What California’s New AB 5 Law Means for Employers

California Governor Gavin Newsom on Sept. 18 signed into law Assembly Bill 5, landmark legislation which codifies, and significantly expands, the reach of the California Supreme Court’s restrictive “ABC” test for determining whether a worker is an employee or independent contractor. The enactment of AB 5 will shine an even brighter light on the risks to California businesses when engaging workers as contractors, particularly in the gig economy.

The Dynamex “ABC” Test

AB 5 adopts the restrictive test for independent contractor status imposed by the California Supreme Court in its April 2018 Dynamex decision. Dynamex created a presumption that a worker is an employee, not an independent contractor, for purposes of minimum wage, overtime and meal/rest period compliance, unless the hiring entity can establish all of the following:

  1. The worker is free from control of the hiring company, both in contract and in fact
  2. The worker is engaged in work that is outside the usual course of the hiring entity’s business and
  3. The worker is customarily engaged in an independently-established trade, occupation, or business

What AB 5 Means for Businesses

AB 5 adopts and integrates the ABC test into California’s Labor Code and Unemployment Insurance Code. As a result, the ABC test now applies to many more laws—not merely those covered by the state wage orders that were the subject of the Dynamex decision—that protect employees in the workplace. This broad expansion creates 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.

AB 5 also imposes 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.

Lastly, with this incorporation of the ABC test into the Labor Code, if a business fails the 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.

Exemptions from the AB 5 Test

Favorably, AB 5 excludes certain positions from the application of the ABC test. The exemptions cover, among others, those performing work under a contract for “professional services,” including law, accounting, 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.

Importantly, these occupations are not exempt from contractor classification scrutiny altogether. Rather, they will be analyzed under the less rigid economic realities (aka the “Borello” test), which includes an assessment of the workers' skills, the duration of services, whether the work is part of the entity’s regular business, the parties' intentions as to the nature of the relationship and other factors. Thus, even if a worker is exempt under AB 5, the business must still establish that the worker is a contractor, albeit under the more flexible Borello test.

Lastly, AB 5 makes clear that it does not diminish the flexibility of employees to (1) work part-time; (2) work on intermittent schedules; or to (3) work for multiple employers. As such, for the time being, nothing in the law prevents California employers from continuing to engage workers through other, non-contractor avenues, including as needed on a temporary, or part-time employment basis.

Effective Date and Next Steps

AB 5 becomes effective on Jan. 1, 2020. However, for practical purposes, the ABC test, and its applicability to claims by or on behalf of misclassified contractors for minimum wage, overtime and meal/rest violations, has been the law of the land for nearly 18 months through the Dynamex decision.

In the meantime, the enactment of AB 5 is a wake-up call for businesses to examine/re-examine their contractor classifications carefully. The stakes are now very high.