Governor Newsom has signed into law Assembly Bill 5 (“AB 5”), a landmark bill that will give millions of California workers job benefits and protections by limiting the circumstances under which employers can classify them as independent contractors. Unlike contractors, employees receive broad protections and benefits under California law—including Labor Code protections (minimum wage, overtime, meal and rest breaks, sick pay), unemployment and disability insurance, workers’ compensation, anti-discrimination law protections, and leave law rights.

1.       What does AB 5 do?

AB 5, authored by Assemblywoman Lorena Gonzalez (D-San Diego), codifies and expands the California Supreme Court’s decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903 (“Dynamex”). In Dynamex, the Supreme Court reaffirmed that all California workers performing services for hire are presumptively employees, and held that the proper test in determining whether a worker should be classified as an independent contractor for purposes of California wage orders is the “ABC” test. Under this test, an employer seeking to classify a worker as an independent contractor bears the burden of establishing:

(A) that the worker 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) that the worker performs work that is outside the usual course of the hiring entity’s business, and (C) that the worker is customarily engaged in an independently established trade, occupation, or business . . . .

(Id. at 955-56.)

AB 5 extends the ABC test to apply to all claims brought under the Labor Code (not just to claims related to wage orders) and to claims for unemployment insurance. The bill has a number of carve-outs, discussed below. It also allows the Attorney General and certain city attorneys or city prosecutors to seek injunctive relief to prevent the continued misclassification of employees as independent contractors.

The California Legislature explained the importance and impact of AB 5 in the bill’s findings and declarations section:

In its [Dynamex] decision, the [California Supreme] Court cited 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.
. . .
The misclassification of workers as independent contractors has been a significant factor in the erosion of the middle class and the rise in income inequality.
. . .
It is . . . the intent of the Legislature in enacting this act 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. By codifying the California Supreme Court’s landmark, unanimous Dynamex decision, this act restores these important protections to potentially several million workers who have been denied these basic workplace rights that all employees are entitled to under the law.
. . .
Nothing in this act is intended to diminish the flexibility of employees to work part-time or intermittent schedules or to work for multiple employers.

AB5 will have sweeping implications for millions of workers, especially those in the “gig economy.” Currently, about one in ten workers is classified as an independent contractor by their employer. Employers frequently misclassify employees as contractors because it is cheaper and easier for them to do so, which passes costs directly onto the workers and taxpayers. AB 5 will ensure that most of these “contractors” working in California will receive employee rights and protections. Employers will be required to make the appropriate payroll tax contributions and deductions for these workers, carry workers’ compensation insurance, pay minimum wage, provide overtime and meal and rest breaks for non-exempt workers, respect anti-discrimination laws, and provide mandated job-protected leave.

2.       What are AB 5’s exemptions?

Given its potential impact, it comes as no surprise that many industries lobbied for an exemption from Dynamex’s application (as laid out in newly added Labor Code section 2750.3). Some succeeded, others did not.

Uber, Lyft, and other tech companies fought hard for an exemption, but their efforts failed. Now, Uber, Lyft, and DoorDash have pledged $90 million to fund a ballot measure that would shield them from AB 5.

Employees in a number of occupations are explicitly excluded from Dynamex’s application as laid out in newly created Labor Code § 2750.3, including the following:

1. Persons and organizations licensed by the Department of Insurance.
2. Physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians licensed by the state (except where currently or potentially governed by collective bargaining agreements).
3. Persons licensed by the state practicing as lawyers, architects, engineers, private investigators, or accountants.
4. Securities broker-dealers, investment advisers, and their agents and representatives registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the state.
5. Direct salespeople (per Section 650 of the Unemployment Insurance Code).
6. Commercial fishermen working on American vessels (until December 31, 2022).
7. Real estate licensees.
8. Licensed repossession agencies.

There is also a carve-out for contracts for “professional services.” A hiring entity must demonstrate all of the following with respect to the individual providing the services (working through a sole proprietorship or other business entity):

(A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity. Nothing in this subdivision prohibits an individual from choosing to perform services at the location of the hiring entity.
(B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession.
(C) The individual has the ability to set or negotiate their own rates for the services performed.
(D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours.
(E) The individual 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) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.

“Professional services” are defined to encompass:

1. Marketing (with restrictions).
2. Administration of human resources (with restrictions).
3. Travel agent services (with restrictions).
4. Graphic designs.
5. Grant writers.
6. Fine artists.
7. Enrolled agents licensed by the U.S. Department of the Treasury.
8. Payment processing agents.
9. Photographers or photojournalists (with restrictions, and provided they do not license content submissions to the employer more than 35 times per year).
10. Freelance writers, editors, or newspaper cartoonists (provided they do not provide content submissions to the employer more than 35 times per year).
11. Licensed estheticians, electrologists, manicurists, barbers, or cosmetologists (provided these individuals set their own rates, process their own payments, and are paid directly by clients; set their own hours and have sole discretion to decide the number of their clients; have their own book of business and schedule their own appointments; maintain their own business licenses for the services offered to clients; and issue 1099 forms to the salon or business owners from which they rent their business space). (The exemption for licensed manicurists will expire December 31, 2021.)

AB 5 also exempts from Dynamex’s coverage:

• Bona fide business-to-business contracting relationships, when certain conditions are met.
• Certain construction contractors using subcontractors, when certain conditions are met.
• Relations between referral agencies and service providers when certain conditions are met.
• Relations between motor clubs and individuals providing services to third parties pursuant to their contract with the motor clubs.

Note, too, that AB 170 adds an additional exemption, through January 1, 2020, to certain newspaper distributors and newspaper carriers.

3.       How is employee or contractor status determined for those exempted from Dynamex’s application?

In those situations where Dynamex does not apply, the determination of whether a worker is an employee or independent contractor is governed by the test adopted in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (“Borello”). Under Borello, the “principal test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.” Borello also identified secondary factors that may be considered (as laid out by the DIR):

1. Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
2. Whether or not the work is a part of the regular business of the principal or alleged employer;
3. Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
4. The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
5. Whether the service rendered requires a special skill;
6. The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
7. The alleged employee’s opportunity for profit or loss depending on his or her managerial skill;
8. The length of time for which the services are to be performed;
9. The degree of permanence of the working relationship;
10. The method of payment, whether by time or by the job; and
11. Whether or not the parties believe they are creating an employer-employee relationship may have some bearing on the question, but is not determinative since this is a question of law based on objective tests.

4.       Does AB 5 apply retroactively?

AB 5 explicitly provides that it is declaratory of existing law with respect to claims related to wage orders and violations of the Labor Code related to wage orders. It therefore applies retroactively as to those claims. It will apply prospectively to work performed on or after January 1, 2020, with respect to Labor Code claims not based on a wage order. It will also apply prospectively with respect to claims for unemployment insurance.

In addition, to the extent that AB 5’s carve-outs serve to relieve an employer from liability, they apply retroactively to existing claims.

Note that AB 5 prohibits an employer from reclassifying individuals who were employees on January 1, 2019 to independent contractor status because of the bill’s passage.

Conclusion

Once again, California has shown itself to be a leader in protecting workers. AB 5 will change the landscape for the millions of contract workers throughout the State. We expect that once it goes into effect and its impact is better understood, the California legislature will put forth further legislation to create additional exemptions and to address any unanticipated consequences from the law. Given that tech companies have much at stake, they will continue to fight AB 5’s implementation and application to their industries. Hopefully, other states will follow suit to similarly protect their workers.

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Written by Ramit Mizrahi, Esq. and John L. Schwab, Esq.

Update 1/10/20: A federal district court issued a temporary restraining order with respect to the application of AB 5 as it applies to motor carrier operators; the hearing on the requested preliminary injunction is set for January 13, 2020.