On September 19, 2019, California Governor Gavin Newsom signed into law Assembly Bill (AB) 5, thereby making it significantly more difficult for businesses in California to classify workers as independent contractors rather than employees. AB 5 essentially codifies the California Supreme Court’s landmark decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903 (Dynamex), adopting the “ABC test” for determining independent contractor classification with respect to the Industrial Welfare Commission (IWC) Wage Orders, and expands its reach to non-wage order claims. Effective January 1, 2020, the ABC test will also be used to determine independent contractor status under the California Labor Code and the Unemployment Insurance Code (though, as explained below, certain provisions of the law apply retroactively).

Presumption of employee status: Under AB 5, a person providing labor or services for remuneration will presumptively be considered an employee rather than an independent contractor unless the hiring entity demonstrates that:

  1. The worker is free from the hiring entity’s control and direction with respect to the performance of the work, “both under the contract for the performance of the work and in fact”;
  2. The worker performs work that is “outside the usual course” of the hiring entity’s business; and
  3. The worker is “customarily engaged in an independently established trade, occupation, or business” of the same nature as that involved in the work performed for the hiring entity.

Exemptions: AB 5 exempts workers in certain occupations, industries and business relationships from the ABC test including, inter alia, licensed insurance agents, certain licensed health care professionals (physicians, surgeons, dentists, podiatrists, psychologists and veterinarians); licensed lawyers, architects, engineers, private investigators and accountants; registered securities broker-dealers or investment advisers; direct sales salespersons; real estate licensees; commercial fishermen; and workers providing licensed barber or cosmetology services.

Individuals who perform work under a “contract for ‘professional services’” are also exempt as long as the hiring entity demonstrates that the individual:

  1. maintains a separate business location;
  2. is able to set or negotiate his or her own rates for the services performed and to set his or her own schedule (aside from the project completion date and the requirement to be available during reasonable business hours);
  3. is customarily engaged in the same type of work as the work performed under the contract with another hiring entity or holds himself or herself out to other potential customers as available to perform the same type of work; and
  4. regularly exercises discretion and independent judgment in the performance of the services.

“Professional services” are specifically defined in the statute and include the following services: marketing, administration of human resources, travel agent services, graphic design, and services provided by photographers, photojournalists, freelance writers, editors or newspaper cartoonists under certain conditions.

AB 5 also includes a “business-to-business” exemption that covers “bona fide” business-to-business contracting relationships if they satisfy twelve specific criteria.  The criteria include that (a) the contract between the entities is in writing; (b) the service provider is free from the contracting entity’s control and direction in connection with the performance of the work, both contractually and in fact; (c) the service provider provides the services directly to the contracting business, not to the contracting entity’s customers; (d) the service provider provides similar services directly to other businesses—not just to the contracting entity—and advertises and holds itself out to the public as available to provide the same or similar services; (d) the service provider has any required business licenses or business tax requisition; (e) the service provider maintains a business location that is separate from the contracting business and provides its own tools, vehicles and equipment to perform the services; and (f) the service provider can negotiate its own rates and set its own hours and location of work.

Under AB 5, the determination of employee or independent contractor status for individuals who work in these exempt occupations and industries is governed by the multi-factor test articulated by the California Supreme Court in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (Borello) rather than the ABC test. Under Borello, the hiring entity’s “right to control” the means and manner in which work is performed is the most important of various factors to be considered when evaluating a worker’s classification. 

While the provisions of AB 5 apply to work performed on or after January 1, 2020, AB 5 provides that the exemption from the ABC test and the Dynamex holding apply retroactively to existing claims and actions “to the maximum extent permitted by law” if the exemption “would relieve an employer from liability.” Notably, despite the specified exemptions in the statute, AB 5 expressly provides that an employer cannot reclassify an individual who was classified as an employee on January 1, 2019, as an independent contractor due to the bill’s enactment.

In addition, in the event that a court determines that the ABC test cannot be applied to a particular context (for reasons other than an express statutory exemption), AB 5 instructs that the court apply the Borello test to determine employee versus independent contractor status.

Impact: AB 5 significantly expands the definition of “employee” under both the California Labor Code and the Unemployment Insurance Code. As a result, the number of workers eligible to receive minimum wage, overtime, meal and rest periods, workers’ compensation benefits, and unemployment and disability benefits in California will increase, as will the potential financial exposure associated with misclassification claims. In addition to expanding the applicability of the ABC test, AB 5 empowers the California Attorney General and specified local prosecuting agencies to bring claims for injunctive relief against businesses suspected of misclassifying independent contractors. Businesses utilizing workers should assess whether their contractors are exempt from the ABC test under AB 5. If not, these businesses should evaluate whether their contractors are properly classified under the ABC test.