ABC Is Not as Easy as 1-2-3 – Which Independent Contractor Classification Test Applies to Whom After AB5?

On September 18, 2019, Governor Gavin Newsom signed California Assembly Bill 5 (AB 5) – codifying the “ABC test” used to classify  California workers as either employees or independent contractors.  The ABC test was first introduced in April 2018 in the California Supreme Court decision Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County (Dynamex).  Beginning on January 1, 2020, the ABC test will be used for most occupations to determine if a worker should be classified as an employee, as opposed to an independent contractor, for California Wage Orders, the Labor Code, and the Unemployment Insurance Code.

This post will discuss the important points California employers should know regarding the impact of AB 5 on worker classification in California.

The Borello Test

For nearly 30 years, California courts, the California Labor Commissioner’s Office, and the California Employment Development Department used the multi-factor test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (Borello) to determine if a worker should be classified as an employee instead of an independent contractor.

The Borello test is comprised of 11 factors to determine employee or independent contractor status.  The factors primarily focus on whether the employer has control over the means and manner of performance of the contracted work.  There are also additional secondary factors, such as who provides work tools and the individual’s opportunity for profit or loss.

The Dynamex ABC Test

In Dynamex, the California Supreme Court revisited whether Borello was the proper legal test to determine employment status for purposes of claims under California Wage Orders, which cover overtime, meal periods, rest breaks, and other issues. The Court concluded that Borello was not the proper test, ruling that the ABC test should instead be used to determine whether a worker is properly classified as an employee or an independent contractor.

Under the Dynamex ABC test, a worker is presumed to be an employee unless the employer proves that the worker:

(A) Is free from the control and direction of the company in performing work, both practically and in the contractual agreement between the parties; and

(B) Performs work that is outside the usual course of the company’s business; and

(C) Is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the company.

Therefore, to satisfy the ABC test and legally classify a worker as an independent contractor, a company must prove that the worker is free from the company’s control, performs work outside the company’s primary business, and is regularly engaged in the trade the worker is hired for which must be independent of work for the company.

Part (B) of the test – which requires the worker to “perform work that is outside the usual course of the hiring entity’s business” – is often the most difficult to satisfy.  Part (C) of the test – which requires the worker to be “customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity” – eliminates most workers who perform side jobs (like those in the gig economy) that are relatively minor compared to their main day-to-day work.

Dynamex arguably only applied the ABC test to issues involving compliance with the California Wage Orders; and prior to AB 5 the test was not to be used in connection with other employer obligations under the California Labor Code, for example for claims regarding reimbursement of business expenses.

See our prior advisory on the Dynamex decision here

See our article published in The Writ comparing California and Nevada employee classification laws prior to the passage of AB 5 here.

AB 5 – Expansion of the Dynamex ABC Test

AB 5 adds Section 2750.3 to the California Labor Code and provides that the Dynamex ABC test will be used for most occupations to determine whether a worker be classified as an employee for purposes the California Wage Orders, the Labor Code, and the Unemployment Insurance Code.

Beginning on January 1, 2020, the ABC test will apply to claims made by workers against employers for misclassification of employment status. For example, workers classified as independent contractors may prosecute claims against employers asserting they are entitled to reimbursement for necessary business expenses, accurate and complete wage statements, meal and rest breaks, overtime, waiting time penalties, and the employer’s payment of social security tax, unemployment insurance tax, employment tax, and workers compensation insurance, among a host of other obligations that employers owe to employees under California law.

Under AB 5, the ABC test will apply to various occupation types that previously were characterized as independent contractors under the Borello test, such as:

  • Health care professionals (occupational therapists, speech therapists, optometrists, nurse practitioners, physician assistants, radiation therapists, licensed professional clinical counselors, marriage and family therapists, licensed clinical social workers, respiratory therapists, audiologists)
  • Rideshare, delivery service workers, and other gig economy workers
  • Truck drivers
  • Janitors & housekeepers
  • Health aides
  • Performers and other entertainment professionals
  • Land surveyors, landscape architects, and geologists
  • Campaign workers
  • Language interpreters
  • Exotic dancers
  • Rabbis and other clergy

AB 5 Exempted Industries – Return of the Borello Test

Although the Dynamex ABC test is generally the default test, AB 5 provides specific exceptions to application of the ABC test for several categories of occupations.  Subject to certain licensing and other requirements, the following is a general list of occupations exempted from application of the ABC test under AB 5:

  • Doctors (physicians, surgeons, dentists, podiatrists, veterinarians, psychologists)
  • Professionals (lawyers, architects, engineers)
  • Professional services (marketing, human resources administrator, travel agents, graphic designers, grant writers, fine artist)
  • Financial services (accountants, securities broker-dealers, investment advisors)
  • Insurance brokers
  • Real estate agents
  • Direct sales (if compensation is based on actual sales and not wholesale purchases or referrals)
  • Builders and contractors
  • Freelance writers and photographers (if contributing no more than 35 submissions to an outlet in a year)
  • Hair stylists and barbers (if licensed and if can set own rates and schedule)
  • Estheticians, electrologists, and manicurists (if licensed)
  • Tutors (that teach their own curriculum, and are not public-school tutors)
  • Commercial fishermen
  • AAA-affiliated tow truck drivers

The above exempt occupations remain subject to the pre-existing multi-factor tests, such as Borello, for determining independent contractor or employee classification. 

Retroactivity

Whether AB 5 requires retroactive application of the ABC text is question that remains unresolved. AB 5 states that “specified Labor Code provisions of the bill apply retroactively to existing claims and actions to the maximum extent permitted by law while other provisions apply to work performed on or after January 1, 2020.”  The ABC test applies retroactively “with regard to wage orders of the Industrial Welfare Commission and violations of the Labor Code relating to wage orders” as do all exceptions “to the maximum extent permitted by law.”

However, California courts have not resolved the retroactivity issues.  In Vazquez v. Jan-Pro Franchising International, the Ninth Circuit Court of Appeals previously found the Dynamex decision applies retroactively, but subsequently withdrew that opinion and certified the question to the California Supreme Court, where the request is now under consideration. In Gonzales v. San Gabriel Transit, Inc., the California Court of Appeal also found the Dynamex decision applies retroactively because it did not establish a new standard, but rather “merely clarified and streamlined” the prior standard.

In Vazquez, the Ninth Circuit Court of Appeals has asked the California Supreme Court to decide whether the Dynamex decision applies retroactively.  If the Court reviews Vazquez, it will likely take the Gonzales decision under review as well. But even if the California Supreme Court grants review of Gonzales, Gonzales will constitute binding authority in California unless the California Supreme Court orders otherwise.

The potential impact of a retroactive application of the Dynamex ABC test is troublesome.  If applied retroactively, employers who relied upon independent contractors would be subject to potential exposure going back four years for the potential misclassification of employees as independent contractors (four years is the maximum statute of limitations period for wage and hour claims) based on a legal standard that did not exist prior to April 2018 (when the Dynamex decision was issued).

Advice for Employers

A careful process of transitioning workers from independent contractors to employees is critical to minimize the risk of triggering claims for past misclassification.  If a business decides not to reclassify, revising existing independent contractor agreements and policies to more clearly satisfy the ABC test will be critical to avoid future the risk of future misclassification litigation and penalties.

Deciding to replace independent contractors with third-party staffing agencies or labor contractors will require selection of agencies or contractors that comply with the law, uphold the obligations of their agreements, and indemnify their clients for violations of the law, because companies are often found jointly liable for the wage and hour violations of their contractors and agencies who provide such workers to their businesses.

Future Legislative and Legal Battles

State legislatures and advocacy groups are expected to remain active in pushing legislation related to worker classification. In California, lobbyists for industry and worker advocacy groups are preparing for a battle during the 2020 legislative session, including a “clean up” bill to address industries that did not receive exemptions to the ABC test under AB 5.

Some major gig economy companies have already announced their pledge of substantial resources for a potential California ballot initiative to exempt the gig industry from AB 5. Worker advocacy groups are gearing up in other states as well, including New York, Washington, and Oregon, for legislative efforts similar to AB 5.

California companies must now examine their independent contractor relationships through the lens of the new framework created by AB 5. Employers continuing to classify independent contractors should ensure satisfaction of the Dynamex ABC test (or the Borello multi-factor test if an exempted occupation) or face the increased risk of defending against individual and/or governmental claims for misclassifying workers as independent contractors.

Employers should monitor how narrowly the California courts interpret the ABC test – especially what prong (B) the “usual course of the hiring entity’s business” means – in assessing legal risk. Prong (B) will likely prove the most problematic of the ABC test factors for most businesses that regularly engage independent contractors.

David W. Wolfe  is an associate attorney with Porter Simon licensed in California and Nevada, with offices in Truckee and Tahoe City, California, and Reno, Nevada. He can be reached at wolfe@portersimon.com or www.portersimon.com.

The content contained and opinions expressed in this blog are solely those of the author. This blog contains content and opinions concerning the law generally, and is not intended to constitute legal advice or to create any attorney‑client relationship with the reader. The reader should consult with an attorney about any specific legal issues prior to embarking on any course of action or inaction involving legal matters. The author makes no claims, promises or guarantees about the accuracy, completeness, or adequacy of the contents of this blog and expressly disclaims liability for any errors and omissions.