March 31, 2020 5:58 pm
The Assembly Bill 5 (AB5) is a new, 2019 law in California and has the ability to radically alter “business as usual” among companies and businesses of all sizes and within all industries. As a controversial law, the state statute seeks to solve the issue of false self-employment and job misclassification associated with the question of who is an employee, and who is an independent contractor. The law, which was signed in September 2019, has a profound impact on how workers are classified within businesses all over California and has the largest effect on the gig economy of California, namely with Gig workers. Gig workers, as noted by Wikipedia, are independent contractors, freelancers, and independent consultants who work via online platforms or via contracts with a variety of firms. Gig workers also include on-call workers and temporary workers. Such workers enter into formal agreements with on-demand companies to provide services to the company’s clients.
That said, the AB5 labor law dictates changes on who can be considered an independent contractor, with the default status for workers associated with a company being an “employee.” Businesses must prove that their worker is an independent contractor, in order for the company to be free of certain insurance, workers’ compensation, HR, tax, and other regulations and processes that businesses must carry out for their employees as dictated by the State of California. This new law, as an extension of the ABC test, is meant to prove that a worker associated with a company is, in fact, an independent contractor, while thus changing how businesses classify those who work for them, and how they legally follow regulations associated with employee benefits.
While the law affects some industries differently, such as the trucking industry versus janitorial workers, most gig working companies are affected by having to provide state regulatory protections for “employees”. This is a financial and administrative blow for companies like Lyft and Uber. Freelancers may gain extra protections and tax advantages, or they may lose out because many freelance jobs are now considered fully-employed work, which limits the types of freelance workers that can exist in California.
While the new law does not eliminate the existence of contract work – whether it be subcontract work or independent (self-employed) contract work – it does ensure that companies do not mislabel their workers in order to cut corners on minimum wage, workers’ compensation, overtime pay, etc. It is now more difficult in California for companies to lay claim to their workforce being independent contractors, while contract workers like janitors, hotel workers, truck drivers, maids, landscape workers, etc. – who have typically not been under worker employee protections and have worked with low wages under the current independent contractor employment model – may gain better workplace benefits and protections.
The Assembly Bill 5, as a labor bill, was signed into law on September 18, 2019, by California governor Gavin Newsom. As of January 1, 2020, it extends the historical ABC Test that determines who is and isn’t, an independent contractor or employee. As an evolution of the ABC test – which was first established by the Commonwealth of Massachusetts Legislature on July 19, 2004 – it gives most contractors more labor protections by re-labeling them as employees. The law helps to give contractors more freedoms and protections as “employees,” while making it more difficult for businesses to call their workers contractors, who do not benefit from certain worker and/or tax benefits.
Because the law mainly affects “gig workers,” who are self-employed contractors or freelancers working “gigs” for companies, the law is known as the “gig worker” bill. Since businesses that hire independent contractors must reclassify them as employees – with some exceptions – the extra costs and administrative processes required to follow this regulation has shaken up businesses of all sizes in the Golden State. While the focus of the law may seemingly be for the many app-based “gig” companies, such as Uber and Lyft, whose workforce of “contractors” are now “employees,” the law affects all low-wage (or higher wage) contractors in the State and all companies who use their skills to provide services to their clients. For many businesses, this means a complete restructuring of their HR and administrative (and even financial) departments to comply with the bill and add a myriad of different employees to their business roster – or risk costly fines from the State/Attorney General. For workers, this law means changes in social security benefits, workers’ compensation benefits, minimum wage benefits, and more.
In order to understand the scope of this law on Gig workers in California and the gig economy within the U.S. (since California adopting the AB5 bill means the rest of the U.S. may as well), one must consider the statistics, as noted by iOffice Corp:
“36 percent of U.S. workers participate in the gig economy through either their primary or secondary jobs.”
“29 percent of all workers in the United States have an alternative work arrangement as their primary job.”
“63 percent of full-time executives would become an independent contractor, given the opportunity.”
“Nearly 40 percent of the American workforce now makes at least 40 percent of their income via gig work.”
“Over 75 percent of gig workers say they would not leave freelance work behind for a full-time job.”
“55 percent of contingent workers also have a regular or full-time job.”
“37 percent of full-time freelancers, independent contractors and consultants are ages 21-38.”
“Over the next five years, 52 percent of the U.S. adult workforce will either be working or will have worked as an independent contributor.”
“At least 90 percent of Americans are open to the idea of freelancing, consulting or independent contracting work.”
“The two most common reasons traditional workers gave for choosing freelance work were “to earn extra money” and to “have flexibility in their schedule.”
This forced reclassification of contractors and freelancers as employees has the ability to have profound rippling effects across the entire gig economy of California, and perhaps the U.S.
The AB5 law has evolved over several years with regard to several key rulings, events, processes, and legislation that have taken place in California. As an evolved form of the largely adopted ABC Test – which is related to the Borello test – the precursor to the AB5 law was adopted via a ruling by the California Supreme Court that determined who was an independent contractor and who was an employee. The ruling – which was called the Dynamex Operations West Inc. vs Superior Court of Los Angeles – was related to several prior rulings regarding Dynamex. As noted by the Sheppard Mullin Labor & Employment Law Blog, “Dynamex is a nationwide same-day courier and delivery service that offers on-demand, same-day pickup and delivery services to businesses and the public. Prior to 2004, Dynamex classified its California drivers as employees. Starting in 2004, however, Dynamex converted all of its drivers to independent contractors as a cost-savings measure.” In doing so, they required their drivers to pay for all of the expenses needed to do their job – as noted by Forbes, “all drivers were required to provide their own vehicles and pay for all of their transportation expenses, including fuel, tolls, vehicle maintenance, and vehicle liability insurance, as well as all taxes and workers’ compensation insurance.”
The critical court case came in January 2005 when a delivery driver (Charles Lee), working as an independent contractor under written agreement, filed a lawsuit against Dynamex claiming that the business had misclassified its drivers, “alleging that Dynamex’s alleged misclassification of its drivers as independent contractors led to Dynamex’s violation of the provisions of IWC wage order No. 9, the applicable state wage order governing the transportation industry, as well as various sections of the Labor Code, and, as a result, that Dynamex had engaged in unfair and unlawful business practices under Business and Professions Code section 17200.”
In order to make their determination, the courts used prior cases, such as the Supreme Court’s decision in Martinez v. Combs, 49 Cal.4th 35, 64 (2010) (“Martinez”) and with G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989)(“Borello”) to define employment and to determine who was an independent contractor.
“In Martinez, the Court held that to “employ” has three alternative definitions: (1) to exercise control over the hours, wages, or workings conditions, (2) to suffer or permit to work, or (3) to engage, thereby creating a common law employment relationship.”
In response, Dynamex pointed to the multi-factor test associated with S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989)(“Borello”), which was used to determine whether a worker was an employee or independent contractor. “In Borello, the Supreme Court held that the “right to control” the means and manner in which work is performed by a worker is the most important of several factors to be considered when evaluating a classification analysis, including secondary factors such as ownership of equipment, opportunity for profit and loss, and the belief of the parties. This test is more flexible because it balances the different factors to arrive at a classification based on the individual circumstances of each case. Prior to Dynamex, many cases (including the Court’s own recent decisions) referred to the multi-factor Borello test as the traditional “common law” classification analysis.”
Ultimately, the Court of Appeal rejected Dynamex’s argument and determined that the misclassification of independent contractors was “harmful and unfair to workers.” Thus, the court adopted the ABC test and rejected the Borello test. Since then, the ABC test became part of the labor code in the form of the signed bill and new law, the AB5, which as of January 1, 2020, becomes the standard independent contractor model within California.
While the Dynamex ruling was related to protecting workers’ wages, hour controls and the conditions set for workers – while being critical for businesses who hire large numbers of gig workers to perform services for their clients – the overall result has affected much more than that within the realm of the AB5 law.
The AB5 law determines who is an employee and who is an independent contractor by codifying and implementing the ABC Test as the default system for determinations. The classification of who is an employee versus who is an independent contractor is thus based on the three-factor ABC system test. The test greatly limits who can be classified as an independent contractor and thus the type of work that qualifies as independent contract work, while determining that most workers in companies are employees. The law applies to all workers in all businesses in California, while a few exceptions still allow some workers to work as independent contractors.
It is important to note that the test is excluded in certain specified cases, where the Borello standard will continue to apply. As noted by Wikipedia, “this is declared without qualification for a specified list of occupations.. and for other stated professional, B2B and construction services, respectively, [a] separate lists of conditions must also be fully applicable in order to establish that a worker is an independent contractor.”
The three-pronged, comprehensive ABC assessment and process is one that businesses are meant to use to prove that their worker is indeed an independent contractor since by default, workers are classified as employees and the burden of proof lies on the hiring entity to prove that their worker is an independent contractor.
The law provides the ability for workers, cities, the Attorney General, and local prosecutors to sue companies for violating the law, the punishment of which can be heavy fines levied against the business.
The three factors of the ABC test include:
“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.”
“The worker performs work that is outside the usual course of the hiring entity’s business.”
“The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.”
The California AB5 law determines that a worker is an independent contractor only if each of the aforementioned conditions are met.
While there are a few professions that are exempt from the AB5 law, and thus can be classified readily as independent contractors, there are several industry types and jobs that are not exempt. Though workers are, by default, regarded as employees, it is legal for companies to apply for an exemption. Most ride-sharing services (i.e. Uber, Lyft) are not exempt. Uber and Lyft – both gig companies who primarily use “contractors” as their labor force, attempted to be exempted from the new law in order to not have to classify their respective drivers as employees, but both were denied. Any company that primarily utilizes freelancers, gig workers, independent consultants, and independent contractors, etc. is not exempt except in certain industries and in specific circumstances.
While a few professions are exempt from the strict new ABC test, most of such workers must pass the 11-point (former) Borello test in order to be classified as an independent contractor, per the Borello test points below:
“Whether the worker is engaged in an occupation or business that is distinct from that of the hiring firm.”
“Whether the work is part of the hiring firm’s regular business.”
“Whether the hiring firm or the worker supplies the equipment, tools, and the place for the person doing the work.”
“The worker’s financial investment in the equipment or materials required to perform the work.”
“The skill required in the particular occupation.”
“The kind of occupation—whether, in the locality, the work is usually done under the hiring firm’s direction or by a specialist without supervision.”
“The worker’s opportunity for profit or loss depending on his or her own managerial skill.”
“How long the services are to be performed.”
“The degree of permanence of the working relationship.”
“The payment method, whether by time or by the job.”
“Whether the parties believe they are creating an employer/employee relationship.”
The primary and most important factor is whether the hiring firm has control or the right to control the worker both as to the work done and the manner and means in which it is performed. Additionally, real estate sale-people and repossessors need not pass the Borello test.
That said, as noted by Nolo.com, the professions that do not need to pass the ABC test (but must pass the Borello test) are:
“Physicians, surgeons, dentists, podiatrists, psychologists, veterinarians”
“Architects and engineers”
“Registered securities broker-dealers and investment advisers”
“Direct sales salespeople who sell goods”
In line with the above, as noted by Nolo.com, certain professionals who provide certain services can be classified as independent contractors if they meet additional criteria and satisfy the Borello test. The types of professionals include:
“Marketing professionals (provided that the contracted work is original and creative)”
“Human resources administrators (provided that the contracted work is predominantly intellectual and varied in character)”
“Payment processing agents through independent sales organizations”
“Photographers or photojournalists who license content submissions to a hiring firm no more than 35 times per year (exception not applicable to individuals who work on motion pictures)”
“Freelance writers, editors, or newspaper cartoonists who provide content submissions to hiring firms no more than 35 times per year.”
However, the aforementioned group must also satisfy the below criteria. They must:
Maintain a business location separate from the hiring firm—this may include their residence.
Have a business license, in addition to any required professional licenses or permits.
Be able to set or negotiate their own rates for the services performed.
Be able to set their own hours.
(A) Be customarily engaged in the same type of work under contract with another hiring firm, or (b) hold themselves out to other potential customers as available to perform the same type of work.
Customarily and regularly exercise discretion and independent judgment performing their services.
Lastly, licensed barbers, manicurists, electrologists, cosmetologists, and estheticians can also be classified as independent contractors if they meet the aforementioned requirements and the below standards as well, where they:
“Set their own rates, process their own payments, and are paid directly by clients.”
“Set their own hours of work and have sole discretion to decide the number of clients and which clients they provide services for.”
“Have their own book of business and schedule their own appointments.”
“Maintain their own business license for the services offered to clients.”
“Issue a Form 1099 to the salon or business owner from which they rent their business space.”
It is important to note, however, that the strict ABC test will apply to licensed manicurists on January 1, 2022.
There are a few businesses that are exempted from the strict ABC/AB5 law and the associated tests as well (while usually requiring Borello test requirements). This includes businesses that conduct B2B contracts with workers, real estate salespeople, construction sub-contractors, and more.
As noted by Nolo.com, business service providers interacting with businesses via a business-to-business contracting relationship can be classified as an independent contractor “if (1) they pass the Borello test, and (2) they satisfy the following criteria, where the business service provider (worker):
Is free from the hiring firm’s control and direction while performing the work (this must be set forth in the contract and be true in fact).
Provides services directly to the contracting business rather than to customers of the contracting business.
Has a written contract.
Has all required business licenses or business tax registration.
Maintains a business location separate from the business or work location of the hiring firm.
Is customarily engaged in an independently established business of the same nature as that involved in the work performed.
Actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring firm.
Advertises and holds itself out to the public as available to provide the same or similar services.
Provides its own tools, vehicles, and equipment to perform the services.
Can negotiate its own rates.
Consistent with the nature of the work, can set its own hours and location of work.
Is not performing the type of work for which a license from the Contractor’s State License Board is required.”
This exemption applies to workers who contractually work with a company as sole proprietors, partners, members of a limited liability company (LLC), or corporations.
As noted by Nolo.com, construction industry subcontractors are exempt from the ABC test. They are thus able to be classified as independent contractors if they pass the Borello test and satisfy the following criteria:
“The subcontract is in writing.
The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license.
The subcontractor has all required business licenses or business tax registration.
The subcontractor maintains a business location separate from the business or work location of the contractor.
The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services.
The subcontractor assumes financial responsibility for errors or omissions in labor or services by having insurance, legally authorized indemnity obligations, performance bonds, or warranties for the labor or services provided.
The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.
The subcontractor has the right to control how the work is performed.
The subcontractor’s IC status is bona fide and not a subterfuge to avoid employee status.”
Licensed real estate salespeople and real estate brokers are not subject to the ABC test. But there are situations in which they must satisfy the Borello test – such as for purposes other than unemployment and worker’s compensation insurance coverage – whereas for unemployment purposes, in order to be considered independent contractors, they must satisfy three criteria, as noted by Nolo.com:
Are duly licensed
Are paid based on sales
Have a written Independent Contractor Agreement”
For workers that are classified as contractors because the business obtained their services via job referral agencies, ten factors are used to determine their employment status when the services provided include 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 services.
The ten factors are:
“The service provider is free from the control and direction of the referral agency while working for the client, both as a matter of contract and in fact.
The service provider has all required business licenses or business tax registration.
If the work for the client requires the service provider to hold a state contractor’s license, the service provider has the required contractor’s license.
The service provider delivers services to the client under the service provider’s name, rather than under the name of the referral agency.
The service provider provides its own tools and supplies to perform the services.
The service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed for the client.
The service provider maintains a clientele without any restrictions from the referral agency and the service provider is free to seek work elsewhere, including through a competing agency.
The service provider sets its own hours and terms of work and is free to accept or reject clients and contracts.
The service provider sets its own rates for services performed, without deduction by the referral agency.
The service provider is not penalized for rejecting clients or contracts (this does not apply if the service provider accepts a client or contract and then fails to fulfill any of its contractual obligations).”
Lastly, other exemptions to the ABC test are provided for:
“Commercial fishermen on American vessels (exception ends on January 1, 2023)
Licensed repossession agencies, and
Individuals providing driving services for motor clubs.”
One of the main questions of the day is how the new law will be both implemented and enforced. While it is possible for misclassified workers to sue, the Attorney General’s Office, the city, and local prosecutors can also sue companies for not abiding by the new law. However, the everyday implementation of the new law – that is, its enforcement – remains to be seen as businesses adapt to restructuring their companies to include its former “contractor” workforce as its employees. Employment Development Department (EDD) audits will be used to ensure the implementation of the new law, while fines will be used as one penalty for companies who do not restructure their worker base according to the new AB5 law stipulations.
The new, strict ABC-based AB5 law has many ramifications that affect not only how businesses operate, but how workers make their living. There are both numerous advantages and drawbacks for workers, depending on their industry and type of work. For the most part, many abuses that contracted workers have experienced at the hands of companies are mitigated due to such workers being forcefully put under the safety regulations and benefits of being an employee of their respective business. Employees typically enjoy many benefits under state law, such as unemployment benefits, tax benefits, workers’ compensation, overtime benefits, and even minimum wage protections. Former independent contractors that are now classified as employees can enjoy more workplace freedoms and protections. At the same time, many former contractors have preferred to remain in the freelance ecosystem and now find it near impossible to be classified as an independent contractor, which necessitates becoming a full-time or part-time employee. This means that such workers must restructure their own work lives in order to adhere to specific standards, and must deal with the (typical) inflexibilities of being a salaried employee.
Workers that are now classified as employees – and no longer as independent contractors – are able to enjoy the rights, privileges, and protections associated with being a salaried employee, including:
Vision Care Insurance
Employee Assistance Program (EAP)
Medical Reimbursement Accounts
For the most part, certain professions – such as truck drivers and janitorial jobs – along with a host of low-wage workers have very tangible benefits with the AB5 law, such that they receive larger wages and greater protections.
Workers classified as employees are now expected to adhere to specific standards in the performance of their work/responsibilities. This means that such freelancers, whose skills may be associated with outside-the-box tasks or specific workflows, now may be required to do (standard) work that they may not be trained to do. Many freelance jobs will also simply cease to exist under the new independent contractor model, as such jobs will be absorbed into the greater salaried employee model of certain companies. Furthermore, such workers are now unable to keep the more flexible schedule typically associated with independent contractor work. Independent contractors will now have a difficult time working as ICs or freelancers and must make a massive adjustment to becoming salaried employees.
While workers must adjust their work lives to live and work as salaried employees, businesses of all sizes must restructure their business model and worker model to be in compliance with the new law. This affects several intra-departmental processes, and can increase financial burdens and resource-requirements within a business:
HR: Everything from workers’ compensation to vacation/leave and other benefits must be figured into employee packages, which now includes former ICs.
Administration: Now businesses must manage and carry out numerous administrative processes for its new “employees,” such as training and inter-departmental transfers.
Finance: Businesses must spend more on the benefits associated with employment laws for its new “employees,” and must absorb extra overhead to compensate such employees under state minimum wage laws ($12-13 USD in California).
Executive Management: Management must manage, organize, and direct a potential batch of new “employees” within the company to ensure that the new workers integrate within the workplace ecosystem, culture, and environment of the business as a whole.
The AB5 law was created due to many companies misclassifying their workers in order to be exempt from employment laws, thus saving up to 30 percent on labor fees. The new law, however, creates a demand within a business to treat its former ICs as employees, which means greater benefits to the worker at the cost of the company.
There are positive effects as well, allowing businesses to tap into new skill-sets of former ICs in a way that was not possible when these workers only carried out specific tasks as contractors. As employees, former contractors can help a business scale if they are leveraged correctly.
Former ICs who are inducted into a business as an employee can carry out new and more expanded tasks than before, which can help a business leverage unique skills that were previously unavailable to them. Having new workers on their teams means that businesses can scale quickly by having such workers carry out skilled tasks and processes that they previously would not have done as an IC. This increased agility and scalability can even help a business expand its product and service lineup and can help the company increase its bottom line.
The new AB5 law, for the most part, requires companies to pay additional costs associated with employee benefits, paid time-off, insurance, workers’ compensation, etc., all of which could significantly and negatively impact the bottom line of the company or even lead to bankruptcy. The additional overhead required to sustain and maintain extra employees may also require a costly restructuring of an entire company. In the end, the extra costs may be passed on to consumers as companies try to adapt and lessen the burden on themselves, which may lead to issues in customer-business relations.
There are several steps that businesses of every size can, and should, take so the new law does not negatively affect their company affairs, projects, finances, management, or processes. Such steps should include:
Legal aid: First, every business should seek legal aid to know exactly how they should proceed to comply with the new law in a way that benefits the business.
Risk Assessments: Business risk analysts should be leveraged to ensure that the company is not under risk for bankruptcy, mismanagement, or issues within different departments when the new employees are integrated into the new ecosystem of the company.
Technology: IT systems should be used every step of the way to aid in the restructuring and management process, which can help HR and administrative tasks associated with integrating the new employees within the ecosystem of the business.
B2B Relationship Establishments: establishing business-to-business relationships with contractors allows businesses to legally continue to classify their workers as ICs under most circumstances.
Whenever a new law is put into place, legal specialists should be hired so a company can follow a carefully-planned roadmap to be in compliance with the new regulations, all in a way that benefits the business.
Any new shift in a business can result in many issues, including financial and managerial issues. Risk analysts can plan every process associated with implementing the new employee model within a business while analyzing how to mitigate every potential problem that may come up.
In terms of structuring your company’s relationship with independent contractors, service provider platforms, management applications, and enterprise suites (such as HR systems) can be leveraged to make the entire transition happen smoothly and seamlessly.
Establish a B2B Relationship With Your Contractors
B2B relationships between a business and a worker can legally allow a company to continue classifying its worker as an IC. This means that businesses can alter their relationship with their contractors to be exempt from the new labor law (for the most part), which requires the contractor to act as a sole proprietor, for instance. Such an IC business model can benefit a company as they will not have to alter their worker model too much, which helps them save on money and overhead.
The new law radically changes business as usual and has the potential to spread to other states within the U.S. (since many states already use the ABC test). Companies within California – as well as companies in other states – should proactively plan how they will financially support their new employees to comply with the new regulations, and how they will restructure the architectural design of their company to turn the new law into an advantage that helps them scale once the new skills of the new employees are leveraged properly. Instead of panicking, some shifting and reordering of business affairs is necessary, but ultimately, businesses of all sizes can reduce any issues in complying with the new law or undertake legal ways that allow them to successfully continue to use the services of independent contractors.
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