California recently enacted a new law which will reshape the current worker classification law landscape by creating the presumption that a worker is an employee rather than an independent contractor for purposes of certain California wage orders and labor and insurance laws. To overcome this presumption, hiring entities must affirmatively demonstrate that certain conditions are satisfied or that an exemption applies. This new law will have a sweeping impact on businesses that rely heavily on the use of independent contractors, including businesses involved in the so-called “gig” economy.
On September 18, 2019, California governor, Gavin Newsom, signed Assembly Bill No. 5 into law, which codifies the California Supreme Court’s unanimous decision in the Dynamexicase and could have a sweeping impact on businesses that rely heavily on the use of independent contractors, including businesses involved in the so-called “gig” economy. Citing the potential harm to misclassified workers and losses to state coffers, effective as of January 1, 2020, this new legislation creates a presumption that a worker is an employee rather than an independent contractor for purposes of certain California wage orders and labor and insurance laws, unless the hiring entity can affirmatively demonstrate that certain conditions are satisfied or that an exemption applies. This new law authorizes the California Attorney General and specified local prosecuting agencies to bring an action for injunctive relief to prevent employee misclassification. If past is prologue, other states may potentially enact similar legislation, and employers having operations in other states that regularly engage independent contractors should familiarize themselves with the California legislation and assess how a similar law, if enacted in those states, could impact their operations.
Overcoming the Presumption of Employee Status under the New California Legislation
The new legislation creates a presumption that an individual providing services is an employee rather than an independent contractor for the purpose of certain California employment laws. To overcome such presumption, a hiring entity in California must either satisfy the conditions of a three-part test, commonly referred to as the “ABC Test”, or demonstrate that an exemption to the ABC Test applies, in which case, the test laid out in the Borello caseii,which takes into account “all potentially relevant factual distinctions in different employment arrangements on a case-by-case, totality-of-the-circumstances basis,” will be used to judge the relationship.
The ABC Test
The presumption of employee status under the new California legislation can be rebutted to the extent that the hiring entity can demonstrate that all of the following conditions are satisfied:
(A) The individual 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) The individual performs work that is outside of the usual course of the hiring entity’s business; and
(C) The individual is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
In the test above, prong (A) generally tracks the common law control standard that many hiring entities in California would already be familiar with prior to the enactment of the new law and the California Supreme Court’s ruling in Dynamex. Prongs (B) and (C), however, add new elements to the traditional common law control standard, making it more difficult to overcome the presumption of employee status under the new law. These new prongs seek to identify individuals that can be viewed as providing services to the business in a role comparable to that of an employee in the case of prong (B), and individuals that have taken steps to create their independent business in the case of prong (C). According to the new legislation, if a court rules that the ABC Test cannot be applied in a particular context, or one of several enumerated exemptions applies, the determination of a worker’s classification will instead be governed by Borello.
Exemptions from the Application of the ABC Test
The new California legislation generally provides for exemptions from the application of the ABC Test for the following occupations:
- Certain persons or organizations licensed by the California Department of Insurance.
- Physicians, surgeons, dentists, psychologists, or veterinarians licensed by California and providing professional or medical services to or by a health care entity.
- Lawyers, architects, engineers, private investigators or accountants licensed and practicing in California.
- Securities broker-dealers or investment advisers and their agents and representatives that are registered with the SEC, FINRA or licensed under certain California law.
- Certain direct sales salespersons and commercial fishermaniii.
- Newspaper distributors working under contract with a publisher, or newspaper carriers working under contract with a publisher or distributoriv.
Professional Services Exemption
The new legislation also provides that the ABC Test generally does not apply to contracts for “professional services” to the extent that the individual service provider meets all of the following requirements:
- maintains a business location separate from the hiring entity;
- is appropriately licensed, if work is performed more than six months after the new law is effective;
- can negotiate or set his or her own rates;
- can set his or her own hours, outside of project completion dates and reasonable business hours;
- is customarily engaged in the same type of work with another hiring entity or holds himself or herself out to other potential customers as being able to perform the same type of work; and
- customarily and regularly exercises discretion and independent judgment over the services.
This professional services exemption from the ABC Test generally applies to services involving (i) original and creative marketing work, non-standardized, varied human resources administration, travel agents, graphic design, grant writing, fine artists, enrolled agents practicing before the IRS and payment processing agents through independent sales organizations, (ii) still photographers, photojournalists, freelance writers, editors or newspaper cartoonists who do not license content submissions to the hiring entity more than 35 times per year, and (iii) certain licensed estheticians, electrologists, manicuristsv, barbers and cosmetologists.
The new legislation further provides an exemption from the application of the ABC Test for bona fide business-to-business contracting relationships in which a business service provider contracts to provide services to another business, and the hiring entity can establish all of the following requirements, including that the contract is in writing and that the business service provider:
- is free from the control and direction of the hiring entity in connection with the work, under contract and in fact;
- provides services directly to the hiring entity (and not its customers);
- has all the necessary business licenses to perform the services;
- maintains a business location separate from the hiring entity;
- is customarily engaged in an independent business involving work of the same nature;
- actually contracts with other businesses to provide the same or similar services and maintains clients without restriction from the hiring entity;
- advertises and holds itself out to the public as providing the same or similar services;
- provides its own tools, vehicles and equipment to perform the services;
- negotiates its own rates;
- sets its own hours and location for the work, consistent with the nature of such work; and
- is not performing work for which a license from the Contractor’s State License Board is required.
In addition to the foregoing, the new legislation generally exempts the application of the ABC Test to certain relationships between service providers and referral agencies or motor clubs, and arrangements subject to the California Business and Professions Code, including real estate licensees and repossession agencies. The new legislation also exempts the application of the ABC Test to individuals performing work pursuant to a subcontract to the extent that over a dozen conditions are satisfied by the contractor.
The new statute likely will face challenges from some of California’s biggest “gig” economy employers, and may even become the subject of a statewide referendum in the near term. Until then, however, the enactment of this new legislation should be of particular concern to companies in California that have traditionally relied on a business model that involves the provision of significant services by independent contractors. Such companies must now reexamine these relationships through the lens of the new legislation to determine whether classification as independent contractors is in compliance with the new standard. In light of the foregoing, companies with operations in states other than California should likewise reexamine their relationships with independent contractors and anticipate whether the classification of such relationships would be susceptible to challenge in the event that similar legislation were to be enacted in their jurisdiction and whether strategies can be developed in advance and quickly implemented to minimize the disruption to their businesses.