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AB 5 – CA’s New Independent Contractor Law – What Employers Should Know – Part 1

by D. Gregory Valenza | | September 19, 2019

OK, AB 5 was just signed into law. It’s very long. You can read it in final form here.

First, some general comments. What we’re going to accomplish here (I hope) is to provide some guidance as to what the law covers, and what tools are required to understand how the law is going to work.  This post covers most of the law.  I will cover the rest, including the confusing “business-to-business” section, in Part 2.

Even if I accomplish my goal, readers responsible for classifying workers probably should obtain legal advice. But at least you’ll be able to understand better what your lawyer tells you. And you’ll better be able to understand if your lawyer is on top of things.  That’s the objective, anyway. 

Now, I’m not even going to pretend to address every scenario that arises under this law. Why?  Well, I have ground glass to eat and obligations of my own and such.  Seriously, the law is complex, and many definitive answers are industry- and employer-specific. In fact, even the bill’s effective date is not straightforward.  On the one hand, the independent contractor legal standards in general aren’t changing. They are based on existing case law (principally two California Supreme Court cases).  So, much of the law already was in effect and so that part of the law is “retroactive.” Independent contractor-employee disputes that were already covered by the Dynamex case and the ABC Test therefore will continue (such as claims arising under violations of Wage Orders).  

What is changing, and in a big way, is which standard applies to what situation. That is, AB 5 sets out how the ABC Test applies to particular businesses and individuals, and how it applies to particular claims. So, the law’s exceptions and exclusions may take effect at different times, The law also contains specific retroactivity provisions that are confusing and that may affect existing claims and relationships, depending on the section that applies.

Bottom line: Much of the law will take effect on January 1, 2020, if it doesn’t apply already.  Other parts take effect in July 2020.  A few parts will sunset or expire.  Most will not. We will have to see what the courts say as litigation unfolds.

In general,  the plan for employers should be the following:

  1. assess independent contractor relationships
  2. determine if they can exist under the new law
  3. fix them if they can exist, and / or
  4. if they cannot exist, plan for how to convert contractors to employee status to mitigate potential liability. 

Why are you still reading? Like, now!  OK, first you can read the rest of the post.  

Here is a summary of what you have to know:

  1. You Have to Know the ABC Test and the “Borello” Test.

Remember, last year, the California Supreme Court held in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903 that independent contractor status in some circumstances would be evaluated under the so-called “ABC” Test.   The employer has the burden of proof.  If one of the three elements of the ABC test fails, the worker is an employee.   What is the ABC Test? We blogged about it (here) and wrote an article (here).  OK, one more time, just for you:

(A) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;

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

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity. 

If the ABC Test applies, chances are it will be difficult to find an independent contractor relationship for many types of independent engagements.  

Now, what makes AB 5 dangerous for employers is that it drastically expands when the ABC Test will apply.  Therefore, it eradicates many independent contractor possibilities.  The California Supreme Court held that the ABC Test applied only to claims brought under the Industrial Welfare Commission Wage Orders.  But AB 5 now makes the ABC Test applicable to any claim under the Labor Code (including Workers’ Comp, eventually), or any unemployment claim, unless an exclusion applies (discussed below). 

The Borello test is based on another California Supreme Court decision, S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989).  The Borello test is the principal way courts evaluated the bona fides of independent contractor relationships before Dynamex endorsed the ABC Test, and before AB 5.  

The Borello test will continue to loom large, even under AB 5.  It is a multi-factor analysis, that focuses on “economic realities.” The most important factor is the hiring entity’s “right to control” the contractor (akin to Factor A of the ABC test).  In addition, the courts consider a number of other factors, many of which are relevant to the ABC Test as well. But, unlike the ABC Test, not every factor has to be present when the Borello test is applied.  You can read more about the Borello test here.  

2.  AB 5 – General Rule 

AB 5’s general rule is codified at Labor Code section 2750.3(a).  It says:  

(a) (1) For purposes of the provisions of this code and the Unemployment Insurance Code, and for the wage orders of the Industrial Welfare Commission, a 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.

See the ABC Test built right into the law?  So, that means that unless one of the exceptions / exclusions in the rest of the law applies, the ABC Test controls whether a worker is an independent contractor or employee, anywhere in the Labor Code or the Unemployment Insurance Code. 

Below are several of the exclusions and when they apply.  I will cover the rest of them in the next post. 

3. Specific Exclusions – Drs., Lawyers, Licensed Professionals, Other Professionals, and More 

Section 2750.3(b) contains specific exclusions to the general rule.  The analysis of whether someone is an independent contractor or employee will be controlled by Borello, not the ABC Test, for the following types of workers:

(1) A person or organization who is licensed by the Department of Insurance pursuant to Chapter 5 (commencing with Section 1621), Chapter 6 (commencing with Section 1760), or Chapter 8 (commencing with Section 1831) of Part 2 of Division 1 of the Insurance Code.
(2) A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California pursuant to Division 2 (commencing with Section 500) of the Business and Professions Code, performing professional or medical services provided to or by a health care entity, including an entity organized as a sole proprietorship, partnership, or professional corporation as defined in Section 13401 of the Corporations Code. Nothing in this subdivision shall apply to the employment settings currently or potentially governed by collective bargaining agreements for the licensees identified in this paragraph.
(3) An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant.
(4) A securities broker-dealer or investment adviser or their agents and representatives that are registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the State of California under Chapter 2 (commencing with Section 25210) or Chapter 3 (commencing with Section 25230) of Division 1 of Part 3 of Title 4 of the Corporations Code.
(5) A direct sales salesperson as described in Section 650 of the Unemployment Insurance Code, so long as the conditions for exclusion from employment under that section are met.
(6) A commercial fisherman working on an American vessel as defined in subparagraph (A) ***** [details omitted, including sunset].

4.Specific Exclusions – Professional Service Contractors (HR Consultants, Still Photographers, Freelance Writers and Others]

Section 2750.3(c ) excludes from the ABC Test a number of service providers who meet the following criteria.  Borello, of course will apply once the contractor and hirer meet the following elements of the law. 

(A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity. Nothing in this subdivision prohibits an individual from choosing to perform services at the location of the hiring entity.
(B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession.
(C) The individual has the ability to set or negotiate their own rates for the services performed.
(D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours.
(E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work.
(F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.

N.B., Performing services at a separate location could support independent contractor status under Borello, even though this section does not prohibit working at the hiring entity’s location.  Note also this section requires the service provider to have a business license

Now, who are the lucky (or well-represented by lobbyists) professionals who may take advantage of this exception?

(i) Marketing, provided that the contracted work is original and creative in character and the result of which depends primarily on the invention, imagination, or talent of the employee or work that is an essential part of or necessarily incident to any of the contracted work.
(ii) Administrator of human resources, provided that the contracted work is predominantly intellectual and varied in character and is of such character that the output produced or the result accomplished cannot be standardized in relation to a given period of time.
(iii) Travel agent services provided by either of the following: (I) a person regulated by the Attorney General under Article 2.6 (commencing with Section 17550) of Chapter 1 of Part 3 of Division 7 of the Business and Professions Code, or (II) an individual who is a seller of travel within the meaning of subdivision (a) of Section 17550.1 of the Business and Professions Code and who is exempt from the registration under subdivision (g) of Section 17550.20 of the Business and Professions Code.
(iv) Graphic design.
(v) Grant writer.
(vi) Fine artist.
(vii) Services provided by an enrolled agent who is licensed by the United States Department of the Treasury to practice before the Internal Revenue Service pursuant to Part 10 of Subtitle A of Title 31 of the Code of Federal Regulations.
(viii) Payment processing agent through an independent sales organization.
(ix) Services provided by a still photographer or photojournalist who do not license content submissions to the putative employer more than 35 times per year. This clause is not applicable to an individual who works on motion pictures, which includes, but is not limited to, projects produced for theatrical, television, internet streaming for any device, commercial productions, broadcast news, music videos, and live shows, whether distributed live or recorded for later broadcast, regardless of the distribution platform. For purposes of this clause a “submission” is one or more items or forms of content produced by a still photographer or photojournalist that: (I) pertains to a specific event or specific subject; (II) is provided for in a contract that defines the scope of the work; and (III) is accepted by and licensed to the publication or stock photography company and published or posted. Nothing in this section shall prevent a photographer or artist from displaying their work product for sale.
(x) Services provided by a freelance writer, editor, or newspaper cartoonist who does not provide content submissions to the putative employer more than 35 times per year. Items of content produced on a recurring basis related to a general topic shall be considered separate submissions for purposes of calculating the 35 times per year. For purposes of this clause, a “submission” is one or more items or forms of content by a freelance journalist that: (I) pertains to a specific event or topic; (II) is provided for in a contract that defines the scope of the work; (III) is accepted by the publication or company and published or posted for sale.
(xi) Services provided by a licensed esthetician, licensed electrologist, licensed manicurist, licensed barber, or licensed cosmetologist provided that the individual:
(I) Sets their own rates, processes their own payments, and is paid directly by clients.
(II) Sets their own hours of work and has sole discretion to decide the number of clients and which clients for whom they will provide services.
(III) Has their own book of business and schedules their own appointments.
(IV) Maintains their own business license for the services offered to clients.
(V) If the individual is performing services at the location of the hiring entity, then the individual issues a Form 1099 to the salon or business owner from which they rent their business space.
(VI) This subdivision shall become inoperative, with respect to licensed manicurists, on January 1, 2022.

5. Specific Exclusion – Real Estate Agents and Repossessors

Section 2750.3(d) excludes from the ABC Test

“A real estate licensee licensed by the State of California pursuant to Division 4 (commencing with Section 10000) of the Business and Professions Code . . . .”   The determination of independent contractor status either will be governed by 10032 of the Business and Professions Code, or several statutes or Borello if that section does not apply.

A repossession agency licensed pursuant to Section 7500.2 of the Business and Professions Code, for whom the determination of employee or independent contractor status shall be governed by Section 7500.2 of the Business and Professions Code, if the repossession agency is free from the control and direction of the hiring person or entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

Real estate businesses should take a hard look at section 10032 of the BPC to see if they can qualify their salespersons under that section. 

6. The “Business to Business” Provision

As someone once said, “A camel is a horse, designed by a committee.”  Why do I bring this up? Oh, no particular reason.   Now where were we? 

Oh, right.  AB 5. So, section 2750.3(e) expressly says it does not apply to agreements between individuals and businesses.  Wait. Isn’t that what independent contractor problems are all about?  Well, yes. That’s what most people thought until yesterday.  But here we are.  Looking at section 2750.3(e).  

Subsection (e) expressly excludes individuals and expressly includes certain contracts between business entities.  Why?  What will happen? What does this all mean?   I do not know.  I do not think the Legislature knows. And I do not know if the Courts will know. So, this section deserves its own post, which I promise will be…. spicy.  Give me a couple of days to let it marinate, and let me calm down.

7.  Contractors and Employees of Subcontractors

Section 2750.3(f) excludes from the ABC Test the relationship between prime contractors and subcontractors‘ employees.  Again, weren’t we talking about whether a contractual relationship was independent versus employer-employee?  We thought so. But the Legislature decided that the relationship between prime contractor and subcontractor will be determined by Borello and Labor Code section 2750.5, but only if the contractor can prove the following: 

(1) The subcontract is in writing.
(2) The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license.
(3) If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration.
(4) The subcontractor maintains a business location that is separate from the business or work location of the contractor.
(5) The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services.
(6) The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided.
(7) The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.
This means that if the Prime Contractor cannot prove all of the above, section 2750.5 or Borello will not apply, and only the ABC Test will control.
This section also covers construction trucking services, for which no contractors license is required (so (2) above would not be applicable).  However, the law sets out a number of additional requirements for construction trucking that I will not repeat here.  From what I was reading, the goal is to ensure that as many construction trucking workers are employees as possible. 

8. Special Note Re: Workers Compensation

The Workers’ Compensation Act is in the Labor Code. The Legislature expressly applies Section 2750.3 and its exceptions etc. to the Workers’ Compensation Act by enacting Labor Code section 3351 as part of AB 5.  That section is not retroactive, and will take effect July 1, 2020.  The point is that the Workers’ Compensation Appeals Board will have to use Section 2750.3 (the ABC Test or an exclusion) to determine whether someone is entitled to workers’ compensation benefits (as an employee) or not (as an independent contractor).  

Next Post – AB 5 Part 2 – Coming Soon.  

In my next post, I will cover the “business to business” issue, the remaining exclusions, and some additional analysis of this statute. 


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