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AB 5 Update: California Legislature Passes Final Bill on September 11, 2019

By Patrick Stokes, Michael Lotito, and Bruce Sarchet

September 13, 2019
20 minute read

This article is an update to prior publications from Littler’s Workplace Policy Institute regarding Assembly Bill 5 (AB 5), passed by the California legislature on September 11, 2019.

On September 11, 2019,¹ the California Legislature passed Assembly Bill 5 (AB 5). The bill entirely redefines the standard for determining whether a person providing labor or services for remuneration may be classified as an independent contractor rather than an employee. All that is left is for Governor Newsom to sign this bill, which he is expected to do.

Dynamex v. Superior Court

AB 5 is the legislature’s reaction to the California Supreme Court's opinion in Dynamex v. Superior Court (Dynamex).² The Supreme Court issued the Dynamex opinion on April 30, 2018. At that time, California courts and state agencies had long applied the common-law test the Supreme Court itself adopted in 1989, in the matter of S. G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello), to determine whether an individual could be classified as an independent contractor, rather than an employee. Throughout the intervening 29 years, California’s courts, state agencies, and businesses relied on the “Borello test” as the applicable standard. Dynamex abruptly imposed the entirely new standard, the “ABC test,” for purposes the California wage orders.³

Dynamex did not, however, completely eliminate all use of the Borello test. The California Supreme Court expressly limited Dynamex to application of the wage orders. That limitation left the Borello test in place for all other purposes, including the Labor Code and the Unemployment Insurance Code.

Despite its stated intention to bring more certainty and clarity to worker classification, Dynamex failed to address the critical issue of retroactive versus prospective application of the new test. Indeed, the court declined to clarify this issue.⁴

The question of retroactivity was taken up by the U.S. Court of Appeal for the Ninth Circuit. On May 2, 2019, the Ninth Circuit issued an opinion in Vazquez v. Jan-Pro Franchising Int'l, Inc. (Vazquez).⁵ Initially, the Ninth Circuit concluded Dynamex applies retroactively. In reaching its decision, the Ninth Circuit expressly relied on the California Supreme Court’s “emphasis in Dynamex” that its holding was “a clarification rather than as a departure from established law.” The Ninth Circuit withdrew that opinion on July 22, 2019, and declared it would certify to the California Supreme Court the question of whether Dynamex applies retroactively. However, the Supreme Court often takes years to respond to such requests, so it will likely not issue any decision on the issue before late 2020.⁶

Assembly Bill 5

Assemblymember Lorena Gonzalez (D-San Diego) first introduced AB 5 on December 3, 2018. The first version contained no substantive provisions, but only expressed an intent to “include provisions that would codify [Dynamex] … and would clarify the decision’s application in state law.” Legislators subsequently amended AB 5 six times.⁷ The final text of the bill is lengthy and complex. Conceptually, it is composed of four basic parts: (1) adopting the ABC test; (2) specifying exceptions that invoke the Borello test; (3) delineating retroactive versus prospective liability; and (4) authorizing the Attorney General and other specified public officials to prosecute actions for injunctive relief to prevent continued misclassification.

ABC Test

AB 5 adopts the ABC test, using the exact language of the Dynamex opinion. Specifically, any person providing labor or services for remuneration shall be considered an employee, rather than an independent contractor, unless the “hiring entity” demonstrates that all of the following conditions are satisfied:

(A) 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 for the performance of the work and in fact.
(B) The person performs work that is outside the usual course of the hiring entity’s business.
(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.⁸

As in Dynamex, AB 5 imposes this test for purposes of the California wage orders. The bill also applies the ABC test to the California Labor Code and Unemployment Insurance Code. As will be explained below, however, the Borello test will remain the applicable standard for occupations and relationships that fall within AB 5’s various exceptions.

Exceptions

The bulk of AB 5 attempts to define “exceptions” for particular occupations and relationships. These exceptions fall into seven categories. If an exception applies, the bill then specifies what standard, other than the ABC test, will govern. For the vast majority of the exceptions, the bill provides “the determination of employee or independent contractor status … shall be governed by Borello.” Therefore, it is not enough that a particular situation falls within one of AB 5’s exceptions. The situation must still satisfy the applicable test, which will usually be the Borello test.

The seven categories of exceptions and their key characteristics are:

Specific occupations⁹
- Insurance agents, surplus line brokers, and analysts.¹⁰
- Physicians, dentists, podiatrists, psychologists, and veterinarians.¹¹ (The exception does not apply to “the employment settings currently or potentially governed by collective bargaining agreements.”).
- Lawyers, architects, engineers, private investigators, and accountants.¹²
- Securities broker-dealers and investment advisors.¹³
- Direct sales salespersons.¹⁴
- Commercial fishermen.¹⁵
- Newspaper carriers working under contract with a newspaper publisher.¹⁶

Contracts for professional services between a hiring entity and an individual providing professional services¹⁷
- This exception is subject to six criteria.¹⁸
- The scope of “professional services” is limited to specific occupations and activities.¹⁹
- The individual may provide the professional services through “a sole proprietorship or other business entity.”²⁰

Real estate licensees²¹ and repossession agencies²²

Business-to-business contracting relationships between a contracting business and a business service provider²³
- This exception is subject to 12 criteria.²⁴
- Both the contracting business and business service provider may be a “sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation.”²⁵
- The exception “does not apply to an individual worker, as opposed to a business entity, who performs labor or services for a contracting business.”²⁶
- The exception does not alter or supersede application of existing Labor Code section 2810.3, which imposes joint and several liability on a “client employer” for specified civil claims of “employees supplied by a labor contractor” under specified circumstances.²⁷

Relationships between a contractor and an individual performing work pursuant to a subcontract in the construction industry²⁸
- This exception is subject to seven criteria;²⁹
- Includes a limited exception for owner-operator truckers in the construction industry,³⁰ which will expire on January 1, 2022.³¹

Relationships between a referral agency and a service provider that uses the referral agency to connect with clients³²
- This exception is subject to 10 criteria.³³
- Limited to specific services.³⁴
- A “referral agency” is defined as “a business that connects clients with service providers that provide [the specific services within the scope of the exception].”³⁵
- A “service provider” is defined as “a person or business who agrees to the referral agency’s contract and uses the referral agency to connect with clients.”³⁶
- A “client” is defined as “a person or business that engages a service contractor through a referral agency.”
- The service provider may be “formed as a sole proprietor, partnership, limited liability company, limited liability partnership, or corporation.”³⁷
- The exception “does not apply to an individual worker, as opposed to a business entity, who performs services for a client through a referral agency.”³⁸

“Motor club” services³⁹

Many of the above exceptions and criteria present considerable practical difficulties of execution, the full measure of which are beyond the scope of this article. However, several difficulties and conflicts are apparent on the face of the statutes.

First, the exceptions for professional services, business-to-business contracting relationships, construction subcontracts, and referral agencies consistently place the burden on those “upstream” entities to satisfy criteria that are not within their direct control. The bill does not address whether and to what extent those entities will be liable for non-compliance with criteria due to circumstances beyond their control.

Second, many of the same criteria are subject to change over time. The bill does not address whether a temporary or emergent failure of one of those criteria will result in retroactive, temporary, and/or permanent loss of the exception.

Third, the business-to-business and referral agency exceptions contain an inherent conflict. These exceptions: (1) expressly provide that the service provider may be formed as a sole proprietorship without sacrificing the exception; (2) refer to a sole proprietorship as a business entity; and (3) expressly exclude “an individual worker, as opposed to a business entity” from the scope of the exception. It is entirely unclear whether an individual operating as a sole proprietor would be considered a sole proprietorship or an individual worker. Many of the individuals who provide the types of services for which the exceptions are intended operate as single-person sole proprietorships. For example, will an individual tutor using a referral service to connect with clients be considered a sole proprietorship or an individual worker? Will the referral agency have to exclude tutors operating as single-person sole proprietorships from its platform? Will all individual tutors have to form solely owned corporations or limited liability companies solely to clarify their status in this regard? What rational purpose is served by requiring tutors to expend financial resources to forming such entities? This uncertainty considerably limits the utility of the exceptions.

Retroactive Versus Prospective Liability

Despite the critical importance of retroactive liability, early versions of AB 5 contained no provisions whatsoever regarding retroactive versus prospective liability. Legislators first added language addressing this issue to the bill’s fifth version, published August 30, 2019. The final text of the bill parses retroactive and prospective liability into three parts:

Dynamex and the ABC test apply retroactively “with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.”⁴⁰

All exceptions apply retroactively to the maximum extent permitted by law, to the extent they would relieve an employer from liability.⁴¹

On and after January 1, 2020, Dynamex and the ABC test will apply for purposes of the Unemployment Insurance Code and all other provisions of the Labor Code.⁴²

On July 1, 2020, Dynamex and the ABC test will apply for purposes of workers’ compensation.⁴³

Unfortunately, the first of these three provisions exacerbates the uncertainty and potential retroactive liability inherent in the Dynamex opinion. Dynamex was expressly limited to the wage orders. Now, AB 5 declares that its legislative adoption of Dynamex is “declaratory of existing law with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders.”⁴⁴ The italicized words appear to impose new retroactive liability on California businesses for “violations of the Labor Code relating to wage orders” stemming from alleged misclassification of an employee as an independent contractor rather than an employee. Worse, it is far from clear which of the thousands of provisions of the California Labor Code are sufficiently “related to” the wage orders to give rise to retroactive liability.

Injunctive Relief

In a last-minute amendment to AB 5, legislators added an entirely new subdivision authorizing the Attorney General and specified public officials to prosecute civil actions for injunctive relief “to prevent the continued misclassification of employees.” The entire provision provides:

(j) In addition to any other remedies available, an action for injunctive relief to prevent the continued misclassification of employees as independent contractors may be prosecuted against the putative employer in a court of competent jurisdiction by the Attorney General or by a city attorney of a city having a population in excess of 750,000, or by a city attorney in a city and county or, with the consent of the district attorney, by a city prosecutor in a city having a full-time city prosecutor in the name of the people of the State of California upon their own complaint or upon the complaint of a board, officer, person, corporation, or association.⁴⁵

This provision mirrors California’s controversial Unfair Competition Law (UCL).⁴⁶ Actions for injunctive relief under the UCL have been relatively rare. Based on the level of interest displayed by organized labor in the passage of AB 5, it seems certain this provision will see more frequent use. It has been speculated that this provision was inserted to counter binding arbitration of individual disputes between businesses and independent contractors.

What Now?

Governor Newsom will have until October 13, 2019, to sign or veto AB 5. Despite the bill’s many flaws, Governor Newsom has publicly expressed support for it.⁴⁷ Businesses should assume AB 5 will be signed into law and begin to plan accordingly. Businesses seeking to maintain or establish independent contractor relationships with workers in California should seek legal counsel to assess whether the particular workers can be validly classified as independent contractors in light of AB 5 and, if so, how to maximize the probability those relationships will withstand misclassification claims.

Littler’s Workplace Policy Institute will soon be publishing a comprehensive report on next steps for businesses as they review their options for a future in which the ABC test applies to vast numbers of workers in the Golden State.

¹ Several media sources reported AB 5 ‘passed’ on September 10, 2019. That is not accurate. The Senate passed a revised version of the bill on September 10, 2019 (29 ayes and 11 noes). That vote did not constitute passage of the bill. The Senate sent the bill back to the Assembly for concurrence in all amendments the Senate made to the bill after the Assembly originally passed it on May 29, 2019. The Assembly concurred in the Senate’s amendments on September 11, 2019 (61 ayes, 16 noes, 2 not voting).

² Dynamex v., Superior Court (2018) 4 Cal. 5th 903.

³ The California wage orders are a series of 17 sets of regulations published by the California Industrial Welfare Commission. Each wage order governs wages, hours, and working conditions in a specific industry or occupation, ranging from the Manufacturing Industry (Wage Order 1-2001) to “Miscellaneous Employees” (Wage Order 17-2001). The Supreme Court expressly limited the Dynamex opinion to application of the wage orders. That limitation left the Borello test in place for all other purposes, including other provisions of the Labor Code (including worker’s compensation) and the Unemployment Insurance Code.

⁴ In Dynamex, the employer filed a petition for rehearing, asking the California Supreme Court to specifically address retroactive versus prospective application of the new test, or at least provide lower courts with some guidance on how the issue should be addressed. The court denied the petition for rehearing, and the original opinion became final as of June 20, 2018.

⁵ Vazquez v. Jan-Pro Franchising Int'l, Inc., 2019 U.S. App. LEXIS 13237, 2019 WL 1945001 (9th Cir. May 2, 2019).

⁶ For example, in the matter of Stewart v. San Luis Ambulance, Inc. (No. S246255), the Ninth Circuit certified three questions to the California Supreme Court regarding rest breaks, meal periods, and derivative wage statement claims under sections 203 and 206 of the Labor Code. The Ninth Circuit filed the request on January 3, 2018. The case has been fully briefed before the California Supreme Court since January 8, 2019. The California Supreme Court has still not set a date for oral argument.

⁷ Amended in Assembly March 26, May 1, and May 24, 2019. Amended in Senate July 11, August 30, and September 6, 2019.

⁸ Proposed Labor Code section 2750.3(a).

⁹ Proposed Labor Code section 2750.3(b).

¹⁰ Proposed Labor Code section 2750.3(b)(1). The exception applies only where the persons and/or organizations involved is/are licensed by the California Department of Insurance.

¹¹ Proposed Labor Code section 2750.3(b)(2). The exception applies only where the individual performing services is licensed by the State of California to practice their profession. The exception does not apply “to the employment settings currently or potentially governed by collective bargaining agreements.”

¹² Proposed Labor Code section 2750.3(b)(3). The exception applies only where the individual performing services holds an active license to practice their profession in the state of California.

¹³ Proposed Labor Code section 2750.3(b)(4). The exception applies only where the individual performing services is: (1) registered with the Securities and Exchange Commission; (2) registered with the Financial Industry Regulatory Authority; or (3) licensed by the State of California to practice their profession.

¹⁴ Proposed Labor Code section 2750.3(b)(5). The exception applies only where: (1) the salesperson falls within the description set forth in Unemployment Insurance Code section 650; and (2) the conditions for exclusion from employment under that section are met.

¹⁵ Proposed Labor Code section 2750.3(b)(6). The exception for commercial fishermen is subject to detailed definitions and restrictions. Fishermen will be eligible for unemployment insurance even if classified as independent contractors pursuant to the exception. The exception will expire January 1, 2023.

¹⁶ Proposed Labor Code section 2750.3(b)(7). This exception is not found in the text of AB 5, but rather was inserted at the eleventh hour through the “gutting and amending” of AB 170. This exception will expire on January 1, 2021. As of the publication of this article, AB 170 is still pending in the Assembly.

¹⁷ Proposed Labor Code section 2750.3(c).

¹⁸ The hiring entity bears the burden of demonstrating all of the following criteria are satisfied: (A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity, but nothing prohibits an individual from choosing to perform services at the location of the hiring entity; (B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession; (C) The individual has the ability to set or negotiate their own rates for the services performed; (D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours; (E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work; (F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services. Proposed Labor Code section 2750.3(c)(1)(A)-(F).

¹⁹ Only the following occupations fall within the bill’s definition of “professional services:” Marketing; Administrator of human resources; Travel agent services; Graphic design; Grant writer; Fine artist; Enrolled agents licensed by the Department of the Treasury to practice before the Internal Revenue Service; Payment processing; Still photographer or photojournalist (subject to additional criteria and limitations); Freelance writer, editor, or newspaper cartoonist (subject to additional criteria and limitations); Esthetician, electrologist, manicurist, barber, and cosmetologist (subject to additional criteria, and the exception for manicurists will cease to exist January 1, 2022). Proposed Labor Code section 2750.3(c)(2)(B).

²⁰ Proposed Labor Code section 2750.3(c)(2)(A).

²¹ The determination of employee or independent contractor status for real estate licensees shall be governed by Business and Professions Code section 10032(b). If that section does not apply, then the determination will be governed as follows: (A) for purposes of unemployment insurance, by Business and Professions Code section 650; (B) for purposes of worker’s compensation, by Labor Code section 3200, et seq; and (C) for all other purposes in the Labor Code, by Borello. Proposed Labor Code section 2750.3(d)(1).

²² The relationship between a hiring entity and a repossession agency licensed pursuant to Business and Professions Code section 7500.2 shall be governed by that section, “if the repossession agency is free from the control and direction of the hiring person or entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.” Proposed Labor Code section 2750.3(d)(2).

²³ Proposed Labor Code section 2750.3(e).

²⁴ The contracting business bears the burden of demonstrating all of the following criteria are satisfied: (A) The business service provider is free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; (B) The business service provider is providing services directly to the contracting business rather than to customers of the contracting business; (C) The contract with the business service provider is in writing; (D) If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration; (E) The business service provider maintains a business location that is separate from the business or work location of the contracting business; (F) The business service provider 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 business service provider advertises and holds itself out to the public as available to provide the same or similar services; (I) The business service provider provides its own tools, vehicles, and equipment to perform the services; (J) The business service provider can negotiate its own rates; (K) Consistent with the nature of the work, the business service provider 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. Proposed Labor Code section 2750.3(e)(1)(A)-(L).

²⁵ Proposed Labor Code section 2750.3(e)(1).

²⁶ Proposed Labor Code section 2750.3(e)(2). Also, the exception does not apply to the relationship between the individual and the business service provider, which is always governed by the ABC test. Proposed Labor Code section 2750.3(e)(3).

²⁷ Proposed Labor Code section 2750.3(e)(4); Labor Code section 2810.3.

²⁸ Proposed Labor Code section 2750.3(f).

²⁹ The contractor bears the burden of demonstrating all of the following criteria are satisfied: (1) The subcontract is in writing; (2) The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license; (3) If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration; (4) The subcontractor maintains a business location that is separate from the business or work location of the contractor; (5) The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services; (6) The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided; (7) The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

³⁰ Proposed Labor Code section 2750.3(f)(8). The exception is limited to “hauling and trucking services provided in the construction industry pursuant to a contract with a licensed contractor utilizing vehicles that require a commercial driver’s license to operate or have a gross vehicle weight rating of 26,001 or more pounds.” Proposed Labor Code section 2750.3(f)(8)(C). An owner-operator trucker need not possess a contractor’s license. Proposed Labor Code section 2750.3(f)(8)(A) and (f)(2). However, the following additional criteria must be satisfied: (i) The subcontractor is a business entity formed as a sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation; (ii) For work performed after January 1, 2020, the subcontractor is registered with the Department of Industrial Relations as a public works contractor pursuant to Section 1725.5, regardless of whether the subcontract involves public work; (iii) The subcontractor utilizes its own employees to perform the construction trucking services, unless the subcontractor is a sole proprietor who operates its own truck to perform the entire subcontract and holds a valid motor carrier permit issued by the Department of Motor Vehicles; (iv) The subcontractor negotiates and contracts with, and is compensated directly by, the licensed contractor. Proposed Labor Code section 2750.3(f)(8)(A)(i)-(iv).

³¹ Proposed Labor Code section 2750.3(f)(8)(D).

³² Proposed Labor Code section 2750.3(g).

³³ The referral agency bears the burden of demonstrating all of the following criteria are satisfied: (A) The service provider is free from the control and direction of the referral agency in connection with the performance of the work for the client, both as a matter of contract and in fact; (B) If the work for the client is performed in a jurisdiction that requires the service provider to have a business license or business tax registration, the service provider has the required business license or business tax registration; (C) If the work for the client requires the service provider to hold a state contractor’s license, the service provider has the required contractor’s license; (D) The service provider delivers services to the client under service provider’s name, rather than under the name of the referral agency; (E) The service provider provides its own tools and supplies to perform the services; (F) The service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed for the client; (G) The service provider maintains a clientele without any restrictions from the referral agency and the service provider is free to seek work elsewhere, including through a competing agency; (H) The service provider sets its own hours and terms of work and is free to accept or reject clients and contracts; (I) The service provider sets its own rates for services performed, without deduction by the referral agency; (J) The service provider is not penalized in any form for rejecting clients or contracts. However, the last criterion does not prohibit a referral agency for penalizing a service provider where the service provider accepts a client or contract and then fails to fulfill any of its contractual obligations. Proposed Labor Code section 2750.3(g)(1)(A)-(J).

³⁴ The exception is limited to the following occupations and activities: Graphic design; Photography; Tutoring; Event planning; Minor home repair; Moving; Home cleaning; Errands; Furniture assembly; Animal services (defined as “daytime and nighttime pet care including pet boarding”); Dog walking; Dog grooming; Web design; Picture hanging; Pool cleaning; Yard cleanup. Proposed Labor Code section 2750.3(g)(2)(A), (C).

³⁵ Proposed Labor Code section 2750.3(g)(2)(C).

³⁶ Proposed Labor Code section 2750.3(g)(2)(E).

³⁷ Proposed Labor Code section 2750.3(g)(2)(B).

³⁸ Proposed Labor Code section 2750.3(g)(3). The determination whether such an individual is an employee of a referral agency is governed the ABC test.

³⁹ Proposed Labor Code section 2750.3(h). The exception applies only to relationships between a motor club and an individual performing services pursuant to a contract between the motor club and a third party to provide motor club services. The ‘motor club’ must also hold a certificate of authority to act as a motor club within the state of California pursuant to Insurance Code section 12160.

⁴⁰ Proposed Labor Code section 2750.3(h)(1).

⁴¹ Proposed Labor Code section 2750.3(h)(2).

⁴² Proposed Labor Code section 2750.3(h)(3).

⁴³ Proposed Labor Code section 3351(i).

⁴⁴ Proposed Labor Code section 2750.3(i)(1) (emphasis added).

⁴⁵ Proposed Labor Code section 2750.3(j).

⁴⁶ Business and Professions Code section 17204.

⁴⁷ Gavin Newsom, On Labor Day, let’s pledge to protect workers and create paths to union membership, The Sacramento Bee (Sept. 20, 2019).