In its April 2018 decision in Dynamex Operations West, Inc. v. Superior Court, the California Supreme Court considered the criteria that courts should utilize to distinguish independent contractors from employees under the California Wage Orders, and substantially changed state law by adopting the restrictive standard commonly known as the “ABC test.” Almost a year and half later, on September 18, 2019, Governor Gavin Newsom signed Assembly Bill 5 (“AB5”), legislation that will, upon its effective date of January 1, 2020, affirm some aspects of the California Supreme Court’s ruling in Dynamex, and resolve many of the issues left open by the court.
The passage of AB5 adds Section 2750.3 to the Labor Code, which specifically codifies the so-called “ABC test” adopted by the California Supreme Court. Accordingly, a company that wishes to classify a worker as an independent contractor will continue to bear the burden of proving that:
- the worker is free from control and direction in the performance of the work, both under the terms of the contract and in fact;
- the worker performs work that is outside the usual course of the hiring entity’s business; and
- 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.
The hiring party must satisfy all three criteria in order for a valid independent contractor relationship to exist. Additionally, AB5 makes clear that its dictates are declaratory of existing law, rather than a change in the law, and therefore applicable retroactively.
Beyond merely codifying the Dynamex ruling, AB5 expands application of the “ABC test” to all claims brought under the Labor Code and the Unemployment Insurance Code, whether or not those claims arise under a Wage Order. In effect, AB5 adopts the “ABC test” as the standard for evaluating independent contractor classification disputes in connection with minimum wage, meal and rest period, overtime pay, unemployment insurance, paid sick leave, and workers’ compensation claims, as well as any other right conferred upon employees via the Labor Code, Unemployment Insurance Code, or the Wage Orders.
Finally, while the Dynamex decision applied to all workers in all industries, AB5 and the resulting codes contain numerous exemptions for certain industries and certain professions. For example, Labor Code Section 2750.3 exempts from application of the “ABC test” a host of specified occupations, including physicians, surgeons, dentists, podiatrists, psychologists, veterinarians, lawyers, architects, licensed engineers, private investigators, accountants, investment advisors and commercial fishermen. Disputes regarding the classification of a person occupying one of these exempted positions remain subject to the traditional multi-point test focusing on the right to control the manner and means of an alleged employee’s work.
What Should Employers Do Now?
As a result of AB5 and the resulting addition of Labor Code Section 2750.3, California employers can anticipate a significant rise in misclassification claims brought by independent contractors. Employers may best prepare themselves by taking these steps:
- Be especially alert to “B” in the "ABC test” – Do not classify persons you hire and pay directly (in contrast with persons you pay through a business entity) as independent contractors if they perform work that is integral to your business.
- Whenever possible, contract with a corporation or a limited liability company for necessary labor, rather than with individuals – In Curry v. Equilon Enterprises, LLC, a California appellate court offered some relief to employers by holding that the "ABC test” does not apply in a “joint employment” scenario in which a worker is officially employed by a business entity such as a corporation or limited liability company, but provides service as a “leased employee” or contractor to a different party. The Curry decision represents a substantial victory for businesses that contract with other companies to fill their staffing needs, as do a substantial number of large companies throughout California. The Curry decision suggests that a company that contracts with another for labor will not be deemed the employer of the leased employees under the “ABC test” as long as the employees are treated as employees and paid on a W-2 basis by the staffing company, although the impact of AB5 on the Curry decision is uncertain at this time.
- Audit existing classifications with the protection of attorney-client privilege – Employers should review the validity of their existing contractor classifications under the “ABC test” standard. Prudent employers will conduct any assessment of their contractors under the guidance of counsel to assure that the outcome of the assessment is protected by the attorney-client privilege and cannot be used against the company in the event of a later dispute.
- Address re-classifications strategically and carefully – If an independent contractor classification is identified as potentially vulnerable to a challenge, confer with counsel and consider the potential options strategically. Employers should remember that re-classification can serve as a double-edged sword – it can eliminate potential future liability, but can also increase the risk of liability for the period during which the contractor classification was in effect. Clumsy or poorly conceived re-classifications may serve only to exacerbate an employer’s liability. In deciding how to address a misclassification, employers should consider factors such as the number of misclassified contractors involved, whether misclassified contractors are still providing service to the company, whether misclassified contractors should have been treated as exempt or non-exempt employees, and the extent to which misclassified contractors who should have been treated as non-exempt employees may have worked overtime.
- Review and update independent contractor agreement templates – Employers that utilize the services of independent contractors should review their contract forms with Labor Code Section 2750.3 in mind, and update their agreements as appropriate. Employers should consider adding or revising independent contractor arbitration provisions to include class action waiver limitations in connection with misclassification claims.
If you have any questions about independent contractors, or any other issue relating to employment law, please contact one of our attorneys: