California Legislature: The Jig Is Up on Independent Contractors in the Gig Economy

These “gig economy” jobs have provided individuals with flexibility and autonomy in their work by allowing workers to choose when and where they want to work — a level of freedom employees do not enjoy.

The tradeoff for independent contractors, however, is that they are not provided with certain rights and protections under the law. Unlike independent contractors, workers classified as employees are subject to certain provisions of California’s Labor Code and Industrial Welfare Commission (IWC) Wage Orders, including but not limited to, entitlement to minimum wage, unemployment insurance, workers’ compensation, expense reimbursements, paid sick leave, health insurance, and social security tax contribution.

Last year, in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, the California Supreme Court redefined the test for determining whether an individual is properly classified as an independent contractor. In doing so, the 3-part “ABC test” set forth in Dynamex for determining “independent contractor” status replaced the 11-point “Borello test” upon which California employers had relied since 1989. Dynamex, however, was subsequently interpreted to only define employees for the purpose of claims brought under the IWC Wage Orders.

Last week, Governor Newsom signed Assembly Bill (AB) 5 into law. Known as the “gig economy bill,” AB 5 codified and expanded the requirements established in last year’s Dynamex decision.

ABC Test Codified

Under Dynamex, now codified as state law under AB 5, in order for a person to be properly classified as an independent contractor, employers carry the burden to show that the individual meets all three elements of the ABC test:

A. 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 and in fact;

B. The worker performs work that is outside the usual course of the hiring entity’s business; and

C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performance.

In addition to codifying the ABC test, AB 5 also expands the class of individuals who have standing to pursue claims for misclassification. Now, the California Attorney General and certain city attorneys can also seek injunctive relief against an employer to prevent continued misclassification.

AB 5 also expands the applicability of the ABC test to all claims brought under the Labor and Unemployment Insurance Codes.

Exceptions to AB 5

Neither AB 5 nor Dynamex completely invalidated the test outlined by the California Supreme Court in S. G. Borello & Sons, Inc. v. Department of Industrial Relations. Rather, the Borello test remains relevant not only to claims outside of the Labor and Unemployment Insurance Codes (like harassment or discrimination claims), but also to several exceptions enumerated in AB 5.

These exceptions are broken down into seven categories:

1. Specific occupations – this exception includes occupations like insurance agents, certain medical professionals, lawyers, architects, engineers, private investigators, accountants, securities broker-dealers, investment advisors, direct sales salespersons, commercial fishermen, and newspaper carriers working under contract with a newspaper publisher; 
2. Contracts for professional services between a hiring entity and an individual providing professional services;
3. Real estate licensees and repossession agencies;
4. Relationships between businesses;
5. Relationships between a contractor and subcontractor in the construction industry;
6. Relationships between a referral agency and a service provider that uses the referral agency to connect with clients; and
7.  “Motor club” services.

Note that nothing stops the California Supreme Court from changing the application of the Borello test once more to the above, the same way it did under Dynamex.

Retroactivity

The California Supreme Court did not address whether its decision in Dynamex would apply retroactively. While the Ninth Circuit in Vazquez v. Jan-Pro Franchising Int’l, Inc. concluded in May 2019 that Dynamex applies retroactively, it subsequently withdrew its opinion in July 2019 and certified the question for the California Supreme Court to answer.

AB 5 included a statement that the codification of the ABC test was simply declarative of existing law. The new law makes clear that the ABC does in fact apply retroactively. It also states that the specific exceptions to the ABC test are to be applied retroactively to the extent they would relieve an employer from liability from existing claims and actions.

However, attempts to apply Dynamex and AB 5 retroactively will most likely still meet legal challenges, despite what AB 5 says. The California Supreme Court has made clear that it is for the courts to decide what is declarative of existing law, not the legislature. It remains to be seen what retroactive effect, if at all, AB 5 will have on existing or prior claims.

Employer Takeaways

AB 5 takes effect on January 1, 2020 for purposes of claims under the Unemployment Insurance Code and all other provisions of the Labor Code. As of July 1, 2020, the ABC test will apply for purposes of workers’ compensation as well.

Employers using independent contractors should carefully evaluate whether they are doing so in compliance with California law. Not only has the test tightened with the clear intent to limit sharply the number of independent contractors, employers can face significant past wage and tax liability, as well as substantial civil penalties. While there are some carve-outs to AB 5, these exceptions come with limitations and in some cases, expiration dates.

Employers should contact their Arent Fox team in order to evaluate their employment practices and consider corrective measures before January 1, 2020 to minimize any potential liability.