INDEPENDENT CONTRACTS v. EMPLOYEES – CODIFYING THE ABC TEST

One of the most significant and widely publicized bills to emerge from this year’s Legislature was AB 5, which codifies and expands the “ABC test” that’s used to distinguish employees from independent contractors under the Industrial Welfare Commission (IWC) Wage Orders.  The ABC test was established by the California Supreme Court’s decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal. 5th 903 (2018).  AB 5 codifies this test and expands its application to the Labor Code and Unemployment Insurance Code.

Under the ABC test, a worker is classified as an employee unless the employer can establish all three of the following:

A. The worker is free from the hiring entity’s control and direction in connection with the performance of the work, both under the contract for the performance of the work and in actually performing the work; AND
B. The worker performs work that’s outside the usual course of the hiring entity’s business; AND
C. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

Keep in mind:

• Expansion of claims that can be brought using the ABC test – Since the ABC test applies now to claims under the Labor Code and Unemployment Insurance Code, there are new incentives for both misclassified contractors and the government to pursue businesses not only for unpaid payroll taxes, but also business expense reimbursement, paid family leave benefits, paid sick leave, workers’ compensation coverage (for service-related injuries) and unemployment benefits.  Claims for such benefits and remedies could be pursued individually, or on behalf of a group or class of misclassified contractors.  Note, claims relating to IWC Wage Orders for misclassified contractors (e.g., overtime, meal/rest breaks, minimum wage) has been the law of the land for over a year and a half through the Dynamex decision.
• Personal exposure of directors/officers – If a business fails the ABC test and lacks sufficient capital to satisfy a misclassification judgment or award, both the government and private litigants now have a more direct basis to pursue Labor Code monetary penalties arising out of such misclassification from officers and directors personally.
• Aggressive new government enforcement mechanisms – The law provides that violating businesses may be subject to injunctive relief, and direct prosecution by the state’s attorney general.  Moreover, business could be subject to prosecution by the city attorney and/or the city prosecutor in the state’s highly populated cities.
• Exceptions – AB 5 carves out numerous exceptions from the ABC test for various industries.  If an exception is applicable, the more flexible common law multi-factor “Borello test” typically applies, focusing on the entity’s control over the worker.  The exemptions cover, among others, those performing work under a contract for “professional services,” including law, accounting, engineering, medicine, architecture, private investigation, registered securities broker-dealers and investment advisers, marketing (provided the work is “original and creative” in character, and “depends primarily on invention, imagination, or talent”), human resources administrators (provided that, among other factors, the work is “predominantly intellectual and varied in character”), graphic designers, and freelance writers.
• Penalties – There are steep penalties for the misclassification of a worker as an independent contractor.  In addition to Labor Code violations for items such as unpaid wages, missed meal and rest breaks, and overtime that would be available to a worker misclassified as an independent contractor, Labor Code section 226.8 also provides for significant civil penalties.  Labor Code section 226.8 provides that employers can be liable for civil penalties of $5,000 to $15,000 for each violation of “willful misclassification” of employees as independent contractors.  In addition, if it is found that the employer has a pattern and practice of misclassifying independent contractors, the penalties can increase to a minimum of $10,000 to $25,000 per violation.