California’s new independent contractor law, Assembly Bill 5 (“AB 5”), creates a strong legislative preference in favor of employer-employee relationships. As a result, few independent contractor relationships will be lawful after January 1, 2020.

Misclassification of employees as independent contractors can result in liability under state and federal law for wages, taxes, and benefits, as well as fines and penalties. Those concerned about avoiding these liabilities should review independent contractor relationships and make necessary changes now.

The ABC Test and Exceptions

Businesses first must take stock of their independent contractor relationships.  Who receives those “1099s”? 

The next step is assessing whether AB 5 requires the so-called “ABC Test” to apply, and whether the independent contractor will “pass” it.  AB 5 mainly is contained in Labor Code section 2750.3. In essence, the relationship between a hiring entity and a service provider – whether an individual or a third party business – is evaluated in one of two ways: under the “ABC Test,” or under a multi-factor analysis called “Borello” for short, named after a California Supreme Court case.

AB 5 applies the ABC Test by default unless an exception applies. The difference between the ABC and Borello analyses may be the difference between a finding of employee or independent contractor status. Therefore, the hiring entity should review section 2750.3 to see if there is a potential exception under which Borello may apply instead.

Borello is preferable to the ABC Test because it is a “totality of the circumstances” analysis. The most important factor is the hiring entity’s “right to control” the method and means of the contractor’s work. After that, however, courts and agencies weigh and consider several factors; not all must be present.

The ABC Test, on the other hand, is cut-and-dried. The hiring entity has the burden of proving all three factors. So, if proof of just one factor is absent, the contractor is an employee. Many independent contractors will fail part “B”: “The person performs work that is outside the usual course of the hiring entity’s business.”  This means, unless an exception applies, any “independent contractor” engaged to perform work related to the “core” of what the hiring business is selling is an employee.  There is no such condition under the Borello analysis.

Similarly, unless the contractor actually operates an independent business, even before the current hiring entity’s engagement, the contractor may fail part “C” of the ABC Test. The Borello analysis does not require as rigorous an analysis.

Revising Independent Contractor Agreements

As stated, AB 5 exempts from the ABC Test a variety of service providers, such as doctors, lawyers, certain other licensed professionals, professional service contractors, real estate agents, and others. Even an exempted class of worker may not qualify as an independent contractor, however. The hiring entity still must ensure that the independent contractor relationship will satisfy the traditional Borello analysis.

AB 5 imposes additional requirements for those classes of independent contractors exempt from the ABC Test, depending on the exemption.  For example, to qualify for Borello, professional service contractors (e.g., certain marketing and human resources professionals) must maintain a separate business location, have a business license, set or negotiate rates, and set their own hours, among other requirements. 

Independent contractor agreements must be revised to incorporate these new statutory requirements. For example, because a human resources contractor must have a separate business location and business license, these requirements should be included in the agreement.  

Because of AB 5’s varying requirements, depending on the particular exemption, a “one size fits all” approach to a properly drafted agreement is not an option.  Hiring entities should not be tempted by templates, or by allowing their independent contractors to present boiler-plate agreements without analyzing and revising them as needed.  Additionally, indemnification and insurance requirements should be carefully considered and strongly drafted.

Reassessing Relationships With Improperly Classified Workers

Another challenge is how to address misclassified contractors going forward. Of course, the hiring entity may choose to employ the worker directly. Alternatively, a hiring entity may choose to utilize a third party to assist in managing a contingent workforce.  For example, if the entity has a large number of software programmers performing similar duties infrequently, it may choose to facilitate work through a third-party employer that will manage payroll, provide benefits, and perform similar administrative functions.  These arrangements may come with problems of their own, of course, such as “joint employer” liability. 

Those businesses hiring former contractors directly may have to confront challenges to existing business practices. For example, former independent contractors may not be comfortable with rigorous timekeeping. They may wish to work remotely, or for irregular or sporadic numbers of hours. They may not understand or wish to comply with meal and rest period requirements.  They may desire to continue to work for multiple employers, some of whom may be in competition.  Overtime, bonuses, paid time off, healthcare and other benefits, and other compensation issues may complicate what used to be a straightforward compensation system. 

These and other similar changes may require hiring entities to look more broadly at their policies, procedures, and benefit plans to ensure they want and are able to adapt to these relationships.

In sum, hiring entities seeking to retain former contractors as employees will have to communicate candidly and consider flexibility to ensure that the conversion to employee status is a “win-win.”  Competent legal counsel must help assess the potential risks and rewards of the different approaches.