As expected, California's governor has signed off on AB 5, a law making it harder for most employers to classify workers as independent contractors. The legislation will have sweeping ramifications for California employers and affect the use of independent contractors for businesses in many other states. While the law will become effective on January 1, 2020, its impact on businesses using independent contractors in California will be immediate. Employers using independent contractors in California should take steps now to understand and comply with AB 5's requirements and also consider how best to mitigate the risks it has created.
AB 5's Adoption of the Dynamex Standard for Classifying Independent Contractors
AB 5, in effect, codifies the independent contractor classification standard set forth by the California Supreme Court last year in Dynamex Operations West, Inc. v. Superior Court.1 In Dynamex, the court adopted a broad definition applicable to determining when a worker is an employee under California's Industrial Welfare Commission (IWC) wage orders. The court's decision established that in wage order disputes, the hiring entity (i.e., the company) has the burden of proving the worker is an independent contractor and not an employee.2 The court further explained that a worker can only be an independent contractor if it passes the so-called "ABC" test, and establishes that all three of the following conditions are met: (a) the worker is free from the control and direction of the hiring entity in connection with the performance of the work; (b) the worker performs work that is outside the usual course of the hiring entity's business; and (c) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.3
Significantly, AB 5 not only adopts the holding in Dynamex, but expands its applicability beyond California's wage orders to the provisions of California's Labor Code and its Unemployment Insurance Code. It makes clear that its amendment to the Labor Code "does not constitute a change in, but is declaratory of, existing law with regard to [IWC] wage orders and violations of the Labor Code relating to wage orders." In prefatory language, and no doubt in an attempt to intimidate employers into compliance, the legislation's language states that the Labor Code already makes it a crime for an employer to violate certain provisions of law with regard to an employee, and that the Unemployment Insurance Code also makes it a crime to violate specified provisions of law with regard to benefits and payments made. The law provides that California's Attorney General can prosecute employers for illegally misclassifying workers and permits the city or county attorneys of larger cities and counties to prosecute violations of AB 5.
Significantly, AB 5 exempts certain occupations from Dynamex's application, and instead provides that these occupations are governed by the independent contractor Borello test familiar to many employers and practitioners but which was not adopted in Dynamex. The occupations exempted include, among others: licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, graphic designers, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and others performing work under a contract for certain types of professional services with another business entity, or pursuant to a subcontract in the construction industry.
What Now? How Should California Employers Respond to AB 5's Passage?
Because of the ever-increasing frequency of use of independent contractors in many segments of the economy (including in most technology companies and start-ups), AB 5 is one of the most important employment laws passed in recent years. In signing AB 5, California's governor stated that the law "will help reduce worker misclassification—workers being wrongly classified as 'independent contractors,' rather than employees, which erodes basic worker protections like the minimum wage, paid sick days and health insurance benefits." The law itself notes the legislature's intent to restore "important protections to potentially several million workers [emphasis added] who have been denied these basic workplace rights that all employees are entitled to under the law."
In light of AB 5's ambitious goal of dramatically reducing worker misclassification, California employers should consider doing the following:
In taking these steps, employers should consult with counsel to ensure proper consideration of the relevant legal requirements and risks.
Wilson Sonsini Goodrich & Rosati closely follows developments in wage and hour laws, including those relating to employee classification and compliance with applicable laws. For more information, please contact Rico Rosales, Marina Tsatalis, Jason Storck, Rebecca Stuart, or any member of the firm's employment and trade secrets litigation practices.