gonzales) (2019 Cal ALS 296, 2018 Cal AB 5, 2019 Cal Stats. ch. 296.), which extended the Dynamex ABC Test to apply in workers' compensation insurance and EDD payroll tax determinations of status, we have been inundated with questions and issues arising out of these significant changes to California worker classification law. I have also noticed that California businesses and some experienced California practitioners are misinformed, or simply mistaken, about some elements of AB 5 and its potential effects on California businesses, independent contractors, and employees.

The Dynamex ABC Test states that, for purposes of wage and hour determinations under the IWC Wage Orders, a worker is properly considered an independent contractor only if the hiring entity establishes that:

(A) the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;

(B) the worker performs work that 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 of the same nature as the work performed for the hiring entity.

Prong B is the hardest to overcome if the contractor is performing work that is the same as that of the hiring entry, for example, where the principal is in the business of performing janitorial services and the contractors are janitors.

AB 5 makes the Dynamex ABC Test applicable to California Employment Development Department (EDD) payroll tax determinations and California workers' compensation insurance determinations, as well as the pre-existing Dynamex application to wage and hour determinations under the California IWC Wage Orders.

Our comments on some common questions about the interrelation between Dynamex and AB 5, and potential effects on businesses, independent contractors, and employees, are below:

a. Is AB 5 to be applied retroactively?

Nowhere in AB 5 does it state that the ABC Test, itself, is to be applied retroactively. California statutes are generally to be interpreted prospectively, not retrospectively. A statute may be applied retroactively only if it contains express language of retroactivity or if other sources provide a clear and unavoidable implication that the legislature intended retroactive application. See McClung v. Emp't Dev. Dep't, 34 Cal. 4th 467, 468 (2004).

AB 5 is effective January 1, 2020 for purposes of EDD payroll taxes and workers' compensation insurance; the application of the ABC Test is not retroactive in this regard.

However, AB 5 does state that specific exceptions to the ABC Test are to be applied retroactively: "Insofar as the application of [enumerated exceptions] of this section would relieve an employer from liability, those subdivisions shall apply retroactively to existing claims and actions to the maximum extent permitted by law." Cal Lab Code § 2750.3(i).

AB 5's ABC Test is only retroactive in terms of applicability to wage and hour issues: "The addition of subdivision (a) [the ABC Test] to this section of the Labor Code by this act does not constitute a change in, but is declaratory of, existing law with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders." Cal Lab Code § 2750.3.

The bill is silent regarding any designation as declaratory legislation in regard to both workers' compensation insurance and EDD payroll taxes.

b. What happens to Independent Contractors following AB 5?

AB 5 does not prohibit the use of independent contractor services. It significantly restricts such use, but there are certainly still opportunities for legitimate use of independent contractors in California.

First, there are situations in which an independent contractor relationship overcomes the ABC Test, for example, when a law firm engages a plumber or a janitorial service. Neither Dynamex nor AB 5 would prohibit these types of engagements.

However, businesses engaging independent contractors to provide services that are integral to the principal business, such as contract software technicians providing services to a software development company or contract drivers working for a transportation provider, may be in need of a new approach to these relationships. Contact one of our attorneys today to discuss your specific facts.

c. How are workers in exempt professions going to be classified following AB 5?

For exempt professions, generally the current standard under S. G. Borello & Sons, Inc. v. Dep't of Indus. Relations, 48 Cal. 3d 341 (1989) will continue to apply. The main feature of Borello is whether the principal retains the right to direct and control the manner, means, and details of the work provided. There are also ten secondary factors considered, as well, by courts and state agencies. See Cal Lab Code § 2750.3(b)-(d) for specific professions exempt from the provisions of AB 5.

Note that, while AB 5 excludes contracts for "professional services," it also adds restrictions to this exemption. Professional services include services provided in the following areas:

  • marketing
  • human resources administrator
  • travel agent
  • graphic designer
  • grant writer
  • fine artist
  • enrolled agent
  • still photographer or photojournalist
  • freelance writer, editor, or newspaper cartoonist (as long as they do not provide content submissions to the same media/news provider more than 35 times per year)
  • licensed esthetician
  • licensed electrologist
  • licensed manicurist
  • licensed barber
  • licensed cosmetologist

See Cal Lab Code § 2750.3(c) for details. Significantly, the contractor must maintain their own business location; however, this may include a home office. The contractor must have a business license in addition to any professional licenses or permits. Finally, the contractor must hold themselves out to other potential customers and provide services through a sole proprietorship or other business entity.

d. What if my Independent Contractors run their own businesses?

There is a "bona fide business-to-business" exception in AB 5. See Cal Lab Code § 2750.3(e) for a list of specific requirements to meet this exemption.

While even a sole proprietorship can qualify as a business-to-business contractor under AB 5, there are plenty of hurdles to overcome. For instance, any business-to-business contractor must provide "services directly to the contracting business rather than to customers of the contracting business." This appears to prohibit the principal from engaging a contractor to work on a client matter. Additionally, consider the requirement that the contractor "actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity."

e. Are there any exceptions for the use of Independent Contractors in the construction industry within AB 5?

AB 5 does exclude relationships "between a contractor and an individual performing work pursuant to a subcontract in the construction industry." See Cal Lab Code § 2750.3(f) for details, or contact one of our attorneys to discuss your specific business model.

f. Are there any exceptions for the use of Independent Contractors in the referral agency industry within AB 5?

AB 5 grants an exception for relationships between a "referral agency and a service provider." See Cal Lab Code § 2750.3(g) for details. However, "referral agencies" are restricted to the businesses that connect clients with "service providers that 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."

As in the business-to-business exception, the referral agency exception requires the service provider to deliver services under its own name, as opposed to the referral agency's name; and it requires the service provider to actually maintain a separate clientele. This completely prohibits the service provider from providing services to a sole principal, which may prove problematic.

Contact one of our attorneys today to discuss your options.

g. Can courts override AB 5's ABC Test?

AB 5 does contain a provision whereby, if a court of law or rules that the ABC Test "cannot be applied to a particular context ... then the determination of ... status ... shall be governed by" Borello. Cal Lab Code § 2750.3(a)(3).

Hopefully, this will be used by competent courts which determine that this overly complicated statute cannot be applied in a particular situation, and thus revert back to the Borello standard. However, AB 5 specifies that it is only a "court of law" that can make such a ruling. Most actions under AB 5, as was the case with Borello, are heard and determined in administrative proceedings and not courts of law.

In addition, there is currently litigation seeking a decision on whether federal regulations in the trucking industry preempt application of Prong B of the ABC Test. If it is determined that federal regulation does preempt Prong B, assumedly it is Section 2750.3(a)(3) will be used to exempt trucking companies from AB 5.

h. How can I seek an exemption from AB 5?

Prior to its passage, our office was instrumental in engaging a registered lobbying firm located in Sacramento and successfully attaining an exception in AB 5 for one of our clients. We are currently forming a lobbying coalition through that same lobbying firm for a group of clients in a specific industry. I am convinced that at least the next legislative session will include a race for exceptions to AB 5. At some point, it is likely that the California legislature will shut the door on exceptions. Convinced that AB 5 will do significant damage to bona fide independent contractor relationships, we will do everything we can to seek such reasonable exceptions for our clients.

Contact our office today to discuss your worker classification issues and whether AB 5 will have an impact on your business.

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