On September 18, 2019, California Governor Gavin Newsom signed into law A.B. 5, codifying a tighter standard of rules for classifying a worker as an independent contractor. The new standard, known as the Dynamex standard, codifies and expands the earlier California Supreme Court decision, Dynamex Operations West, Inc. v. Superior Court of Los Angeles. It replaces the former Borello test, and puts in place a more simple three-pronged ABC test. The significant effect is that many workers in California will now be classified as employees instead of independent contractors (also informally known as “1099” workers). This change is one of the most significant disruptions to California employment law in decades. The law will take effect on January 1, 2020.
The new law is convoluted, and has numerous exceptions for various professions, as discussed in further detail below. To further complicate matters, the law codifies Dynamex for purposes of claims made under the California Labor Code, Unemployment Insurance Code, and wage orders, but curiously does not mention the California Government Code, under which workers may seek redress for harassment and discrimination, among other things.
In addition, the newly created exemptions to the ABC test will apply “retroactively to existing claims and actions to the maximum extent permitted by law.”
In order to ensure that your company’s workers are properly classified (in order to avoid substantial fines and expensive misclassification lawsuits), contact a qualified employment law attorney as soon as possible to ensure you are complying with the law and following the new rules.
What Is the Potential Impact of This Change?
According to the LA Times, “State Capitol Democrats and organized labor say their new ‘gig’ law will correct the misclassification of 1 million California workers who are falsely deemed independent contractors.”
Others disagree: according to labor lawyer Brad Shafer, “A problem with AB 5 is some people got exemptions because they had political juice and other people didn’t. This is a legal standard that forces people who want to be independent contractors to be classified as employees. Take any performer who comes on stage at Staples Center. That entertainer would arguably be an employee of Staples Center. The performer is providing entertainment, and that is the business of Staples Center.”
These changes can continue to impact the Golden State’s desirability as a place to do business for many employers. For example, according to Richard Burgess, who heads the American Association of Independent Music, says, “this could have a big impact on the California recording industry. Already, we’re hearing labels say, ‘Oh, well, we’re not going to do anything in California anymore.’ They don’t want to be working where costs go through the roof.” For some employers of gig workers, this may wipe out their business model as they add additional costs and compliance measures.
Gig companies such as Uber and Lyft vow to continue to fight, even by attempting to get a ballot measure before the California electorate. Uber, Lyft and DoorDash have contributed $30 million apiece to a fund to work toward placing a measure on the November 2020 ballot. While the text won’t be written until next month, it’s likely to seek to create a network driver category of independent contractors with a wage floor and some benefits. They are pledging to fight this law tooth-and-nail because if Uber and Lyft must now treat their California drivers as employees, it could cost Uber $500 million a year, and Lyft $290 million a year, according to a Barclays analysis.
For the average employer, adding benefits such as minimum wage, workers’ compensation, unemployment insurance, expense reimbursement, paid sick leave and paid family leave, and half of employees’ Social Security tax could add 30% to labor costs.
The New Labor Code
The revised California Labor Code Section 2750.3 codifies the California Supreme Court’s 2018 decision in Dynamex Operations West Inc. v. The Superior Court of Los Angeles County, which established a streamlined test (known as the “ABC test“) for determining whether a worker is an employee or independent contractor. Under the “ABC test,” the vast majority of workers will be deemed employees for wage order purposes (with the exceptions listed below). This change is projected to cost companies billions of dollars as they now have to provide worker’s compensation insurance, overtime, paid sick leave, and other benefits to their newly-classified employees. They will also have to prepare and maintain significant paperwork to evidence compliance with California employment law.
While Dynamex has been the law in California for more than a year, many companies were waiting for more assurance that they would need to make the change before making the investment in doing so, but now is the time to act.
All three elements must be met to allow an employer to classify their worker as an independent contractor:
- The business is not able to control or direct what the worker does, either by contract or in actual practice;
- The worker performs tasks outside of the entity’s usual business; and
- The worker is engaged in an independently-established trade, occupation, or business.
The Previous Standard: Borello
The Borello test was the standard until the California Supreme Court over-ruled it in April 2018. The principal factor of the Borello test is whether the “person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.” There were nine additional guiding factors that helped the courts determine the status of the worker, but none as definite or binding as the new Dynamex standard. However, if the profession is included in one of the professional carve-outs listed below, it would not be evaluated under the Dynamex analysis, but rather, it invokes the more involved Borello analysis, under which the following multiple criteria are evaluated:
- Right to discharge at will, without cause;
- Whether the one performing the services is engaged in a distinct occupation or business;
- 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;
- The skill required in the particular occupation;
- Whether the principal or the worker supplies the instrumentalities, tools and the place of work for the person doing the work;
- The length of time for which the services are to be performed;
- The method of payment, whether by the time or by the job;
- Whether or not the work is part of the regular business of the principal; and
- Whether or not the parties believe they are creating a relationship of employer-employee.
Arguments Against Workers Becoming Employees
Uber has already positioned itself as exempt from the law, claiming that it is a technology, not a transportation, company. However, that argument was rejected by the U.S. District Court for the Central District of California in 2015 in O’Connor v. Uber Technologies Inc., 82 F.Supp. 3d 1133 (2015).
Uber’s self-definition as a mere “technology company” focuses exclusively on the mechanics of its platform (i.e., the use of internet-enabled smartphones and software applications), rather than on the substance of what Uber actually does, which is to enable customers to book and receive rides). In fact, Uber does not simply sell software; it sells rides.
According to the O’Connor Court, “Uber is no more a ‘technology company’ than Yellow Cab is a ‘technology company’ because it uses CB radios to dispatch taxi cabs, John Deere is a ‘technology company’ because it uses computers and robots to manufacture lawn mowers, or Domino Sugar is a ‘technology company’ because it uses modern irrigation techniques to grow its sugar cane. …[It] is clear that Uber is most certainly a transportation company, albeit a technologically sophisticated one…. Even more fundamentally, it is obvious drivers perform a service for Uber because Uber simply would not be a viable business entity without its drivers.”
Uber has stated in its initial S-1 form for an initial public offering that it “believe[s] that drivers are independent contractors because, among other things, they can choose whether, when, and where to provide services on [its] platform, are free to provide services on [its] competitors’ platforms, and provide[s] a vehicle to perform services on [its] platform.”
Exceptions to the New Standard for Certain Licensed or Registered Professionals Occupations and Professions, Including Certain Licensed or Registered Professionals
The Borello standard will still apply to the numerous and various carve-outs to the Dynamex standard, as outlined in A.B. 5, meaning that they can still be classified as independent contractors. These include, among others,
- Licensed insurance agents,
- Certain licensed health care professionals,
- Registered securities broker-dealers or investment advisers,
- Direct sales salespersons,
- Real estate licensees,
- Commercial fishermen,
- Workers providing licensed barber or cosmetology services, and
- Others performing work under a contract for professional services, with another business entity, or pursuant to a subcontract in the construction industry.
Other exemptions include licensed practicing lawyers, architects, engineers, private investigators and accountants.
Exceptions for Professional Services in Marketing, HR Administration, Graphic Design, Fine Art, Photography, Photojournalism, Freelance Writing, Grant Writing and Editing
For those working under a contract for professional services in marketing, HR administration, graphic design, fine art, photography, photojournalism, freelance writing, grant writing and editing, among others, six factors have been added:
1. The individual must maintain a business location (which may include a personal residence) that is separate from the hiring entity;
2. If the work is performed for more than six months after the law goes into effect, the individual must have a business license;
3. The individual must be able to set or negotiate his or her own rates;
4. The individual must be able to set his or her own hours;
5. The individual must be customarily engaged in the same type of worked performed under contract with another hiring entity or hold him or herself out to potential customers for such work; and
6. The individual must customarily and regularly exercise discretion and judgment.
Other factors have been added for services provided by licensed estheticians, electrologists, manicurists, barbers and cosmetologists, including requirements that they have their own book of business and schedule their own appointments.
- Graphic design,
- event planning,
- minor home repair,
- home cleaning,
- furniture assembly,
- animal services,
- dog walking,
- dog grooming,
- web design,
- picture hanging,
- pool cleaning, or
- yard cleanup, as well as
- car repair services provided through a motor club by a third party not employed by the motor club.
What is the Impact of This New Rule?
- If it is determined that an employer intentionally violated the law, it could be required to pay civil penalties of $10,000 to $25,000 per misclassified worker under Labor Code Section 226.8, along with back wages, meal and rest break penalties, and a whole host of other statutory and civil penalties. By “expanding the definition of an employee … the bill would expand the definition of a crime…” while authorizing the attorney general or city attorney to seek injunctive relief to prevent the continued misclassification of workers.
- Retroactive civil fines: Since the law is codifying the 2018 court case, companies that intentionally violated it could be subject to extensive civil penalties per misclassified employee.
- Continued litigation: Several companies, including Uber, have pledged to spend tens of millions of dollars fighting this bill. The next step of attack is to attempt to put it forward for state-wide referendum in 2020.
- Increasing lawsuits: The Attorney General of San Diego has already filed a suit against Instacart for the misclassification of their workers.
- Expansion to other states: Many other states are looking at California’s law as a model and we could see expansion of these laws over the coming months.
How Will AB-5 Be Enforced?
Various California government agencies, including the Labor Commissioner’s Office, the Employment Development Department (EDD) and the Franchise Tax Board (FTB), have authority over worker misclassification, but their efforts mainly stem to individual cases.
Expect to see a rash of lawsuits, both from private and public attorneys. AB5 empowers the attorney general, city attorneys in large cities, and local prosecutors to sue companies over violations. For example, the city attorneys of San Francisco and Los Angeles both appear ready to enforce the new rules. In Los Angeles, City Attorney Mike Feuer said through a spokesman that he “would welcome the additional authority and would carefully review and analyze any potential case for possible litigation.”
However, it would take a judge’s order to force Uber and Lyft to reclassify their workers, which they have indicated they would be poised to fight such a legal battle for years.
Unfortunately for California employers, this new law is far from clear and is likely to result in increased litigation, with potentially devastating consequences for businesses that have or continue to misclassify their workers. Of note, the law allows more individuals to be classified as independent contractors than was the case before its passage. Under Dynamex, there were no exceptions to ABC for wage order purposes. Now, if a worker falls under one of the enumerated categories listed above, he or she might only have to meet the Borello test, plus any additional applicable factors in order to show that he or she is an independent contractor.
Ultimately, it will be up to the company’s risk tolerance to decide whether their proposed exceptions to the rule would pass muster in a lawsuit, versus making everyone an employee and saving themselves the costs and headaches of defending potential litigation.
In addition, companies with a multi-state workforce will need to weigh the costs of maintaining a two-class system that may include independent contractors in some states, and employees in California. If the employers have employees classified differently by state, there may be backlash or lawsuits brought by the workers deprived of employment benefits that their co-workers receive in other states. Otherwise, a safer bet (and more costly to the states that don’t have the same obligations) is to change all of its workers to “employee” status. In the future, as is common in many areas of the law, if other states follow California’s lead, this last approach could save companies considerable pain in the long run because they will be poised to be compliant with classification rules in their states.
To be safe during this time of flux and ongoing court battles, smaller companies that lack the big budgets for extended court battles may decide to reclassify their workers as employees preemptively. While it may cost more in the short-term, it could save substantial time and money by preventing a future claim for misclassification.
The Grady Firm, P.C. attorneys specialize in helping businesses grow and succeed through employment, business, and immigration law advising for clients. The Grady Firm attorneys provide the following employment law services:
- Employee v. independent contractor classification analysis;
- Assistance with converting independent contractors to employees;
- On-site, classroom-style Sexual Harassment training for employees and supervisors;
- “Experiential” supervisor training in which managerial employees practice processing a harassment complaint and commencing an investigation in pairs with other trainees. Draft and review Employee Handbooks, arbitration agreements, and Anti-Harassment policies;
- Employee personnel file audits;
- E-Verify account creation and monitoring;
- Assistance with the employee on-boarding, discipline, and termination process;
- Medical leave policies and implementation advising; and
- Litigation defense.
To learn more about ensuring your business is compliant with state and local laws, schedule a complimentary 15-minute consultation with The Grady Firm’s attorneys; call +1 (323) 450-9010; or fill out a Contact Request Form. The Grady Firm has offices in Beverly Hills, Irvine, and San Diego, California.
*Jennifer A. Grady, Esq. is licensed to practice employment law in California.
This article is for informational purposes only, and does not constitute legal advice or create an attorney-client relationship. This article does not make any guarantees as to the outcome of a particular matter, as each matter has its own set of circumstances and must be evaluated individually by a licensed attorney.