On September 18, California Governor Gavin Newsom signed Assembly Bill 5 (AB5). The law, which goes into effect January 1, 2020, severely limits employers’ ability to classify workers as independent contractors in California, meaning that the vast majority of workers will need to be treated as employees.

AB5 codifies and expands on the April 2018 California Supreme Court decision in Dynamex v. Superior Court that established the “ABC test” for determining whether a worker is an independent contractor under state law. All three parts of the ABC test must be satisfied to treat a worker as an independent contractor, and the burden lies entirely with the hiring entity to do so:

  1. 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.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Taken together, and particularly in light of the requirement that the worker must perform work outside the normal course of the hiring entity’s business, AB5 presents a very high bar for hiring entities to meet to justify the independent contractor label. For example, a company that manufactures, distributes, and sells widgets will still be able to hire a plumber as an independent contractor to fix its plumbing, or independent contractor janitors to clean its offices, but workers who are engaged in any part of the manufacturing, marketing, sales, or other facets of the widget business will almost certainly fall within the employee classification. As such, the state’s Labor Code, Wage Orders, and other regulations such as those governing minimum wage, overtime, rest and meal breaks, payday timing, wage statement requirements, and final paychecks will apply to them. Moreover, and likely more complicating for management, the ever-multiplying minefield of local ordinances that provide for an alternative minimum wage, health care and sick leave benefits, as well as other benefits and requirements will also apply to workers reclassified as employees.

Unfortunately, the good news for California’s businesses is scarce when discussing AB5. That said, the law does carve out specific exceptions from the ABC test for workers such as doctors, hairdressers, insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, and others.

What does this mean for employers and businesses?

  • Many workers previously classified as independent contractors should now be considered employees.
  • Additional laws apply to these newly classified employees: the Labor Code, the Unemployment Insurance Code, and the wage orders of the Industrial Welfare Commission.
  • Costs: Employees are entitled to benefits such as minimum wage, workers’ compensation, unemployment insurance, expense reimbursement, paid sick leave, and paid family leave. Payroll taxes apply to them as well.
  • Penalties for misclassification of employees as independent contractors are stiff, as are consequences of misclassification — such as back wages and penalties (including PAGA penalties) — for overtime, minimum wage, meal and rest break violations, and myriad other administrative traps for the unwary.

The bottom line is that all businesses in California should closely evaluate whether it is lawful to treat workers as independent contractors in this newly emerging landscape as failing to properly analyze this situation exposes companies to substantial risk.

Employers and businesses should stay tuned as this is a rapidly changing area of law, in particular because the extent to which AB5 is retroactive is unclear. The law was the subject of intense negotiations, and companies such as Uber and Lyft have vowed to continue their fight to keep drivers as contractors, possibly via the ballot box. In his signing message, Governor Newsom said he would continue the discussion with business and labor groups, so AB5 is by no means the end of this story.