On September 18, 2019, California Governor Gavin Newsom signed into law a contentious piece of legislation—AB5—that could potentially reclassify millions of independent contractors as employees and dramatically reshape the future of independent workforces in California and beyond.
As its nickname, the “gig worker bill”, suggests much of the discussion around AB5 has focused on its effects on the Ubers and Lyfts of the world. But it is actually far, far bigger than that, with the potential to touch nearly all companies in California—and even some outside of California—that use independent contractors (see below for some notable industry exemptions).
While the immediacy is most keenly felt in California, if “as California goes, so goes the nation” holds true then the door is wide open for other states to follow suit and enact similar laws that make it even more difficult to classify workers as independent contractors (ICs). In addition, because of how the law is written, its reach may even extend to companies outside of California if those companies contract with independent contractors who cross into California—even on a limited basis.
The state of panic has been palpable, but before the dread of restructuring an entire workforce sets in, there are some proactive steps that can be taken to function in a post-AB5 economy.
What does AB5 do?
AB5 codifies the landmark April 2018 decision in the Dynamex case. With this decision, California’s Supreme Court determined that the rigorous, three-pronged “ABC Test” must be used to determine worker classification in wage-order claims.
Under the ABC Test a worker is presumed to be an employee—and the burden to demonstrate their independent contractor status is placed squarely on the shoulders of the hiring company. To do this successfully a company must demonstrate (the emphasis is on “demonstrate” as scrupulous documentation is critical) that the worker satisfies all 3 criteria of the test (1 or 2 doesn’t cut it).
A worker can only be classified as an independent contractor if:
(a) the worker is free from control and direction in the performance of services; and
(b) the worker is performing work outside the usual course of the business of the hiring company; and
(c) the worker is customarily engaged in an independently established trade, occupation, or business.
This definition of an independent contractor is much narrower than that of the multi-factor Borello test—the standard previously used in California, which made it far easier to classify workers as independent contractors.
AB5 makes the ABC Test the law in California, but it also expands its application beyond wage-order claims to all provisions under the state Labor and Unemployment Insurance codes.
How will AB5 be enforced?
This is really the (multi-) billion-dollar question, one that will take some time to be answered as there is a significant gap between what law dictates and how it is interpreted by the courts.
A variety of California agencies oversee worker classification as it pertains to claims made by individuals. However, those individual claims can trigger larger agency audits of hiring companies’ classification practices—and those audits will now look to the ABC Test to determine improper classification.
We can almost certainly expect to see enforcement duked out in some lengthy legal battles. AB5 enables the California attorney general, city attorneys, and local prosecutors to sue companies over violations. If this occurs it would require a judge’s order to force companies to reclassify their workers; and large entities with deep pockets like Uber and Lyft would likely fight their cases for years. In addition, expect years of lobbying efforts for industry-related exemptions at the legislative level.
This is where the issue of interpretation comes into play, in the wake of the Dynamex ruling, so far the Supreme Court of California has yet to apply all 3 prongs of the ABC test in any single case. The point here is that the interpretation of AB5 will be just as critical as the legislation itself. And right now, that interpretation is an unknown.
Certainly, compliantly structuring, implementing and documenting independent contractor relationships will be more challenging under the ABC Test, but it is possible that courts will interpret AB5 in a way that permits some companies to classify workers as ICs.
Who is exempt from AB5—and who isn’t?
Prior to its passage, AB5 was the subject of major lobbying efforts on both sides of the issue. The result is that over 50 professions or types of businesses are exempt from the bill. Exemptions include doctors, dentists, insurance agents, lawyers, accounts, real estate agents, hairstylists, and a variety of creative professionals.
However, AB5 also exempts business-to-business contractors that meet 12 specific requirements and referral agencies that meet 10 specific requirements. This keeps the door open for establishing a sound business-to-business relationship between hiring companies/ referral agencies and independent contractors, but also requires a deliberately planned strategy to achieve compliance with all of the various requirements.
To be clear, exemption from AB5 does not mean that workers can automatically be classified as independent contractors by virtue of waving some kind of classification magic wand. Rather, it means the former Borello test will be used to determine their classification for both wage-order and non-wage-order claims. So structuring and documenting the independent contractor arrangement to comply with the multi-factor test is crucial for exempt businesses.
Are there implications outside California?
Very likely, yes. In recent years, 20 states have already implemented the ABC Test in one form or another, although primarily in relation to unemployment insurance or workers’ compensation claims. The passage of AB5 could certainly hasten the ABC Test trend and expand it not only to other states but to other claim types. Because California’s economy is larger than any other US state, legal and political developments there tend to have a ripple effect both across other states and at the federal level.
Since it is certainly possible similar bills will begin to pop up elsewhere, businesses operating outside of California should be proactive in shoring up the appropriate independent contractor processes and relationships now. Though it will take some time for any new legislation to actually be passed, that legislation could be applied retroactively so the sooner a company’s ducks are in a row, the better.
Is it time to start panicking yet?
Planning, not panic, is the most helpful here. There’s no doubt that AB5 will have a meaningful impact, both inside and outside California. But again, how the law will be interpreted and applied remains to be seen. Certainly, fear of non-compliance is justified, but there are some proactive steps to take.
If you operate in California, it’s a good idea to start acting now. If you operate outside of California, you have more time, but taking the necessary steps now could save you some sleepless nights later.
What steps can my business take?
- Get the right legal counsel. First things first, consult an attorney that specializes in independent contractor and employment law. Seek out a specialist that has a full grasp of the nuances and who understands the possibilities for structuring the independent contractor relationship.
- Assess your risk. Under guidance from your counsel, conduct an audit of your independent contractor management processes. Every touchpoint with an independent contractor is relevant here to help you understand what is and isn’t compliant. A comprehensive audit would take a wide view to include:
- engagement guidelines
- contractual terms
- IC incorporation requirements
- rate negotiations
- documentation processes
- work structure and level of control
- staff and IC interactions
- Leverage technology. The right technology can help you structure your business’s relationship with independent contractors to minimize risk. You’ll want a platform and managed service provider that can help you with the risk assessment in step 2 but also provide guidance on and implement best practices specific to your industry, independent contractor relationship model, and changing regulations. It’s critical that this solution also includes comprehensive documentation of your company’s relationship with the IC at every stage of the IC lifecycle.
- Create separation. Establishing an arm’s length, business-to-business relationship with independent contractors is one of the most important steps you can take to stay compliant, no matter what state you’re in. AB5 specifically exempts business-to-business contractors from the ABC Test as long as they meet a set of 12 criteria—all of which demonstrate that the contractor operates as their own business entity.Implementing technology can act as the intermediary between you and the independent contractor to support a business-to-business model while also providing the necessary tools for the contractor to establish themselves as a separate business.
Final thoughts: Are there other unintended consequences we may see?
The fallout from AB5 is not limited to companies utilizing independent contractor workforces. Two very significant issues will quickly be felt by all California residents:
- The ineligible worker fallout. Federal law, through the Form I-9 process, requires employers to verify that every employee is eligible to work in the United States at the time of hire. This is the “show your passport or social security card” process we have all been through—unless you are an independent contractor. Independent contractor eligibility to work in the US is spotty at best. In fact, some experts estimate that ineligible workers may make up as much as 25% of the total Uber/Lyft workforce in some areas. How will California potentially absorb tens of thousands of workers in the event that they are suddenly turned away from Uber and Lyft because they cannot meet I-9 requirements? No one is quite sure.
- Increased costs to businesses and consumers. Experts predict that shifting a transportation-related independent contractor workforce to an employee workforce can increase the cost of labor by 35% or more. With razor thin margins in most of the transportation industry, this translates to some serious cost increases to both businesses and consumers in California. Some estimate that Uber fares would need to increase by 20% or more to accommodate those increased labor costs. Those $20 fares are now $24 or more. Are Californians willing to tolerate this? No one is quite sure.
Updated January 28, 2020
In a win for the trucking industry, the Southern District of California has granted a preliminary injunction prohibiting California state officials from enforcing AB5 against motor carriers. The California Trucking Association (CTA) successfully argued the Federal Aviation Administration Authorization Act (FAAAA) preempts the state’s application of AB5.
“Here, however, there is little question that the State of California has encroached on Congress’ territory by eliminating motor carriers’ choice to use independent contractor drivers,” wrote Judge Roger T. Benitez of the U.S. District Court for the Southern District of California in his concluding report.
So what does all this mean? The injunction will remain in place while the CTA’s lawsuit goes to trial. The legal standard for worker classification will revert to the multi-factor Borello test for the duration of the injunction. However, this injunction only applies to the trucking (a designation which in and of itself could be open to interpretation).
While this constitutes a temporary win for the trucking industry, it is critical to note that the interpretation of AB5 will likely play out in the courts for a long time to come. And with similar legislation now in place in New Jersey, and pending in states like New York and Illinois, this issue will not simply go away soon. For now, businesses–in transportation and beyond–that utilize a 1099 workforce may best be served by looking at their processes and finding ways to establish and reinforce a business-to-business relationship with independent contractors.