Independent Contractors and Employees: an AB 5 Primer

What small businesses and nonprofits need to know about hiring independent contractors under California's landmark new labor laws.

On January 1, 2020, California's Assembly Bill 5 went into effect. This legislation passed by the legislature last September seeks to affirm, codify, and provide some more nuance to a landmark California Supreme Court ruling that's already been in effect for over a year. Together overall, these new laws make it more difficult for employers to hire someone as an independent contractor (a.k.a. a “1099 worker” or “1099 contractor” per the IRS tax form used for these workers) instead of as an employee. Many businesses and nonprofit organizations prefer to hire some workers as independent contractors instead of as employees to reduce costs and administrative hassles. Hiring employees entails complying with numerous legal requirements such as having a workers' compensation insurance policy in place for each worker to cover any job-related injuries, paying at least minimum wage, paying a higher hourly rate for overtime work, and paying payroll taxes, among other requirements that are more onerous and costly than hiring an independent contractor.

This blog post provides some political context to recent changes in California workers' rights laws and summarizes the new laws that anyone in a leadership position in any small business, nonprofit, or cooperative should know about.

Important Disclaimer: This blog post is a general summary of new laws in California intended for general information purposes only; it’s not offered as legal advice. This post does not cover all of the nuances of employment law, not even all of the nuances of the recent changes. If you have questions about how the new laws apply to your business or nonprofit please contact me for a consultation to discuss your specific situation.

First let's start with a discussion of the California Supreme Court's landmark ruling and then we'll get into AB 5.

What is Dynamex?

In April, 2018 the California Supreme Court issued a ruling in the case Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018) (“Dynamex”). The Dynamex case upheld a relatively strict standard called the “ABC Test” for determining whether a worker can be legitimately classified as an independent contractor instead of as an employee. Previously, most employers had been relying on a looser set of criteria regarding which workers could be treated as independent contractors as spelled out in a prior court ruling, S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (“Borello”). In Borello and in prior case law, the criteria for determining who can be an independent contractor were multifaceted (and I won't delve into all the criteria in this post), but one major factor has been the extent to which the employer controls the means and manner of the performance of the work. Before Dynamex, in situations where a business owner hires someone to accomplish a task, say to deliver a package, and where the worker has control over the means and manner of accomplishing that work, say the worker can decide what route to take to deliver the package, what vehicle or mode of transportation to use, and exactly what time the work will be performed, then it was possible that a court would conclude that this worker may be treated as an independent contractor. Other factors that favored treating a worker as a contractor included whether the worker used their own tools or equipment to perform the work, and if the worker is in the business of regulatory providing similar services to numerous clients or customers, but none of those factors alone were decisive.

Abuse of Independent Contractor Status by “Gig Economy” Tech Giants

Big Tech companies in the “gig economy” such as Uber, Lyft, Postmates, TaskRabbit, and so many others have become notorious for exploiting the use the independent contractor relationship with their drivers, delivery workers, errand runners, task rabbits, etc. Many workers' rights advocates have insisted that such “gig economy” workers should be treated as employees of the tech companies whose platforms solicit their labor. By arguing that such “gig economy” workers exercise “control” over how they accomplish their work, and that tech platforms are merely a marketplace where a service provider (such as a driver) and a customer (such as someone who needs a ride) can connect, Big Tech has argued that their companies don't have to treat service providers as employees. However, in many ways these tech giants actually do exercise a lot of control over the working conditions of workers. For example, Uber adopts strict policies that drivers must follow, including policies that drivers must accept a certain number of rides while on the platform, even when accepting certain rides is not cost effective for the driver. Additionally, many gig economy tech platforms dictate the rates of pay of workers, whereas traditionally independent contractors set their own rates or negotiate rates with clients or customers. There have been numerous court battles revolving around the status of “gig economy” workers and tech platforms in addition to extensive political discourse over whether it has been proper for these tech giants to treat workers as independent contractors.

ABC Test

Back to the landmark Dynamex ruling: in this case the court upheld a stricter set of standards for determining when an employer can evade the costs and hassles of treating workers as employees. The Dynamex ruling upheld what's known as the “ABC Test” where the law presumes that a worker is an employee, unless an employer can show that its relationship to the worker meets all three of the following criteria:

(A) The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

(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 that involved in the work performed.

Thus in the ABC Test, not only is it vital that the independent contractor have control over the performance of their work as has traditionally been the case with independent contractors, but the relationship must also meet the other two prongs B and C above. This is a very stringent set of standards that has prompted concern among many enterprises and organizations that pay people to do work.

However, the law actually just became even more nuanced with AB 5.

What is AB 5?

Almost immediately after the Dynamex ruling there was talk among the California Legislature and business leaders, especially those in Big Tech, about possibly amending state law to undermine the effects of this ruling. Even many lawmakers on the pro-labor left had concerns about the the ABC Test in the Dynamex being overly broad and having harmful effects. Thus, the legislature could no longer evade taking action on this highly controversial topic of independent contractors in the “gig economy.”

The headline-grabbing legislation that passed in the California Legislature as a response to the Dynamex ruling was AB 5. It was introduced and carried by the powerful San Diego Assemblymember Lorena Gonzalez, who had a long career in labor unions prior to her election to the Legislature. The bill was signed by the Governor in September. In the preamble to AB 5 the Legislature declares among other things that “[t]he misclassification of workers as independent contractors has been a significant factor in the erosion of the middle class and the rise in income inequality.”

More specifically, AB 5 uplifts and codifies the three-part ABC Test as described above, however, in response to concerns raised by legitimate small business owners who perform freelance work for numerous different clients as independent contractors, it creates a few exemptions from the ABC Test where it’s permissible to use the older, more flexible criteria for determining whether someone can be treated as an independent contractor.

For small businesses and nonprofits, one especially notable exemption from the stricter ABC Test is for legitimate “business-to-business” contracts that meet numerous requirements including that the “business service provider is providing services directly to the contracting business rather than to customers of the contracting business.” (California Labor Code § 2750.3(e)(1)(B)) In this clause the legislature seems to be thinking about gig economy workers, such as Uber drivers among many others, who provide services directly to customers of a business, rather than to the business itself. Thus, in this business-to-business exemption, the legislature has arguably tried to exclude most gig economy laborers and seems to call on the tech companies to treat Uber drivers, delivery workers, etc. as employees, not independent contractors. Meanwhile, this clause in AB 5 will hopefully open up opportunities for other legitimate small business owners to work as independent contractors for clients.

More about the Business-to-Business Exemption

Per AB 5, “business-to-business” transactions are able to use the older more flexible criteria (from the Borello case) for determining whether someone is an independent contractor, provided that the relationship meets all of the following criteria:

(A) The independent contractor is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.

(B) The independent contractor is providing services directly to the hiring entity rather than to customers of the hiring entity.

(C) The contract for services is in writing.

(D) If the work is performed in a jurisdiction that requires the independent contractor to have a business license or business tax registration, then independent contractor has the required business license or business tax registration.

(E) The independent contractor maintains a business location that is separate from the business or work location of the hiring entity.

(F) The independent contractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

(G) The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity.

(H) The independent contractor advertises and holds itself out to the public as available to provide the same or similar services.

(I) The independent contractor provides its own tools, vehicles, and equipment to perform the services.

(J) The independent contractor can negotiate its own rates.

(K) Consistent with the nature of the work, the independent contractor can set its own hours and location of work.

(L) The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required (i.e. the independent contractor is not doing construction, repair, or landscaping work). (California Labor Code Section 2750.3(e))

Other Exemptions

There are many other exemptions in AB 5 that are specific to certain professions or industries, but this blog is getting a little long so I will stop here. Stay tuned for a forthcoming blog about other exemptions from application of the ABC Test.

If you’d like to discuss these new employment laws and how they affect your business, organization, or cooperative, please contact me for a consultation.

Updates: I have a second blog post here summarizing some additional exemptions from the strict ABC Test provided by AB 5. Also, the California Attorney General and numerous major city attorneys in California have announced that they are suing Uber and Lyft, seeking to force these tech giants to treat Uber and Lyft drivers as employees, pursuant to these new laws.