Despite Exemption, Contractors Do Not Escape AB5 Completely Unscathed

10.14.2019

By now, most construction industry participants have heard about AB5, California’s new strict independent contractor test.  It is the talk of the town.  Less talked about, however, is what this change portends for the construction industry.  In AB5’s infancy we can, at best, offer illumination more than   definitiveness.  But as a general matter, despite some pains, AB5 leaves the traditional contractor-subcontractor relationship intact.    

The ABC Test

AB5 codifies the California Supreme Court’s holding in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (2018).   In Dynamex, the Court adopted the ABC test for independent contractor status, a stricter test when compared to the multi-factor analysis set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989).  

Under AB5, a worker is presumed to be an employee, unless the hiring party can show the worker is (A) “free from control and direction of the hiring entity in connection with 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 of the same nature as that involved in the work performed.”  If the worker fails any of the three prongs, then the worker will be deemed an employee. 

Despite this new ABC test, the Borello factors remain important because they control when AB5 is inapplicable or when exemptions apply.  Indeed, much of the text of AB5 concerns several exemptions from the strict ABC test.  The construction industry obtained such an exemption.  It should be emphasized that the standards of any exemption will be strictly construed.    

The “Construction Subcontract” Exemption

AB5 excludes from its coverage relationships “between a contractor and an individual performing work pursuant to a subcontract in the construction industry” that meet certain criteria.  Before AB5, contractors had to meet Labor Code Section 2750.5 and the Borello factors to prove a worker was an independent contractor. Now they must meet the AB5 criteria for this exemption, in addition to Borello and Labor Code Section 2750.5. The AB5 criteria for this exemption are as follows:   

• The subcontract is in writing.
• The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license.
  • This requirement, however, does not apply to a subcontractor providing construction trucking services for which a contractor’s license is not required if certain requirements are met; the topic of AB5’s effect on construction-related trucking will be addressed in a separate Alert. Further, where a contractor is dealing with an unlicensed worker other than a trucker, they may qualify for the “business-to-business” exemption which will also be the subject of a separate Alert.       
• If the subcontractor works in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration.
• The subcontractor maintains a business location that is separate from the business or work location of the contractor.
• The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services.
• The subcontractor carries insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided.
• The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

This final bullet mirrors the requirement of prong C of the ABC test.  Here are some questions to ask when evaluating this factor:    

1. What sources of revenue does the contractor have? Is the hiring entity the only or principal source of revenue or does the contractor have others?
2. Is the contractor a formal business registered and licensed in California?
3. Does the contractor hold any other special licenses or certifications?
4. Does the contractor employ helpers or is it a one-person company?
5. Does the contractor own its own tools or equipment (e.g., trucks)?
6. Does the contractor’s business have its own trade name, trade dress, business cards, etc.?
7. What is the contractor’s investment in its business?
8. What is the opportunity for profit or loss depending on the contractor’s managerial skill?
9. Is the contractor’s business generally regarded as an independent business within the industry?

Although contractors can obtain an exemption from the strict ABC test, such exemption comes at a price.  Having to meet the exemption requirements and the Borello factors ushers in increased costs in oversight, administrative duties, and contractual obligations, such as:  warranty requirements, increased indemnity/insurance obligations, and/or performance bonds for labor or services provided.  The uncertainty surrounding a contractor’s ability to meet the new AB5 exemption requirements also renders contractors more vulnerable to labor claims, DIR Civil Wage Penalty Assessments, and increased premiums for Employment Practice Liability Insurance.  These costs will ultimately be included in contractor’s bids, increasing the overall cost of construction. 

Further, contractors should be aware that if they are not in strict compliance with AB5, and pay employees as independent contractors, they face significant potential liability, including but not limited to:  unemployment insurance; workers' compensation coverage, claims, and premiums; penalties; interest; and attorneys’ fees.  What you should you do as a result of AB5?    At a minimum, you should have a written contract with all independent contractors, and those contracts should be reviewed by an expert.

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. 

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