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New California Law AB 5 Greatly Impacts Independent Contractor Relationship

A new California law, AB 5, effective January 1, 2020, establishes a new three-pronged test that a business must satisfy to maintain that a worker is an independent contractor for employment purposes in the state.

The Dynamex case that the bill is modeled after held that there is a general presumption that most workers are employees and should be classified as such, with the burden of proof on employers to classify individuals as independent contractors by using what is now referred to as the “three-pronged ABC test.” The ABC test is much narrower than the standard previously used in California, which had made it far easier to classify workers as independent contractors. Consequently, for many employers, AB 5 could represent a costly change and expansion of potential risks and exposures including, but not limited to, the following:

  • Wage and hour risks. Misclassification of workers who are eligible for overtime could result in significant legal exposure for businesses.
  • Workers’ compensation programs. Beyond the fact that more individuals will now be eligible for statutory workers’ compensation benefits in the event of work-related injuries, the reclassification of independent contractors will almost certainly increase the cost of insurance for many employers.

While AB 5 applies to California, lawmakers in other states have expressed interest in passing similar legislation. That means businesses not directly affected by the new law should keep an eye on its progress and consider how similar legislation elsewhere could affect their organizations.

Although AB 5 is expected to face legal challenges and there remain unanswered questions, businesses with independent contractors in California should nonetheless begin to prepare. 

What is the three-pronged ABC test?

Under the ABC test, for a worker to be classified as an independent contractor, an employer must first prove the following:

  1. The worker is free from the control and direction of the hiring company “in connection with the performance of the work, from both a ‘practical perspective’ as well as under the contractual agreement between the parties”;
  2. The worker performs work that is “outside the usual course of the hiring company’s business”; and
  3. 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 ABC test is a much stricter standard of proof than the previous test, and, for most companies, meeting all of the above standards set forth in the ABC test will be challenging. It appears that the failure to prove any one of these three prerequisites will be sufficient to establish that the worker is an included employee, rather than an excluded independent contractor. In particular, the “B” standard is a large change in the rules.

Who is exempt from AB 5 and who isn’t?

Prior to its passage, AB 5 was the subject of major lobbying efforts on both sides of the issue. As its nickname, the “gig worker bill” suggests, much of the discussion around AB 5 has focused on its effects on Uber and Lyft-type businesses. But the impact is considerably larger than that, with the potential to touch nearly all companies in California that use independent contractors. However, as it stands now, approximately 50 professions or types of businesses are exempt from the bill. Exemptions include doctors, dentists, insurance agents, lawyers, accountants, real estate agents, hairstylists, and a variety of creative professionals. In addition, AB 5 also exempts business-to-business contracts that meet specific requirements.

An exemption from AB 5 does not mean that workers can automatically be classified as independent contractors. For the vast majority of the exemptions, the bill provides that the determination of employee or independent contractor status shall be governed by the old test.

Take action now!

Although AB 5 is expected to face legal challenges and there remain some unanswered questions, businesses should prepare to adapt to the new law if they have any independent contractors in California and to understand the potential impacts of a similar law in their state. We strongly encourage you to consult with legal counsel experienced in employment practice matters to review your independent contractor relationships, to determine the appropriateness of these classifications, and to assist you, if necessary, if you are subject to AB 5 to determine if reclassifications may be required to mitigate potential business exposure.