In rather Cinderella-like circumstances, legislation—known as the “gig worker bill”—may have, at the stroke of midnight on December 31, 2019, turned hundreds of thousands of “independent contractors” into “employees.” California’s Assembly Bill 5 (AB5), which codifies the April 2018 ruling by the state’s Supreme Court in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, is now in effect. AB5 lays down new rules on how workers should be classified, which could significantly raise the cost of hiring and retaining workers.
As the Dynamex case docket points out, “if a worker should properly be classified as an employee, the hiring business bears the responsibility of paying federal Social Security and payroll taxes, unemployment insurance taxes and state employment taxes, providing worker’s compensation insurance, and… complying with numerous state and federal statutes and regulations governing the wages, hours, and working conditions of employees.”
In Dynamex, the justices proposed a new approach for deciding whether a worker was an employee or simply an independent contractor. All workers would prima facie be considered employees, unless a putative employer could show the worker met the requirements of the “ABC test.” AB5 now bolsters this worker-friendly approach by elevating the principle in Dynamex to statutory level. Compliance with AB5 will, undoubtedly, raise the cost of doing business in many concerns. But there may be opportunities for restructuring operational models in a way that improves business performance. Putting someone on the payroll fosters a closer alignment with company objectives and allows a degree of control that may be vitally necessary if the worker’s activities are central to an enterprises’ core business.
Background to the Dynamex decision and AB5
The ruling in Dynamex had meant that in determining worker classification in wage-order claims, the courts would apply a set of exceptions—known as the ABC test—to the premise that all workers were employees. With the passage of AB5, which amends and adds to California’s Labor and Unemployment Insurance Codes, the ABC stipulations have now become the law of the state. Employers must classify workers in line with ABC, ab initio, or face the risk of punitive action and fines of up to $25,000 per violation.
State legislators advanced the aim of the legislation, which was “to ensure workers who are currently exploited by being misclassified as independent contractors instead of recognized as employees have the basic rights and protections they deserve under the law, including a minimum wage, workers’ compensation if they are injured on the job, unemployment insurance, paid sick leave, and paid family leave,” adding that the “misclassification of workers as independent contractors has been a significant factor in the erosion of the middle class and the rise in income inequality.”
Dynamex is a courier and logistics company that had originally classified its drivers in California as employees. Beginning in 2004, in an effort to cut costs, the company reclassified its drivers as independent contractors. The following year, Charles Lee joined Dynamex as an independent contractor to provide delivery services. He worked for just 15 days in January 2005 and then left. Three months later, in April 2005, he sued Dynamex alleging, among other things, that the company had misclassified its drivers and thus failed to pay overtime compensation, to properly provide itemized wage statements, and to compensate drivers for business expenses.
These alleged omissions, if true, amounted to a violation of California’s Industrial Welfare Commission (IWC) Wage Order No. 9, the applicable state wage order governing the transportation industry, and unfair and unlawful business practices under California’s Business and Professions Code. After a series of appeals, the matter reached the California Supreme Court, which ruled in Lee’s favor. In so doing, the court adopted a version of Massachusetts’ independent contractor test, now known as the ABC test.
The “ABC Test”
The ABC test consists of three rebuttals to the presumption that a worker is an “employee.” In order to classify a worker as an independent contractor, a company must show that the worker’s employment circumstances satisfy all three prongs of the test, which are:
(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.
But AB5 also provides an exception to the general rule in cases where the 3-part ABC test is inappropriate. In such instances, the old common law rule set out in S. G. Borello & Sons, Inc. v. Department of Industrial Relations will apply. AB5 also exempts certain professions from the ABC test; to these professions Borello would also apply. The exempt professions include licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and those performing work under a contract for professional services with another business entity, or under a subcontract in the construction industry. The B2B area is less easy than it looks. Businesses contracting with other businesses must meet 12 specific requirements, while referral agencies must meet 10 specific requirements.
Implications & Issues
AB5 will undoubtedly raise costs for businesses, by as much as 40 percent, based on data released by the U.S. Bureau of Labor Statistics (BLS). In a September 2019 release, the BLS determined that, on average, benefits such as insurance, retirement and savings programs, and paid leave, accounted for 30 percent of an employer’s total personnel costs. This means two things. First, Alpha Company, which employs only independent contractors, would incur just 70 percent of the costs of Beta Company, which pays its workers as employees. Second, if Alpha Company has to reclassify its labor, its costs would increase by 30 cents for every 70 cents it formerly spent, an increase of 30/70 or 42.9 percent.
AB5 will also increase the compliance burden of hiring. To ensure workers have the proper authorization to work in the U.S., employers must complete Form I-9, Employment Eligibility Verification for every hire. However, no such requirement is necessary for using an independent contractor. But compliance goes beyond simply classifying workers as either employees or independent contractors. Companies could be audited by Immigration and Customs Enforcement (ICE) and, therefore, should be prepared by having a list of their independent contractors and ensuring none can be classified as employees. If ICE thinks the contractor is really an employee, the agency will ask to see an I-9 for that individual. Of course, there will be none and the company may end up paying a fine. The amount of the fine varies, and can extend to instances where the individual does not currently work for the company but did in the past. If the work occurred on or before November 2, 2015, the penalty is $110-$1,100, if after November 2, 2015, the penalty is $224-$2,236.
Do take some time to review your hiring practices and the criteria your company uses to classify workers as either “employees’ or “independent contractors.” Self-auditing may be onerous, particularly with pressing operational matters at hand. But it can save you from undue stress and from incurring hefty penalties from federal and state agencies.