AB 5 Employment Classifications
Independent Contractors Need Holistic Approach Reflecting Modern Workforce
AB 5 (Gonzalez; D-San Diego), signed by Governor Gavin Newsom on September 18, 2019, is touted as one of the most significant pieces of California legislation in decades impacting employment classifications. AB 5 codified the 2018 California Supreme Court decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (Dynamex), and extended the application of Dynamex to several additional California employment laws while creating industry-specific exemptions. Upon the signing of AB 5, Governor Newsom, the author and the proponents (mainly labor unions), indicated there was more work to be done on this issue and that additional legislation would be expected in 2020.
Before Dynamex, California courts and state agencies had long applied what is known as the Borello test for determining whether a worker was an independent contractor or employee for labor and employment purposes (S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations (1989) 48 Cal.3d 341). This flexible, multi-factor approach looked primarily at whether the hiring entity had a “right to control” the manner in which the worker performed the contracted service.
Despite the Borello test being used for nearly three decades in the employment context, the California Supreme Court in Dynamex made a surprising and unprecedented departure from the Borello test and announced a significant change in the law, adopting the “ABC” test for determining whether an individual is an employee under the Wage Orders.
Per Dynamex, and now AB 5, a worker is presumed to be an employee unless the hiring entity establishes all three of the following conditions:
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.
Because of the rigidity of the ABC test—specifically factors “B” and “C”—most individuals who control their own schedule, projects or tasks, and the way in which they perform these projects or tasks, will likely lose existing contracts and work opportunities. The reason is that if the worker performs work which is similar to that of the business entity retaining the worker’s services and/or is not in an independent business or trade of the same work being performed, the worker will be classified now as an employee per the ABC test.
Although the Dynamex ruling applied only to California’s Wage Orders and therefore was limited to minimum wage, overtime, and meal period and rest break liability, AB 5 is more expansive. Per AB 5, misclassified workers also are eligible for workers’ compensation coverage, unemployment insurance and various other benefits. Additionally, because hundreds of thousands of workers now will be considered employees, those workers may assert their civil rights protections and potentially the ability to unionize.
2020 Push For Additional Exemptions
AB 5 in its original form exempted certain occupations from the ABC test, clarifying that Borello would apply instead. Those exemptions included, but were not limited to: persons or organizations licensed by the Department of Insurance; doctors, surgeons, dentists, podiatrists, psychologists and veterinarians; lawyers, architects, engineers, private investigators and accountants; securities broker-dealers and investment advisers; direct salespersons; specified commercial fishermen; and specified newspaper carriers and distributors.
Other industries were exempted under the professional services contract exemption. These industries are exempt only if specific criteria are met. These industries include: human resources administrators; travel agents; marketers; graphic designers, grant writers, fine artists, payment processing agents, enrolled agents licensed by the U.S. Treasury, certain photographers or photojournalists, certain freelance writers, editors and newspaper cartoonists.
Other professional exemptions carry additional conditions. For example, estheticians, electrologists, manicurists, barbers, and cosmetologists are exempt, but only if they set their own rates, are paid directly by clients, schedule their own appointments, and follow several other requirements more akin to independent workers than employees.
AB 5 also provided specific exemptions and requirements for a real estate licensee, repossession agency, those subcontracting in the construction industry, construction trucking industry, referral agency relationships, and a motor club exemption.
By February 2020, more than 30 bills were introduced to add a myriad of exemptions to the ABC test. The proposed exemptions included small businesses, franchisees, interpreters, freelancers, music industry professionals, and many others. The result was the enactment of AB 2257 (Gonzalez; D-San Diego), which added exemptions and made changes to the existing exemptions. As a result of the adoption of AB 2257, which was signed into law on September 4, 2020 and took effect immediately, there now are 109 exemptions to the ABC test. Those include:
• Recording artists, songwriters, composers, musicians, vocalists and other music industry occupations (although there are certain limits on musicians; for example, they are not exempt if they are part of a symphony headlining in a large venue seating more than 1,500 attendees).
• Cartographers, content contributors, specialized performers, home inspectors, narrators.
• Inspectors for insurance underwriting.
• Comedians, magicians and other similar performers as long as they meet certain criteria.
• Manufactured housing salespersons.
• Certain animal services workers.
• Competition judges.
• Licensed landscape architects.
The bill also eliminated the 35-submission cap that previously had been placed on photographers, freelance writers and similar occupations. Under AB 5’s original text, if any of those persons made more than 35 submissions to one organization, the ABC test would have applied to determine if they were employees of that organization. AB 2257 also added services to the referral agency exemption, including youth sports coaches, wedding and event planners, and interpreters.
Notably missing from the list of exemptions were certain industries that have filed lawsuits against the application of AB 5, including the trucking industry and gig companies. In January 2020, a federal court granted a preliminary injunction barring AB 5 from being enforced against motor carriers and owner-operators in the trucking industry in California Trucking Association et al. v. Becerra et al., Case No. 3-18-cv-02458 (S.D. Cal. 2018). The judge agreed with the trucking industry representatives that they were likely to prevail in demonstrating that AB 5 as applied to them is preempted by the Federal Aviation Administration Authorization Act. The case is still ongoing.
The gig companies have not been successful to date in multiple lawsuits arguing that AB 5 should not be enforced against them, but scored a large victory in the 2020 election with the passing of Proposition 22. Proposition 22 establishes that workers at transportation network companies and delivery network companies, such as Uber, Lyft, Postmates and DoorDash, are independent contractors, but provides certain benefits, including guaranteeing at least 120% minimum wage during engaged time, payment per mile, health care coverage for those who work a certain number of hours, and the development of anti-harassment policies.
A question remains as to whether the portion of Proposition 22 that establishes drivers as independent contractors is retroactive or if drivers may still pursue claims for unpaid wages by arguing that they were misclassified prior to Proposition 22 taking effect. In granting the preliminary injunction in People v. Lyft, Inc., et al., Superior Court Judge Ethan Schulman found the proposition was not retroactive. This issue will inevitably arise in other cases pending against these gig companies, giving other courts the ability to weigh in as to whether they agree with Judge Schulman’s interpretation.
One of the concerns about AB 5 was that it may affect vendor relationships by usurping the joint employer analysis, allowing employees of a vendor to claim they are employees of the contracting business based on the ABC test, or even allowing the owner of a separate business to claim the owner is actually an employee of the hiring entity under the ABC test. Several lawsuits are pending on this issue.
In an effort to address this concern, AB 5 included an exemption for business-to-business relationships; however, the exemption was extremely narrow and required that the business retaining a contractor meet 12 specific requirements.
In a letter to the California Assembly’s Daily Journal, the author of AB 5 stated that the business-to-business provision is not intended to suggest that business service providers are necessarily employees if the requisite criteria are not satisfied. She further stated that AB 5 is “not intended to replace, alter, or change joint-employer liability between two businesses. AB 5 is focused upon the determination whether an individual is an employee or an independent contractor.”
AB 2257 made some changes to the business-to-business exemption, but the original version is largely still intact. The exemption was slightly expanded to apply to an individual acting as a sole proprietor and to arrangements between businesses and public agencies or quasi-public corporations. AB 2257 also provides that the requirement that the provider provide services directly to the contracting business rather than its customers does not apply if the employees are providing the services under the contract under the name of the business service provider and that provider regularly contracts with other businesses. This was one of the primary factors that businesses had been concerned about in determining when the exemption could be applied. There was also concern about the requirement that the business service provider “actually contracts” with other businesses to provide the same or similar services. The language “actually contracts” was amended by AB 2257 to “can contract,” which relaxes this requirement. Further, AB 2257 clarifies what terms need to be in the contract between the businesses for the exemption to apply.
AB 5 itself is not retroactive, but it does provide differing retroactive and prospective applications in certain areas (See Myers v. Philip Morris Cos., Inc., 28 Cal. 4th 828, 844 (2002); Quarry v. Doe I, 53 Cal.4th 945, 955 (2012)). AB 5 is prospective for violations of the Labor and the Unemployment Insurance codes (beginning January 1, 2020) and for violations of workers’ compensation (beginning July 1, 2020) (except for Labor Code violations “relating to wage orders.” See AB 5).
However, AB 5 explicitly states that the exceptions apply retroactively “to the maximum extent permitted by law,” ensuring specific industry carve outs. The bill also states that it does not change, “but is declaratory of, existing law” with regard to the IWC Wage Orders and “violations of the Labor Code relating to wage orders.” (Note: It is unclear which Labor Code sections are “related” to the wage orders. However, in a May 2019 opinion letter, the Division of Labor Standards Enforcement explained that it would be appropriate to apply the ABC test to any claim, including Labor Code violations, that rest on an employer’s obligations under a wage order, including minimum wage, overtime, reporting time pay, recordkeeping violations, meal and rest periods, and others.)
In other words, AB 5 does not change existing law related to the wage orders, most notably the Dynamex decision.
At the start of 2021, the issue of whether the Dynamex decision is retroactive remained unsettled. In May 2019, the Ninth Circuit in Vazquez v. Jan-Pro Franchising International, Inc. concluded that Dynamex did apply retroactively. Then, in July 2019, the Ninth Circuit issued an order granting a petition for panel rehearing, withdrawing its decision in Vazquez, and stating that it would certify the question of whether Dynamex applies retroactively to the California Supreme Court. The California Supreme Court on November 20, 2019, agreed to answer the Ninth Circuit’s certified question and heard oral arguments almost one year later on November 3, 2020. During the arguments, both parties asked the California Supreme Court to decertify the question of retroactivity because they believe that issue was not central to this specific case. The justices appeared somewhat surprised by each party’s lack of interest in the court’s addressing retroactivity.
On January 14, 2021, the California Supreme Court held that Dynamex is retroactive because the decision did not change any “settled rule” about what test applied to the Wage Orders and doing so is not “improper or unfair” to employers. The court explicitly rejected Jan-Pro’s argument that Dynamex should not be retroactive because it, and others, had reasonably relied on Borello in determining how to classify its workers, reasoning that employers had no reasonable basis for relying on Borello for Wage Order claims and claiming that Dynamex was not a “sharp” departure from the basic approach of Borello.
Even if the court is technically correct that Borello was not a Wage Order case, the court’s decision unfortunately does not reflect reality. Worse, it opens up businesses, that acted in good faith under the universally accepted Borello standard, to millions of dollars of exposure. The court’s Vazquez opinion states Dynamex applies retroactively to all cases “not yet final” as of the date of the Dynamex decision. Most claims for unpaid wages under the California Labor Code carry a three-year statute of limitations that can be extended to four years as long as the plaintiff also includes a claim under California’s Unfair Competition Law, plus the penalties that can be added to those claims under both the Labor Code and the Private Attorneys General Act. A business that relied in good faith on Borello can now be liable for not following the ABC test before the Dynamex decision was ever issued.
What to Expect in 2021
AB 5 and AB 2257 have created a patchwork of arbitrary exemptions to the ABC test, allowing the California Legislature to pick and choose which industries must be subjected to the ABC test and those which can apply the more flexible Borello standard. Despite the success of Proposition 22, demonstrating that a majority of California voters are in favor of increased flexibility for employers to utilize independent contractors, the willingness of the Legislature to consider additional amendments may be waning thin.
The California Chamber of Commerce anticipates that certain industries will continue to push for more expansive exemptions, and it remains to be seen whether legislation will be introduced to undermine the effects of Proposition 22. Any direct amendments to the initiative must be approved by 7/8 of the Legislature. Other potential issues that may arise include clarifying how the joint employer analysis interacts with the ABC test.
In light of the Supreme Court ruling in Vazquez, the Legislature should make it clear that the exemptions also apply retroactively. This would ensure that at least some businesses which reasonably relied on the once universally accepted Borello standard are spared from costly litigation.
The current workforce values flexibility, which is why the Dynamex decision is so detrimental to millions of California workers. Failing to further amend AB 5 to provide additional industry exemptions and broaden the business-to-business exemption has the potential to eliminate the vast majority of independent contractors in California.
Although the CalChamber appreciates the recognition in AB 5 that the Dynamex decision is not one-size-fits-all and agrees the professions identified should be exempted under AB 5, the Legislature should not stop with selecting just a few professions and not others that are similarly situated. What’s needed is a more progressive and holistic approach to applying Dynamex that reflects today’s modern workforce.
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