United States: California Legislature Moves Forward With Bill To Redefine Independent Contractor Relationships

Last Updated: July 23 2019
Article by Patrick C. Stokes, Bruce J. Sarchet and Michael J. Lotito

On July 10, 2019, the California Senate Labor, Public Employment, and Retirement Committee (Committee) advanced a proposed legislative response to the California Supreme Court's opinion in Dynamex v. Superior Court, which abruptly and drastically altered the legal landscape for independent contractor relationships.  The Committee heard three hours of testimony and public comment, debated, and ultimately voted 4 to 11 to pass Assembly Bill 5 (AB 5) with the understanding that further amendment is still needed to address several critical issues. 

Dynamex v. Superior Court2 and its Implications

On January 28, 2015, the California Supreme Court granted review of a lower court's class action certification involving a package and document delivery company.  The named plaintiffs in the case were delivery couriers, who claimed the company improperly classified them and similarly situated couriers as independent contractors in and after 2004.

On December 21, 2016, the California Supreme Court considered:

In a wage and hour class action involving claims that the plaintiffs are misclassified as independent contractors, may a class be certified based on the Industrial Welfare Commission definitions [contained in California's Wage Orders]3 ... or should the common law test for distinguishing between employees and independent contractors discussed in [S. G. Borello & Sons, Inc. v. Department of Industrial Relations] control?

At that time, California courts and state agencies had long applied the common law test the California Supreme Court itself adopted in 1989, in the matter of S. G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello) as the applicable test. Over the course of nearly 30 years, employers had come to reasonably rely on the "Borello test" as the standard for determining whether a worker was an employee or an independent contractor for purposes of both the Labor Code and the California Wage Orders.

The Borello test involved a highly flexible analysis of numerous factors. The test focused primarily on whether the alleged employer had a right to control the manner and means of the alleged employee's work. However, the test also included a list of nine "additional factors," ranging from "right to discharge at will, without cause" to whether or not the parties intended to form an employer-employee or independent contractor relationship.

On April 30, 2018, the California Supreme Court issued a unanimous decision in Dynamex imposing an entirely new standard for determining whether a worker is an employee or an independent contractor for purposes the California Wage Orders. In place of the Borello test, the court imposed the "ABC test."

The ABC test presumes a worker is an employee, and places the burden on the hirer to establish that the worker is an independent contractor. The worker is an employee unless the hiring entity establishes each of the following three factors:

(A) that 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) that the worker performs work that is outside the usual course of the hiring entity's business; and

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.4

Despite its stated intention to bring more certainty and clarity to the law, the court failed to address the critical issue of retroactive versus prospective application of the new test. The employer filed a petition for rehearing, asking the court to resolve this apparent oversight by specifically deciding the issue, or at least providing lower courts with some guidance on how the issue should be addressed. The California Supreme Court denied the petition for rehearing, and the original opinion became final as of June 20, 2018.

In only a year, the decision has already affected a diverse array of businesses and industries that bear no resemblance to delivery services. Indeed, the unintended impact has spread to settings that bear no indicia of worker exploitation, and in which independent contractor relationships are strongly preferred by both workers and hiring entities. In a substantial number of such settings, independent contractor relationships are even necessary to ensure compliance with legal and ethical requirements.5

Retroactive Application of Dynamex

On May 2, 2019, the U.S. Court of Appeal for the Ninth Circuit ruled that Dynamex applies retroactively.6 In reaching this decision, the Ninth Circuit cited other decisions of the California Supreme Court to the effect that judicial decisions are generally given retroactive effect. The Ninth Circuit recognized that the California Supreme Court has allowed exceptions to retroactivity "when a judicial decision changes a settled rule on which the parties below have relied." The Ninth Circuit, however, declined to apply that exception, based on a perceived "emphasis in Dynamex on its holding as a clarification rather than as a departure from established law." The Ninth Circuit brushed aside due process concerns on the grounds that: (1) retroactive application of Dynamex imposed only civil, not criminal, liability; (2) "deference is owed to judicial common-law developments, which by their nature must operate retroactively on the parties in the case;" (3) "[a]pplying Dynamex retroactively is neither arbitrary nor irrational;" and (4) "applying Dynamex retroactively ... ensure[s] that the California Supreme Court's concerns are respected."

The Ninth Circuit's analysis tracks the decisions of several California trial courts that reached the same result. To date, no California appellate court has ruled on the issue.

Assembly Bill 5

Assembly Bill 5 is a proposed legislative "fix" to Dynamex. The present text of AB 5 consists of three parts: (1) express adoption of the ABC test; (2) exceptions to the first part; and (3) a statement of intent to separately address workers' compensation issues by future amendments to existing law.

Adoption of the ABC test

The bill would add Labor Code section 2750.3, which expressly adopts the ABC test for purposes of the Labor Code, Unemployment Insurance Code, and California Wage Orders.  The bill's statement of the three elements of the ABC test is identical to the language in the Dynamex opinion.  Notably, the bill goes beyond the scope of the Dynamex decision, which only applied the ABC test for purposes of the California Wage Orders.  

Exceptions

The bill creates a number of exceptions for certain workers and situations.  For the vast majority of these exceptions, if the applicable criteria are met, the Borello test instead of the ABC test will apply.  For a small number of the exceptions, meeting certain criteria will cause other tests to apply.7

The proposed exceptions have been the most hotly debated aspect of the bill.  The list has been amended numerous times to add new exceptions and to revise existing ones.  Further amendments are expected.

At present, the exceptions can be broken down into four categories, as follows:

  1. Specific professions and businesses:8

    • Insurance brokers;
    • Physicians and surgeons;
    • Securities broker-dealers, investment advisors, and their agents;
    • Direct sales salespersons as described in section 650 of the Unemployment Insurance Code;
    • Real estate licensees;
    • Hairstylists, barbers, electrologists, estheticians, and workers providing natural hair braiding;
    • Workers performing repossession services for repossession agencies.
  2. Service providers9

The apparent goal10 of this exception is to allow an individual or entity (the "contracting business") to receive services from a worker employed by another individual or entity (the "service provider"), yet have the worker's relationship with the contracting business be governed by the Borello test.  In order to fall within the exception, the contracting business must demonstrate that 12 criteria11 are satisfied.  Several of these criteria are problematic, for four reasons. 

First, it will often be difficult for the contracting business to conclusively verify that the service provider actually maintains a separate business location, is "customarily engaged in an independently established business of the same nature as that involved in the work performed," contracts with other businesses to provide the same or similar services, and maintains a clientele independent of the contracting business entity.  On these issues, the contracting business must largely rely on the representations of the service provider.  The bill does not address under what circumstances the contracting business may be held liable where the service provider's inaccurate representations result in non-compliance with these criteria.

Second, several of the criteria are not within the contracting business's control.  The service provider controls whether it possesses a business license (if required by the jurisdiction in which the work is performed), advertises its services to the public, maintains a clientele independent of the contracting business entity, and maintains a separate business location.  The bill does not specify under what circumstances the contracting business will be held liable where the actions or omissions of the service provider result in non-compliance with these criteria.

Third, the criterion that the service provider have "no other financial relationships with the contracting business" is vague.  The statute does not provide any guidance regarding what "financial relationships" will be deemed to violate this criterion.

Fourth, several criteria are subject to change over time.  The service provider may lose its business license, close its separate business location, cease advertising to the public, and lose its contracts with other businesses.  These lapses may result in temporary or permanent failure to satisfy the corresponding criteria of the exception.  The statute does not specify: (1) whether lapse of criteria will result in retroactive, temporary, or permanent loss of the exception; or (2) whether and to what extent the contracting business will be held liable.

  1. Contracts for professional services12

The apparent goal of this exception is to allow an individual or entity (the "hiring entity") to receive "professional services" from an individual or entity (the "individual") yet have the relationships with the persons and entities to whom they are providing services be governed by the Borello test.  Notably, the reference to the professional as the "individual" does not mean the professional must provide services as an individual—the individual may provide the services through a sole proprietorship or business entity.13 

To fall within this exception, the services must first fall within the bill's proposed definition of "professional services," defined as "services that meet any of the following" four categories:

  • The services require an active license from the State of California and involve the practice of one of the following recognized professions: law, dentistry, architecture, engineering, podiatrists, veterinarian, private investigation, or accounting.14
  • The services require possession of an advanced degree that customarily involves a prolonged course of specialized intellectual instruction and study in the field of marketing or the administration of human resources from an accredited university, college, or professional school, as distinguished from a general academic education.15
  • The services are performed by a freelance writer who does not provide content to any one publication more than 25 times per year.  This item is subject to additional sub-criteria.16
  • The services are provided by "fine artists, professional grant writers, and graphic designers."  This item is also subject to additional sub-criteria.17

The current text does not expressly place the burden on the hiring entity to demonstrate the services meet the criteria of these categories.18 

Notably, the bill currently states, "'[p]rofessional services' does not include professionals engaged in the fields of health care and medicine."19  This language is inconsistent with the provisions specifically including dentists and podiatrists within the scope of the first category of professional services, above.

If the services fall within the above requirements, the hiring entity must demonstrate that nine criteria are satisfied.20  Many of these criteria are also problematic, for the same reasons discussed above regarding the criteria for the exception for service providers.

  1. Construction Industry

This exception appears calculated to allow an individual or entity (the "contractor") to receive services from an individual performing work (the "individual") pursuant to a contract in the construction industry, yet have the relationship between the contractor and the individual governed by the Borello test. 

Unlike the other exceptions, described above, this exception does not specify whether the individual performing services may do so through a sole proprietorship or other business entity.  However, the remaining text of the exception suggests this would be allowed.  Specifically, the enumerated criteria for the exception refer to a "subcontractor."  If the individual and the subcontractor are construed as different persons/entities, then the exception allows the individual to provide services through a third party.   

In order to fall within this exception, the contractor must demonstrate that eight criteria are satisfied.21  Many of these criteria are also problematic, for the same reasons discussed above regarding the criteria for the exception for service providers. 

Intent to Separately Address Workers' Compensation Issues

The bill contains only one very narrow provision directly addressing workers' compensation.  Specifically, if real estate licensees are not subject to section 10032 of the Business and Professions Code, then their classification for workers' compensation purposes shall be governed by Labor Code section 3200, et seq.22 This provision does not appear to alter existing law.

Rather, the bill amends Labor Code section 3351 to add the following statement: "It is the intent of the Legislature to amend the law to address workers' compensation and the holding in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903."  It appears those amendments, if any, will be made by legislation other than AB 5.23

Potential Additional Amendments to AB 5

During the meeting, Committee members expressed several concerns regarding the current text of AB 5.  Committee Chair Senator Jerry Hill and Committee Vice Chair Senator Mike Morrell spoke on this subject in detail.  Of particular note, the bill's author, Assembly member Lorena Gonzalez—along with members of the Committee—expressly contemplated extensive revisions to AB 5. 

The Committee's concerns included:

Consideration of potential alternatives to Borello test:  The Committee's written analysis of the bill expressed sharp criticism of the AB 5's application of the Borello test to workers falling within the bill's various exceptions.  The Committee wrote:

Essentially, the bill is saying, "if your workers were independent contractors before Dynamex, then they can continue to be independent contractors under Assembly Bill 5." That said, by retaining the Borello test, these occupations remain in the messy muddle of a failed employment test that met the needs of neither employers nor workers. Should Assembly Bill 5 become law, the Legislature will need to revisit the remnants of Borello in the future.

(Emphasis in original.)

Need for revisions to exceptions: Committee members claimed the business-to-business exceptions require additional work.  Sen. Hill noted the temptation to ensure independent contractors are charging twice the minimum wage is understandable, but would be difficult to administer and enforce.  He expressed concern that several criteria for the exceptions are outside the hiring entity's control.  He proposed focusing not on the rate paid, but on whether the person performing the work truly has the power to set his or her own rates.  He opined that companies that allow "true" rate setting should be allowed to continue contracting with workers as independent contractors.

Workers' compensation: Sen. Hill also expressed concern regarding the workers' compensation implications of AB 5.  He opined that it would be illogical to apply wage and hour law, but not workers' compensation law, to a worker.  However, he recognized that any change to workers' compensation laws would require careful consideration and time that may not be available during this legislative session.

Implementation: Committee members noted any legislative solution should avoid abrupt change.  Sen Hill proposed that any major shift occur over time. 

Trucking Owner-Operators: Nearly every member of the Committee commented on the plight of trucking owner-operators.  All appeared to agree that the bill should contain explicit recognition of legitimate owner-operators.

Avoiding retroactive liability under Dynamex: The Committee expressed that the retroactive implications of Dynamex must be equitable and just.  Sen. Hill stated that a legislative solution should protect businesses that were following the law as it existed at the time.

Transparency: Sen. Hill and Sen. Morrell requested increased transparency regarding selection of certain occupations and situation for exceptions. 

In sum, most members of the Committee voted to pass AB 5, with the understanding that legislators would work with each other and stakeholders to resolve the above issues before the Senate votes on it.

In her own closing comments, Assembly member Gonzalez acknowledged that the Committee probably would not address every situation in the time allotted, and anticipated the legislature would be working on this issue "for a few years."

Numerous members of the public attended the hearing and expressed support for legislative action.  Of those, approximately 50% simply stated they support the bill, and the rest expressed their support for the bill "if amended" to allow them to continue working as independent contractors in their own professions or to continue hiring independent contractors in their own businesses.   

What's Next?

All legislators who spoke during the hearing expressed a sense of urgency regarding the need for legislative action this session.  In order to accomplish this, both the Assembly and Senate will have to pass a revised version of the bill no later than September 13, 2019.  It appears possible (but far from certain) that legislators will accomplish this feat.  If a bill is passed on the last day, Governor Newsom will have until October 13, 2019, to sign or veto it.  Governor Newsom has not yet expressed any position regarding AB 5 or any other potential legislative solution to Dynamex.

Footnotes

1 Yea: Sen Jerry Hill (Chair), Sen Hannah-Beth Jackson, Sen Holly J. Mitchell, and Sen Richard Pan. Noe: Sen Mike Morrell (Vice Chair).

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

3 The California Wage Orders are a series of 17 sets of industry-specific regulations published by the California Industrial Welfare Commission. Each Wage Order governs wages, hours, and working conditions in a specific industry, ranging from the Manufacturing Industry (Wage Order 1-2001) to "Miscellaneous Employees" (Wage Order 17-2001).

4 "In sum, we conclude that unless the hiring entity establishes (A) that 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) that the worker performs work that is outside the usual course of the hiring entity's business, and (C) that the worker is customarily engaged in an independently established trade, occupation, or business, the worker should be considered an employee and the hiring business an employer under the suffer or permit to work standard in wage orders. The hiring entity's failure to prove any one of these three prerequisites will be sufficient in itself to establish that the worker is an included employee, rather than an excluded independent contractor, for purposes of the wage order." Dynamex, supra, 4 Cal. 5th at 964.

5 For example, California law prohibits laypersons and most business entities from directly employing many categories of licensed healthcare providers.

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

7 For example, the current exception for real estate licensees provides: (1) if the licensee falls within the scope of section 10032 of the Business and Professions Code, then that section will apply; (2) if section 10032 does not apply, then: (a) for purposes of unemployment insurance, Unemployment Insurance Code section 650 will apply; (b) for purposes of workers compensation, Labor Code section 3200, et. seq., will apply; and (c) for all other purposes under the Labor Code, the Borello test will apply.

8 Under the current text of AB 5, these exceptions would be defined by Labor Code section 2750.3(b)(1)-(7).

9 Under the current text of AB 5, this exception would be defined by Labor Code section 2750.3(b)(8).

10 The text of this portion of the bill is unclear, but the intent of this exception is apparent from legislators' comments during the July 10, 2019, hearing of the CA Senate Labor, Public Employment, and Retirement Committee.

11 Under the current text of AB 5, these criteria are defined by 2750.3(b)(8)(A)-(J), as follows:

(A) The 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 service provider is providing services to the contracting business rather than to customers of the contracting business; (C) The contract with the service provider is in writing; (D) If the work 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; (E) The service provider maintains a business location that is separate from the business or work location of the contracting business; (F) The service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed; (G) The service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity; (G) The service provider advertises and holds itself out to the public as available to provide the same or similar services; (H) The service provider has no other financial relationships with the contracting business; (I) The service provider can negotiate its own rates, provided that the rate is equal to or greater than two times the minimum wage for hours worked; (J) The service provider can set its own hours and location of work; (K) The service provider is not performing the type of work for which a license from the Contractor's State License Board is required, pursuant to Section 7000 and following of the Business and Professions Code.

12 Under the current text of AB 5, this exception would be defined by Labor Code section 2750.3(c).

13 The current text proposed Labor Code section 1750.3(c)(1) refers to the professional providing services as "the individual." However, 1750.3(c)(2)(A) clarifies "For purposes of this subdivision ... An 'individual' includes an individual providing services through a sole proprietorship or other business entity."

14 Current text of proposed Labor Code section 2750.3(c)(2)(B)(i)(I).

15 Current text of proposed Labor Code section 2750.3(c)(2)(B)(i)(II).

16 Current text of proposed Labor Code section 2750.3(c)(2)(B)(i)(III). The additional criteria applicable to a "freelance writer" are: (1) the worker must actually set their own hours, locations, and rate of pay; and (2) the worker's rate of pay shall be equal to or greater than two times the minimum wage.

17 Current text of proposed Labor Code section 2750.3(c)(2)(B)(i)(IV). The additional criteria for "fine artists, professional grant writers, and graphic designers" are that the worker must actually set their own hours, locations, and rate of pay. Note the absence of any requirement that the worker's rate of pay be equal to or greater than two times the minimum wage.

18 By contrast, the bill expressly places the burden of establishing all other criteria for the exception on the hiring entity.

19 Current text of proposed Labor Code section 2750.3(c)(2)(B)(ii).

20 Under the current text of AB 5, these criteria are defined by 2750.3(c)(1)(A)-(I), as follows:

(A) The individual maintains a business location, which may include the individual's residence, that is separate from 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 use their own employees in the completion of the work, where reasonable, and has the authority to hire and fire other persons who assist in providing the services. Nothing in this section requires an individual to hire an employee; (D) The individual has the ability to engage in other contracts for services than with the hiring entity; (E) Both the individual and the hiring entity have the ability to negotiate compensation for the services performed; (F) Outside of project completion dates and reasonable business hours, the individual has the ability to set their own hours; (G) For services that do not reasonably have to be performed at a specific location, the individual can determine where to perform the services under the contract; (H) The individual is customarily engaged in the same type of work performed under the contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work; (I) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.

21 Under the current text of AB 5, these criteria are defined by 2750.3(d)(1)-(8) as follows:

(1) The individual is free from the control and direction of the contractor in connection with the performance of the work, both under the contract for the performance of the work and in fact; (2) The subcontract is in writing; (3) The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license; (4) If the work is performed 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; (5) The subcontractor maintains a business location that is separate from the business or work location of the contractor; (6) The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services; (7) The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, performance bonds, or warranties relating to the labor or services being provided; (8) The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

22 Current text of proposed Labor Code section 2750.3(b)(5).

23 Based on legislators' comments during the July 10, 2019, hearing of the CA Senate Labor, Public Employment, and Retirement Committee.

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