The CaliforniaLegislature introduced AB 5 to codify the ABC test set forth in theDynamex holding and proposes additional parameters to specify towhom and when the ABC test applies. (Photo: Shutterstock)

In May, the California State Assembly overwhelminglypassed a bill set to have a major impact on how companies classify their workers in the state. AssemblyBill 5 (AB 5) aims to codify the new standard expounded byDynamex Operations West, Inc.  v. Superior Court ofLos Angeles for determining whether workers regulated by the17 Wage Orders in California are employees or independentcontractors.

Proponents of AB 5 see it as a means to address inadequateworkplace protections and loss of revenue due to underpaid payrolltaxes, workers’ compensation premiums, state unemployment, anddisability insurance. Critics, however, argue that the bill harmsworkers’ schedule flexibility and opportunities for supplementalincome.

Related: Employers could win big on latest DOL gig workerdecision

AB 5 must still pass the State Senate and be signed by thegovernor. But if AB 5 becomes law, certain industries whereindependent contractors are prevalent may face increased laborcosts, as many of those workers require reclassification toemployee status and obtain all the benefits and protections ofemployee status triggered under state law.

Origins of AB 5

The Dynamex case arose when a nationwide courier and deliverycompany reclassified its drivers from employees to independentcontractors in 2004. The drivers brought a class action lawsuitalleging they had been misclassified, given that they performedessentially the same tasks in the same manner as when they wereemployees.

On April 30, 2018, the California Supreme Court issued itsmonumental ruling in the Dynamex case in favor of a new legalstandard under state law for classifying workers regulated by wageorders. The decision marked a dramatic departure from the priortest governing worker classification. For several decades,California courts used the Borello test to determine whether aworker was an employee or an independent contractor. The Borellotest was a facts-and-circumstances test that used multiple factorsbut placed particular emphasis on the factor of “whether the personto whom services is rendered has the right to control the mannerand means of accomplishing the result desired.” The Borello test ismore flexible and easier to establish independent contractor statusunder.

The Dynamex Court rejected the Borello test and adopted a newstandard dubbed the “ABC” test. Under the ABC test, a worker is anindependent contractor only if:

1.  The worker is free from the control and direction ofthe hirer in connection with the performance of the work, bothunder the contract for the performance for such work and infact;
2. The worker performs work that is outside the usual course ofthe hiring entity’s business; and
3. The worker is customarily engaged in an independentlyestablished trade, occupation, or business of the same nature asthe work performed for the hiring entity.

The court explained that the first prong aligns with the commonlaw test for employment, evaluating the degree of control exercisedby the company over the worker. The second prong examines whetherthe worker can reasonably be viewed as working in the hiringcompany’s business. Lastly, the court provides that the third pronginquires whether the worker independently made the decision to gointo business. The fact that the hiring company does not prohibitthe worker’s engagement in such an independent business is notsufficient.

Impact of AB 5 on companies

The California Legislature introduced AB 5 to codify the ABCtest set forth in the Dynamex holding and proposes additionalparameters to specify to whom and when the ABC test applies.

In its current form, AB 5 exempts several professions includinglicensed insurance brokers, licensed physicians and surgeons,registered securities broker-dealers or investment advisers, directsalespersons (if compensation is based on actual sale), real estatelicensees, hairstyling and barbering (if the worker is free fromdirection or control from the contracting entity), and professionalservice providers working under a contract with another businessentity. In such cases, the original worker classification testdescribed in Borello will continue to govern.

In addition to codifying Dynamex, the bill provides that forpurposes of the Labor Code, the Unemployment Insurance Code, andthe Industrial Welfare Commission’s (“IWC’) Wage Orders, wheredefinition for employee is not provided, the ABC test shall apply.For example, the ABC test will be used to determine whether workersin certain industries are considered employees for purposes ofunemployment insurance, overtime pay, such as administrative,executive, or professional workers that are currently exempt fromthe IWC Wage Orders As a result, the bill may increase liabilityfor employers engaging workers newly determined to beemployees.

If signed into law in its current form, AB 5 carries sweepingconsequences for certain industries that engage a significantindependent contractor workforce. Particularly the technologyindustry that has facilitated the growth of the gig economy. Recentcues from the National Labor Relations Board and the Department ofLabor signal how worker classification for virtual marketplacecompanies might be determined on a federal level. Applying testssimilar to Borello, both agencies determined workers in this spaceto be independent contractors. Under Dynamex, the standard AB 5seeks to apply, these same workers may be classified as employees.This could unravel the gig economy for a growing percentage ofCalifornia’s workforce.

What companies should consider

The California State Assembly passed AB 5. The bill passedthrough the California Senate’s Labor, Public Employment andRetirement Committee last month and is expected to undergo morerevisions in the Senate Appropriations Committee before coming to afull vote in the Senate. If passed, it could land on GovernorNewsom’s desk in September.

If the AB 5 is passed and signed into law, employers will likelyhave a window of time to work towards compliance. Some bestpractices to consider would include:

• Performing a worker classification audit with the assistance oflegal counsel, including review of all contracts withpersonnel.
• Determine which benefits and protections should now be providedto the reclassified workers. For example, must the company’sretirement plan, health insurance and other benefits be extended tothe reclassified employees.
• Determine whether any actions must be taken to notify orcorrection prior misclassification with any state agency.
• Assess whether worker classification under state law conflictswith, or requires changes to, the company’s responsibilities underfederal law. For example, will the reclassification require thecompany to perform federal income tax withholding, FICA payment andwithholding.
• Review of messaging used to workers versus employees.

Even if AB 5 is not passed and adopted, employers shoulddetermine whether their current worker classificationdeterminations comply with applicable state and federal law. Giventhe potential impact of the proposed law, companies arewell-advised to monitor the evolution of AB 5 in consultation withlegal counsel.

By Nancy Hilu, Raymond Lynch, Jennifer Yazdi,and Nancy Dollar of HansonBridgett.

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