United States: California Statute Offers Dramatic Change To Independent Contractor, Franchise-Franchisee Relationships

On September 18, 2020, California Governor Gavin Newsom signed a new measure — Assembly Bill 5 — which will redefine how businesses classify their workers. Commonly known as "AB 5," the new law seeks to codify the "ABC Test" for determining the existence of an employer/employee relationship. Simply put, the bill will make it much more difficult for businesses to utilize workers as independent contractors. The law will take effect on January 1, 2020, and will require many businesses, especially those in the so-called "gig economy," to restructure their operations or transform workers into employees. The law contains no exceptions for franchisor/franchisee relationships and could potentially require reassessment of many such arrangements.

How Did AB 5 Come to Be?

As we have previously reported, in April 2018, the California Supreme Court issued a sweeping ruling in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, which under certain circumstances eliminated a previous, more flexible multifactor inquiry for determining whether independent contractors were properly classified. For claims under the California Wage Orders, Dynamex instead adopted the ABC Test, which states that a worker is now considered an employee unless the alleged employer can satisfy all three of the following:

  1. The alleged worker is free from the control and directions of the alleged employer in connection with the work performed, both under the relevant contract for the work at issue and in fact;
  2. The alleged worker performs work that is outside the usual course of the hiring entity's business; and
  3. The alleged worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the alleged employer. 

Dynamex left unanswered questions about its applicability to other state laws and whether the enforcement agencies could apply it retroactively. So, workers' advocates and organized labor moved in aggressively to get the legislature to codify Dynamex and the ABC Test as the undisputed law of the state. In May 2019, the California State Assembly passed AB 5. The assembly's Republican members, the California Chamber of Commerce, and gig economy companies like Lyft, Uber, and DoorDash opposed, yet in August 2019 the California State Senate approved the bill, and on September 11 the full assembly passed the final version of the bill.

The Far-Reaching Impact of AB 5

The impetus for AB 5, Dynamex, only applied to California's Wage Orders and, thus, was relatively limited in scope to minimum wage, overtime, and meal and rest break rules. AB 5, however, reaches further, subjecting alleged employers to liability for workers' compensation coverage, unemployment insurance, paid sick leave, family leave, and other benefits. Further, workers who were formerly independent contractors (and certain franchisees) may now seek protection under the state's antidiscrimination and harassment laws, and organize themselves into unions.

The final bill became somewhat of a demonstration of which industries had the most lobbying muscle and were best able to obtain exemptions from AB 5. Examples of those fortunate to obtain at least limited carve-outs are listed below:

  • Physicians, dentists, podiatrists, and veterinarians;
  • Lawyers, architects, engineers, and accountants;
  • Securities broker-dealers and investment advisors;
  • Licensed real estate salespersons, repossession agents, estheticians, electrologists, manicurists, barbers, and cosmetologists;
  • Certain construction subcontractors and motor club service providers; 
  • Travel agents, HR administrators, marketing contractors, grant writers, fine artists, payment processing agents, freelance writers, cartoonists, and editors who are able to meet certain other requirements outlined in the bill; and
  • Referral agencies connecting clients with those providing services in graphic design, photography, tutoring, event planning, minor home repair, home cleaning, moving, errands, furniture assembly, animal services, dog walking and grooming, web design, picture hanging, pool cleaning, or yard cleanup also able to meet certain other requirements outlined in the bill. 

Importantly, businesses that hire other businesses (i.e., vendors) are also in danger of liability under AB 5. A vendor's employees could claim they are also the employees of the "contracting business," under the bill's definition, unless the contracting business can satisfy 12 requirements in the statute. Some of these requirements include 1) proof that the vendor provides the similar or same services to other clients, 2) the vendor providing its services directly to the contracting business and not its customers, and 3) the vendor advertising to the public. Finally, at least two courts have held that Dynamex's ABC Test is retroactive, going back four years, while certain aspects of AB 5 are too. 

Businesses face difficult decisions in the coming days, ahead of January 1. Should they reconfigure their operations in order to avoid liability under AB 5? Should they proceed with reclassifying their independent contractors as employees? Either choice presents a host of legal and technical issues that are best addressed on a case-by-case basis. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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