California Governor Newsom recently signed Assembly Bill 5 (AB 5), which codifies the test used to determine if a worker is an employee or an independent contractor and added several exceptions and clarifications.
In April 2018, the California Supreme Court created a new three-part test to establish whether a worker is an employee or independent contractor with its decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles. Previously, courts weighed a range of factors to determine independent contractor classifications. In Dynamex, the Supreme Court introduced a three-element ABC test.
AB 5 now expands that test and applies it to all provisions of California’s Labor Code and Unemployment Insurance Code. Under the test, California presumes any person providing labor is an employee of the hiring entity, unless the following three criteria are met:
- 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 and in fact;
- The person performs work outside the usual course of the hiring entity’s business; and
- The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
If the person does not meet all three prongs of this ABC test, then they must be classified as an employee.
AB 5 includes several exceptions. Licensed professionals are exempt from AB 5, including lawyers, architects, accountants, and engineers. The law also creates exceptions for certain industries such as construction subcontractors and for business-to-business service providers.
Both exceptions require the independent contractor to have a written contract, proper licensing, a business independent of the hiring entity, and to operate from a separate business location than the hiring entity.
The business service provider exception also requires that the independent contractor provide services directly to the hiring business, not the hiring business’ clients; maintain a clientele separate from the business; advertise to the public as available to provide similar services to other businesses; be free from the control and direction of the hiring business; set its own rates; provides its own tools; and not perform work for which a license from the Contractors State License Board is required.
The construction subcontractor exception also requires the independent contractor have the authority to hire and fire employees and be financially responsible for errors or omissions in labor or services.
While AB 5 attempts to simplify the classification question by applying the more straightforward ABC test to the entire Labor Code, it still requires employers to the assess the elements to determine if someone they hire is a bona fide independent contractor and the many exceptions create opportunities for good-faith mistakes. AB 5 also confirms the employer still bears the burden of demonstrating that a worker is properly classified as an independent contractor.
We expect employees and employers to litigate the meaning of the new law. With civil penalties of $10,000 to $25,000 for each misclassified worker, a cautious and conservative approach in applying AB 5 is encouraged until the courts provide clarification of the proper way to apply the law and its exceptions.