California Enacts New Independent Contractor Status Analysis - The Impact of AB 5 on Public Agencies

10.14.2019

We have heard a great deal about Assembly Bill No. 5 (“AB 5”) which codified into law the new “ABC” test for determining whether an independent contractor should be deemed an employee.  Effective January 1, 2020 AB 5 will add section 2750.3 to the Labor Code.  But what is the impact of the law on the operations of public agencies?

The new law is based upon two key judicial opinions issued by the California Supreme Court in the Dynamex case and the Borello case. 

Dynamex

The California Supreme Court first articulated the ABC test in its Dynamex Operations West v. Superior Court (2018) 4 Cal.5th 903 (“Dynamex”) decision, issued on April 30, 2018. The Dynamex decision reviewed the employee or independent contractor question in one specific context. The court decided what standard applies, under California law, in determining whether workers should be classified as employees or as independent contractors for purposes of California wage orders, which impose obligations relating to the minimum wages, maximum hours, and a limited number of very basic working conditions (such as minimally required meal and rest breaks) of California employees. In California, wage orders are constitutionally-authorized, quasi-legislative regulations that have the force of law.  (Cal. Const., art. XIV, § 1; Lab. Code, §§ 1173, 1178, 1178.5, 1182, 1185; Industrial Welfare Com. v. Superior Court (1980) 27 Cal.3d 690, 700-703.) 

In Dynamex, two individual delivery drivers, suing on their own behalf and on behalf of a class of allegedly similarly situated drivers, filed a complaint against Dynamex Operations West, Inc. (“Dynamex”), a nationwide package and document delivery company, alleging that Dynamex had misclassified its delivery drivers as independent contractors rather than employees. The drivers claimed that Dynamex’s alleged misclassification of its drivers as independent contractors led to Dynamex’s violation of the provisions of Industrial Welfare Commission wage order No. 9, the applicable state wage order governing the transportation industry.

The Dynamex court held that workers are presumed to be employees unless all three of a specific set of standards are met. These standards are referred to in the Dynamex opinion as an “ABC” test and consist of the following three conditions:

(A)  The individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and

(B)  The service is performed outside the usual course of the business of the employer; and,

(C) The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

This holding established a new standard for determining whether a worker is an independent contractor or an employee.

Borello Test

Prior to Dynamex, California law followed the “multi-factor” or the “economic realities” test for determining independent contractor status adopted by the California Supreme Court in the case of S. G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341 (“Borello”). In applying the economic realities test, the most significant factor to be considered was whether the person to whom service is rendered (the employer or principal) has control or the right to control the worker both as to the work done and the manner and means in which it is performed. The Borello test also considers “secondary” factors, such as whether the worker was engaged in a distinct occupation or business, the skill required in the particular occupation, whether the hiring entity supplied the tools used to perform the work and where the work was performed. California courts and public agencies have historically applied the Borello test for determining whether a worker is an independent contractor or employee for most wage & hour, tax and insurance related purposes.

Highlights of Assembly Bill No. 5

The following are the highlights of the Bill:

1. AB 5 specifically codifies the Dynamex presumption with respect to the application of provisions of the Labor Code, the Unemployment Insurance Code, and the Wage Orders of the Industrial Welfare Commission, that a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates:
   • A) the person is free from the control and direction of the hiring entity in connection with the performance of the work;
   • B) the person performs work that is outside the usual course of the hiring entity’s business; and
   • C) the person is customarily engaged in an independently established trade, occupation, or business.
2. AB 5 provides that any statutory exception from employment status or any extension of employer status or liability remains in effect, and that if a court rules that the 3-part test cannot be applied, then the determination of employee or independent contractor status shall be governed by the test adopted in Borello “economic realities test.”
3. AB 5 exempts various occupations and industries from the application of the ABC test, and would instead provide that these are governed by the Borello economic realities test, subject to additional statutorily specified conditions or criteria being satisfied. Exempt occupations include, among others, licensed insurance agents, certain licensed health care professionals (e.g., physicians, dentists, psychologists, etc.), licensed professionals in other specified licensed professions (attorneys, architects, engineers, private investigators, accountants), registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, and commercial fishermen. AB 5 additionally states exemptions for contracts for specified “professional services,” provided that six specified conditions are met with respect to the individual providing the services. Such “professional services” include, among others, human resources administrators, grant writers, graphic designers, and freelance writers.    Also exempt (again, subject to specified conditions) is the relationship between a contractor and an individual performing work in the construction industry.  
4. AB 5 also exempts a “bona fide business-to-business contracting relationship” that exists between two business entities (formed as a sole proprietorship, partnership, limited liability company, or corporation). Provided that specified criteria are satisfied, the determination of employee or independent contractor status of the business entity that is providing services is determined under the Borello test.
5. AB 5 makes additional related changes to the definition of “employee” for purposes of unemployment insurance (Sections 606.5 and 621 of the Unemployment Insurance Code) and workers’ compensation (Section 3351 of the Labor Code).
6. AB 5 provides that the addition of Section 2750.3 to the Labor Code does not constitute a change in, but is declaratory of, existing law with regard to violations of the Labor Code relating to wage orders of the Industrial Welfare Commission. Moreover, AB 5 provides that it will 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. Lastly, AB 5 prohibits an employer from reclassifying an individual who was an employee on January 1, 2019, to an independent contractor due to the bill’s enactment.

AB 5 Impact on Public Agencies

A question that many are asking is, “Does AB 5 apply to public agencies?”  While it is clear that AB 5 applies to public agencies in some respects, further clarification is needed from the Legislature or courts to answer this question definitively.

Courts in California have long applied a general rule of statutory construction that a statute does not apply to a public agency unless the express terms of the statute indicate that it does apply, or the statute applies by necessary implication.  How courts would apply this rule of construction to AB 5 remains to be seen.   

AB 5 does not by its own terms expressly apply to, or exempt public agencies.  Labor Code 2750.3 does, however, make clear that “for purposes of this code [i.e., the Labor Code] and the Unemployment Insurance Code and for the wage orders of the Industrial Welfare Commission,” the “ABC” test of Dynamex/AB 5 applies.  The Unemployment Insurance Code expressly includes public agencies within its definition of employer.  It therefore seems plain that AB 5 applies to public agencies for purposes of unemployment insurance.  The minimum wage requirements of the wage orders have been held by California courts to apply to public agencies (although by their own terms, the wage orders exempt public agencies from some of their provisions, such as overtime, and meal and rest periods).  It therefore also seems clear that AB 5 applies to public agencies at least for purposes of the minimum wage requirements of the wage orders.

Whether and to what extent AB 5 applies to public agencies for purposes of the Labor Code, however, is a more nuanced question.  Some provisions of the Labor Code, such as workers’ compensation, paid family leave (Labor Code 233) and paid sick leave (Labor Code 245 et seq.) expressly apply to public employers by their own terms.  For these provisions of the Labor Code, it seems clear that AB 5 applies.  Other provisions of the Labor Code, however, expressly exclude public employers from their application, or are silent.  In many instances, statutes that specifically apply to public agencies (for example, the Meyers-Milias-Brown Act or other provisions of the Government Code) may address subjects also covered by the Labor Code (for example, overtime pay, prompt payment of wages, indemnification of employees, contracting for personal services etc.) but in terms that are not identical to those of the Labor Code.  In these cases, the application of AB 5 is less clear. 

Pending clarification from the courts or Legislature, the conservative approach generally will be to assume that AB 5 does apply, since the misclassification of employees as independent contractors may create substantial risk of exposure to statutory penalties and other liabilities.  By the same token, however, a concession that AB 5 applies to a public agency in a given context, where arguably it may not, may impose obligations or liabilities on the agency that could otherwise be avoided.  Consultation with legal counsel as to the application of AB 5 in a specific setting or for purposes of a particular issue is therefore advisable.

Public agencies must remain mindful of the concept of “joint employment.” Where an individual who is an employee or independent contractor of an entity that itself contracts to perform services for some other agency or business, in some circumstances it may be claimed that the individual is an employee of both entities.  In Curry v. Equilon Enterprises (2018) 23 Cal.App.5th 289, the Court of Appeal held that the Dynamex/ABC test did not apply to questions of joint employment, but rather that a different “common law” test would continue to apply.  Arguably, if the intent of AB 5 was to codify Dynamex, this principle should still apply.  However, it remains to be seen whether and how courts will apply AB 5 to questions of joint employment.

AB 5 will require public agencies to carefully review existing personal service agreements (PSA) and other independent contractor relationships in order to properly classify individuals working with the organization.

• The “A” prong in the ABC test: “The person is free from the control and direction of the hiring entity in connection with the performance of the work.”

Ask yourself if the consultant is performing work without the public agency’s direct. supervision and control.  If yes, the evidence supporting that conclusion is crucial to rebutting the presumption of an employee/employer relationship.  The engagement must also meet the other two prongs of the ABC test.

• The “B” prong in the ABC test: “The person performs work that is outside the usual course of the hiring entity’s business.”

The “B” prong poses unique difficulties to employers, in distinguishing between “the usual course” of the hiring entity’s business and an ostensible independent contractor’s work. The Dynamex court explained that if a retail store hires an outside plumber to repair a leak in a bathroom and an electrician to install a new electrical line, “the services of the plumber or electrician are not part of the store’s usual course of business as the store would not reasonably be seen as having suffered or permitted the plumber or electrician to provide services to it as an employee.”

The scenario above provides a simple example in which the service provided by the independent contractor (i.e., plumbing) is plainly different from the “usual course of business” of the employer (i.e., retail store).  In other circumstances, the evaluation becomes less clear, and requires the hiring entity to define its scope of business in precise and defensible terms.  In other states using comparable versions of the ABC test, an employer must assess whether an individual provides a service that is necessary or merely incidental.  For instance, a public agency may provide a multitude of services, including police, fire, public works, and transit.  An evaluation of whether the agency’s transit services (for example) are within the “usual course of business” depends on the extent to which those services are deemed necessary or incidental to essential public safety functions or civic-centered operations. 

• The “C” prong in the ABC test: “The person is customarily engaged in an independently established trade, occupation, or business.”

The “C” prong is potentially problematic for many public agencies wanting to retain the services of a highly skilled professional who is newly retired or has recently become a consultant. The “C” prong appears to require that the individual (1) was already in business for him- or herself prior to working with the public agency and (2) the individual works in a customarily independent profession. This latter requirement is less clear than the former, and whether new professions – work that had not existed previously – could ever be accepted as “customarily” independent remains open for debate.

PRINCIPLES IN ACTION

A recent court decision provides a cautionary tale about the risks posed for public employers for misclassifying employees as independent contractors.  In the Francisco Gonzales v. San Gabriel Transit, Inc. (October 8, 2019) 2019 WL 4942213 (“Gonzales”) decision, San Gabriel Transit Inc. (“SGT”) contracted with public agencies to provide transportation services.  Gonzales and 550 other drivers brought a class action against SGT challenging their misclassification as independent contractors.  Their claims were based on various provisions of the Labor Code, several wage orders, and other statutory provisions. While the dispute was pending, California’s Supreme Court issued its Dynamex decision and adopted the ABC test. 

The court held that the Dynamex decision changed its evaluation of Gonzales’ class action in several important ways.  First, the court found that the ABC test applied retroactively, to pending wage and hour lawsuits.  As a general rule, courts often will apply new judicial decisions or standards to pending litigation, so this outcome is not surprising.  However, the decision highlights that public agencies can now fairly anticipate that other courts may apply the ABC test for wage and hour disputes which were filed before AB 5 and are currently pending.

Second, the court held that the ABC test applied to various provisions of the Labor Code, specifically those that are “rooted in” wage orders or “predicated on conduct alleged to have violated a wage order.”  If either of these two circumstances are not involved, the Borello test applies. The court agreed that the current dispute involved nuanced allegations based on wage orders as well as various provisions of the Labor Code, but cautioned against applying different tests in such circumstances.   For example, while some of Gonzales’ claims were expressly based on specific Wage Orders and provisions of the Labor Code (such Wage Order 9 and LC section 2802), other claims generally alleged violations of both standards.  Given that most of the claims involved were “rooted in wage order protections and requirements” and involved “close if not inseparable ties” between the Labor Code and wage orders, the ABC test should apply.

Notably, the court acknowledged in a footnote that AB 5 had recently been signed into law, and summarized its new requirements.  While “it appears our decision in this case is consistent with AB 5,” the court decided the case “independently of that enactment.”  (Gonzales, supra, 2019 WL 4942213, at *1 fn. 4.)  This part of the decision is dicta or non-essential to its holding, but suggests that courts may conclude that AB 5 applies with equal force to public agencies.

Third, the court found that the Borello test applies to misclassification claims which are not based on “wage and hour protections” but other statutes, such as unfair business competition laws.

While this decision was brought against a private company, the decision and AB 5 highlight that the issue of misclassification is an important issue for members of the Legislature, the plaintiff’s bar and the public at large. Given the importance of these developments, and the risks and liabilities posed by misclassification, public agencies should take steps to review their practices and risk tolerance with respect to independent contractors.  Recommended steps include the following:

• Review current or pending independent contractor agreements, in light of AB 5 and court decisions interpreting the new ABC test. For public sector employers, we advise particular attention be paid to how they may define and explain the agency’s “usual course of business” and whether an independent contractor falls inside or outside these services.
• Conduct an audit of its practices and policies concerning the use of independent contractors, particularly in the level of interaction, supervision, and other involvement between these outside parties and internal managers or public employees.
• Review the records retained with respect to work performed by independent contractors.

Finally, the discussion above illustrates that assessments of the employment status of particular individuals as independent contractors depends on the circumstances involved.   Our firm is ready and available to provide advice and assistance in addressing this complex issue.

This AALRR publication is intended for informational purposes only and should not be relied upon in reaching a conclusion in a particular area of law. Applicability of the legal principles discussed may differ substantially in individual situations. Receipt of this or any other AALRR publication does not create an attorney-client relationship. The Firm is not responsible for inadvertent errors that may occur in the publishing process.