Dynamex Is Now The Law of Independent Contractor Land, For Most Employers
Posted October 8, 2019

On September 18, 2019, Governor Newsom penned his signature on AB 5. With that simple act, he codified and expanded the pro-employment “ABC test” for determining independent contractor status first outlined in the Supreme Court’s 2018 decision in Dynamex Operations West, Inc. v. Superior Court. His signature makes the ABC test a fixture of the California Labor Code, Unemployment Insurance Code and the California Industrial Commission Wage Orders (specifically, AB 5 adds Section 2750.3 to the Labor Code, and amends Section 3351 of the Unemployment Insurance Code). AB 5 will be effective on January 1, 2020, but is retroactive to misclassification cases before that date.

AB 5 is not all bad news, however, as it creates exemptions to the application of the ABC test for a limited number of professions and specific types of contractual relationships commonly used in certain industries. These limited exemptions, where applicable, will allow for the continued use of the former “control” test used by California as outlined in S G. Borello & Sons, Inc. v. Department of Industrial (test provided below), instead of the stricter ABC test.

With the passage of AB 5, all companies using independent contractors now face an increased risk of misclassification claims by workers and government agencies (through audits). As such, employers are strongly cautioned to immediately review their independent contractor relationships with competent employment counsel.

A Quick Dynamex, ABC Test Refresher

Before getting into the weeds of AB 5 and the exemption, below is a brief refresher on the Dynamex ABC test (as codified in AB 5). The ABC test provides that:

“A 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) [CONTROL] 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) [USUAL COURSE] The person performs work that is outside the usual course of the hiring entity’s business.

(C) [ESTABLISHED TRADE] The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”

The ABC test – in particular Prong B – makes it much harder for an individual worker in California to be classified as an independent contractor. Remember also that under the ABC test the worker in question is “presumed” to be an employee UNLESS the hiring entity can prove ALL THREE PRONGS of the ABC test; the burden is on the employer. Although the ABC test is over a year old, many employers were waiting to see what would happen next; it is likely that the passage of AB 5 will require tens of thousands of employers to reclassify many workers formerly classified as contractors under the Borello test.

Limited Exemptions to the ABC Test Under AB 5 (Meaning the Borello Test Still Governs)

In addition to codifying Dynamex and expanding the application of the ABC test beyond just the Wage Orders, AB 5 also carved out a limited number of exemptions for specific professions, as well as certain types of contractual relationships.

IMPORTANT NOTE: Even if a specific profession or a certain type of contractual relationship is exempted from coverage under the AB 5/ ABC Test, that does not automatically mean that independent contractor status is legally viable; rather, employers looking to institute (or maintain) independent contractor relationships must still run the potential independent contractor through the former 12-factor “control” test (Borello test – see below for the factors). As an upside, if the exemptions apply to the circumstances, employers have decades of jurisprudence and regulatory guidance on how to apply the Borello test appropriately, and the Borello test is much more flexible and employer-friendly compared to the ABC test.

The ABC test is NOT applicable to the following PROFESSIONS (the applicable test is the “Borello” test):

  • A person or organization licensed by the Department of Insurance;
  • A licensed physician and surgeon, dentist, podiatrist, psychologist, or veterinarian;
  • An actively licensed individual practicing as a lawyer, architect, engineer, private investigator, or accountant;
  • A registered securities broker-dealer or investment adviser or their agents and representatives;
  • A direct sales salesperson [e.g., Avon reps];
  • A commercial fisherman working on an American vessel (there is a sunset clause);
  • A licensed real estate licensee for whom the determination of employee or independent contractor status shall be governed by subdivision (b) of Section 10032 of the Business and Professions Code; and,
  • A licensed repossession agency for whom the determination of employee or independent contractor status shall be governed by Section 7500.2 of the Business and Professions Code.

The ABC test is also NOT applicable to the following types of CONTRACTUAL RELATIONSHIPS (the applicable test is the “Borello” test):

  • “a contract for ‘professional services’ [“professional services” defined below] –
  • “bona fide business-to-business contracting relationships” –
  • “the relationship between a contractor and an individual performing work pursuant to a subcontract in the construction industry… if the contractor demonstrates that all the following criteria are satisfied”:
  • “the relationship between a motor club (like AAA) holding a certificate of authority… and an individual performing services pursuant to a contract between the motor club and a third party to provide motor club services utilizing the employees and vehicles of the third party…if the motor club demonstrates that the third party is a separate and independent business from the motor club”.

NOTE: Multiple factors must be satisfied for each of these contractual relationship exemptions. For brevity, only a few are listed under each type of contractual relationship. Please refer to the actual bill for the full list of factors for each type of relationship.

The Catch-All Exemption

AB 5 also created a general exclusion as follows, “If a court of law rules that the three-part test in paragraph (1) cannot be applied to a particular context based on grounds other than an express exception to employment status as provided under paragraph (2), then the determination of employee or independent contractor status in that context shall instead be governed by the California Supreme Court’s decision in S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (Borello).”

A Quick Borello Test Refresher:

If the ABC test does not apply, then the determination of independent contractor status is made through application of the Borello test:

1. Most important factor: “Who controls the means of production?”

Additional Factors:

2. Whether the person performing services is engaged in an occupation or business distinct from that of the principal;

3. Whether or not the work is a part of the regular business of the principal;

4. Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;

5. The alleged employee’s investment in the equipment or materials required by his task;

6. The skill required in the particular occupation;

7. The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;

8. The alleged employee’s opportunity for profit or loss depending on his managerial skill;

9. The length of time for which the services are to be performed;

10. The degree of permanence of the working relationship;

11. The method of payment, whether by time or by the job; and

12. Whether or not the parties believe they are creating an employer-employee relationship.

Although beyond the scope of this summary, the Employment Development Department, the Division of Labor Standards Enforcement, and the federal Department of Labor, and the Internal Revenue Service, each has its own internal tests for determining control and properly applying the Borello or similar tests. There is also significant case law guidance available.

Retroactive Application Has Now Been Codified:

AB 5 states that it is deemed to be declaratory of existing law, “this act does not constitute a change in, but 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”; this means that as of January 1, 2020, the ABC test will be applied retroactively to the misclassification analysis. Recall that the Ninth Circuit initially held that Dynamex was not retroactive, but then backtracked and referred the question to the California Supreme Court. (See Vazquez v. Jan-Pro Franchising Int’l). That case is still pending, and presumably the ABC test would not be applied retroactively to anything beyond violations of the Wage Orders, or Labor Code sections related to the Wage Orders, at least until January 1, 2020.

To that point, AB 5 states explicitly that its effective date applies to, “…work performed on or after January 1, 2020,” AND that if AB 5 or its exemptions “…would relieve an employer from liability, those subdivisions shall apply retroactively to existing claims and actions to the maximum extent permitted by law.”

What Are the Consequences of Misclassification?

The consequences of misclassifying an employee as an independent contractor can include potential liability for:

  • Unpaid wages, including overtime; unpaid payroll taxes; workers’ compensation liability; Private Attorneys General Act and/or the Unfair Competition Law claims; civil penalties of no less than $5,000 and no more than $15,000 for each violation, and civil penalties between $10,000 to $25,000 for a pattern and practice of violations (no private right of action); being required to prominently display a notice (signed by an officer of the company) on the company website for one year admitting to violating the law; and
  • In addition, AB 5 also explicitly creates an action for injunctive relief by the Attorney General (or a local prosecutor in certain circumstances) and brought “…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.”

Final Thoughts:

Although it is very likely that AB 5 will be amended through future legislation (or possibly a ballot measure) and also clarified through case law, employers are cautioned to act now. Although AB 5 goes into effect on January 1, 2020, the Dynamex ruling and the ABC test are operative now. To assist you in the process, here are three things employers can do now to prepare:

  1. Review your “independent contractor” potential exposure with competent counsel – if you use “independent contractors” currently, they may actually be “employees” under the ABC or Borello tests. Prepare a list of those contractors and review them with your employment counsel.
  2. Review your vendor relationships – Business-to-business, personal services, or other types of contractual relationships should also be reviewed to ensure compliance with the law, and to make sure the ABC test is not applicable. Remember that if the vendor does not have a separate business location, or has no other clients, these are red flags.
  3. Make corrections ASAP – Work with employment counsel to review whether or not you need to reclassify contractors as employees to comply with the law and avoid significant liability.
  4. If you have questions about AB 5, independent contractor arrangements, vendor or any other employment law questions, contact the employment attorneys at LightGabler for assistance.

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