This article is an update to prior publications from Littler’s Workplace Policy Institute regarding Assembly Bill 5 (AB 5), passed by the California legislature on September 11, 2019.

On September 11, 2019,1 the California Legislature passed Assembly Bill 5 (AB 5). The bill entirely redefines the standard for determining whether a person providing labor or services for remuneration may be classified as an independent contractor rather than an employee. All that is left is for Governor Newsom to sign this bill, which he is expected to do.

Dynamex v. Superior Court

AB 5 is the legislature’s reaction to the California Supreme Court's opinion in Dynamex v. Superior Court (Dynamex).2 The Supreme Court issued the Dynamex opinion on April 30, 2018. At that time, California courts and state agencies had long applied the common-law test the Supreme Court itself adopted in 1989, in the matter of S. G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello), to determine whether an individual could be classified as an independent contractor, rather than an employee. Throughout the intervening 29 years, California’s courts, state agencies, and businesses relied on the “Borello test” as the applicable standard. Dynamex abruptly imposed the entirely new standard, the “ABC test,” for purposes the California wage orders.3

Dynamex did not, however, completely eliminate all use of the Borello test. The California Supreme Court expressly limited Dynamex to application of the wage orders. That limitation left the Borello test in place for all other purposes, including the Labor Code and the Unemployment Insurance Code.

Despite its stated intention to bring more certainty and clarity to worker classification, Dynamex failed to address the critical issue of retroactive versus prospective application of the new test. Indeed, the court declined to clarify this issue.4

The question of retroactivity was taken up by the U.S. Court of Appeal for the Ninth Circuit. On May 2, 2019, the Ninth Circuit issued an opinion in Vazquez v. Jan-Pro Franchising Int'l, Inc. (Vazquez).5 Initially, the Ninth Circuit concluded Dynamex applies retroactively. In reaching its decision, the Ninth Circuit expressly relied on the California Supreme Court’s “emphasis in Dynamex” that its holding was “a clarification rather than as a departure from established law.” The Ninth Circuit withdrew that opinion on July 22, 2019, and declared it would certify to the California Supreme Court the question of whether Dynamex applies retroactively. However, the Supreme Court often takes years to respond to such requests, so it will likely not issue any decision on the issue before late 2020.6

Assembly Bill 5

Assemblymember Lorena Gonzalez (D-San Diego) first introduced AB 5 on December 3, 2018. The first version contained no substantive provisions, but only expressed an intent to “include provisions that would codify [Dynamex] … and would clarify the decision’s application in state law.” Legislators subsequently amended AB 5 six times.7 The final text of the bill is lengthy and complex. Conceptually, it is composed of four basic parts: (1) adopting the ABC test; (2) specifying exceptions that invoke the Borello test; (3) delineating retroactive versus prospective liability; and (4) authorizing the Attorney General and other specified public officials to prosecute actions for injunctive relief to prevent continued misclassification.

ABC Test

AB 5 adopts the ABC test, using the exact language of the Dynamex opinion. Specifically, any person providing labor or services for remuneration shall be considered an employee, rather than an independent contractor, unless the “hiring entity” demonstrates that all of the following conditions are satisfied:

(A) The person 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 person performs work that is outside the usual course of the hiring entity’s business.

(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.8

As in Dynamex, AB 5 imposes this test for purposes of the California wage orders. The bill also applies the ABC test to the California Labor Code and Unemployment Insurance Code. As will be explained below, however, the Borello test will remain the applicable standard for occupations and relationships that fall within AB 5’s various exceptions.

Exceptions

The bulk of AB 5 attempts to define “exceptions” for particular occupations and relationships. These exceptions fall into seven categories. If an exception applies, the bill then specifies what standard, other than the ABC test, will govern. For the vast majority of the exceptions, the bill provides “the determination of employee or independent contractor status … shall be governed by Borello.” Therefore, it is not enough that a particular situation falls within one of AB 5’s exceptions. The situation must still satisfy the applicable test, which will usually be the Borello test.

The seven categories of exceptions and their key characteristics are:

  1. Specific occupations9
    • Insurance agents, surplus line brokers, and analysts.10
    • Physicians, dentists, podiatrists, psychologists, and veterinarians.11 (The exception does not apply to “the employment settings currently or potentially governed by collective bargaining agreements.”).
    • Lawyers, architects, engineers, private investigators, and accountants.12
    • Securities broker-dealers and investment advisors.13
    • Direct sales salespersons.14
    • Commercial fishermen.15
    • Newspaper carriers working under contract with a newspaper publisher.16
  1. Contracts for professional services between a hiring entity and an individual providing professional services17
    • This exception is subject to six criteria.18
    • The scope of “professional services” is limited to specific occupations and activities.19
    • The individual may provide the professional services through “a sole proprietorship or other business entity.”20
  1. Real estate licensees21 and repossession agencies22
  1. Business-to-business contracting relationships between a contracting business and a business service provider23
    • This exception is subject to 12 criteria.24
    • Both the contracting business and business service provider may be a “sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation.”25
    • The exception “does not apply to an individual worker, as opposed to a business entity, who performs labor or services for a contracting business.”26
    • The exception does not alter or supersede application of existing Labor Code section 2810.3, which imposes joint and several liability on a “client employer” for specified civil claims of “employees supplied by a labor contractor” under specified circumstances.27
  1. Relationships between a contractor and an individual performing work pursuant to a subcontract in the construction industry28
    • This exception is subject to seven criteria;29
    • Includes a limited exception for owner-operator truckers in the construction industry,30 which will expire on January 1, 2022.31
  1. Relationships between a referral agency and a service provider that uses the referral agency to connect with clients32
    • This exception is subject to 10 criteria.33
    • Limited to specific services.34
    • A “referral agency” is defined as “a business that connects clients with service providers that provide [the specific services within the scope of the exception].”35
    • A “service provider” is defined as “a person or business who agrees to the referral agency’s contract and uses the referral agency to connect with clients.”36
    • A “client” is defined as “a person or business that engages a service contractor through a referral agency.”
    • The service provider may be “formed as a sole proprietor, partnership, limited liability company, limited liability partnership, or corporation.”37
    • The exception “does not apply to an individual worker, as opposed to a business entity, who performs services for a client through a referral agency.”38
  1. “Motor club” services39

Many of the above exceptions and criteria present considerable practical difficulties of execution, the full measure of which are beyond the scope of this article. However, several difficulties and conflicts are apparent on the face of the statutes.

First, the exceptions for professional services, business-to-business contracting relationships, construction subcontracts, and referral agencies consistently place the burden on those “upstream” entities to satisfy criteria that are not within their direct control. The bill does not address whether and to what extent those entities will be liable for non-compliance with criteria due to circumstances beyond their control.

Second, many of the same criteria are subject to change over time. The bill does not address whether a temporary or emergent failure of one of those criteria will result in retroactive, temporary, and/or permanent loss of the exception.

Third, the business-to-business and referral agency exceptions contain an inherent conflict. These exceptions: (1) expressly provide that the service provider may be formed as a sole proprietorship without sacrificing the exception; (2) refer to a sole proprietorship as a business entity; and (3) expressly exclude “an individual worker, as opposed to a business entity” from the scope of the exception. It is entirely unclear whether an individual operating as a sole proprietor would be considered a sole proprietorship or an individual worker. Many of the individuals who provide the types of services for which the exceptions are intended operate as single-person sole proprietorships. For example, will an individual tutor using a referral service to connect with clients be considered a sole proprietorship or an individual worker? Will the referral agency have to exclude tutors operating as single-person sole proprietorships from its platform? Will all individual tutors have to form solely owned corporations or limited liability companies solely to clarify their status in this regard? What rational purpose is served by requiring tutors to expend financial resources to forming such entities? This uncertainty considerably limits the utility of the exceptions.

Retroactive Versus Prospective Liability

Despite the critical importance of retroactive liability, early versions of AB 5 contained no provisions whatsoever regarding retroactive versus prospective liability. Legislators first added language addressing this issue to the bill’s fifth version, published August 30, 2019. The final text of the bill parses retroactive and prospective liability into three parts:

  1. Dynamex and the ABC test apply retroactively “with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.”40
  1. All exceptions apply retroactively to the maximum extent permitted by law, to the extent they would relieve an employer from liability.41
  1. On and after January 1, 2020, Dynamex and the ABC test will apply for purposes of the Unemployment Insurance Code and all other provisions of the Labor Code.42
  1. On July 1, 2020, Dynamex and the ABC test will apply for purposes of workers’ compensation.43

Unfortunately, the first of these three provisions exacerbates the uncertainty and potential retroactive liability inherent in the Dynamex opinion. Dynamex was expressly limited to the wage orders. Now, AB 5 declares that its legislative adoption of Dynamex is “declaratory of existing law with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.”44 The italicized words appear to impose new retroactive liability on California businesses for “violations of the Labor Code relating to wage orders” stemming from alleged misclassification of an employee as an independent contractor rather than an employee. Worse, it is far from clear which of the thousands of provisions of the California Labor Code are sufficiently “related to” the wage orders to give rise to retroactive liability.

Injunctive Relief

In a last-minute amendment to AB 5, legislators added an entirely new subdivision authorizing the Attorney General and specified public officials to prosecute civil actions for injunctive relief “to prevent the continued misclassification of employees.” The entire provision provides:

(j) In addition to any other remedies available, an action for injunctive relief to prevent the continued misclassification of employees as independent contractors may be prosecuted against the putative employer in a court of competent jurisdiction by the Attorney General or by a city attorney of a city having a population in excess of 750,000, or by a city attorney in a city and county or, with the consent of the district attorney, by a city prosecutor in a city having a full-time city prosecutor in the name of the people of the State of California upon their own complaint or upon the complaint of a board, officer, person, corporation, or association.45

This provision mirrors California’s controversial Unfair Competition Law (UCL).46 Actions for injunctive relief under the UCL have been relatively rare. Based on the level of interest displayed by organized labor in the passage of AB 5, it seems certain this provision will see more frequent use. It has been speculated that this provision was inserted to counter binding arbitration of individual disputes between businesses and independent contractors.

What Now?

Governor Newsom will have until October 13, 2019, to sign or veto AB 5. Despite the bill’s many flaws, Governor Newsom has publicly expressed support for it.47 Businesses should assume AB 5 will be signed into law and begin to plan accordingly. Businesses seeking to maintain or establish independent contractor relationships with workers in California should seek legal counsel to assess whether the particular workers can be validly classified as independent contractors in light of AB 5 and, if so, how to maximize the probability those relationships will withstand misclassification claims.