February 2020
Proper Classification under California Law – Independent Contractor or Employee?
California lawmakers passed California Assembly Bill 5 (“AB 5”), codifying and clarifying the California Supreme Court’s 2018 decision in Dynamex Operations West, Inc. v. Superior Court, which altered the test for determining the classification of workers as employees or independent contractors in California. The Dynamex decision provides that workers are presumed to be employees for purposes of claims for wages and benefits arising under Industrial Welfare Commission wage orders, and companies must meet a three-pronged “ABC test” to overcome this presumption and establish that an individual is an independent contractor. Effective January 1, 2020, Section 2750.3 of the California Labor Code codified the ABC test into law:
“(a) (1) For purposes of the provisions of this code and the Unemployment Insurance Code, and for the wage orders of the Industrial Welfare Commission, a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all of the following conditions are satisfied: (A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact. (B) The person performs work that is outside the usual course of the hiring entity’s business. (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.” Cal. Lab. Code § 2750.3(a)(1).
In our opinion, the prong that will likely create issues for many employers, and will likely be difficult to satisfy, is B. 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.” There are many articles which discuss the difficulty in satisfying prong B; including the following excerpts which highlight the aforementioned difficulty:
“Many employers in California using independent contractors have been confronted with the reality that, given the ABC test—particularly Prong B—their business model is in trouble. The California Supreme Court reasoned that services that would ordinarily be viewed by others as falling within the hiring entity’s business rather than a worker’s ‘own independent business’ render that worker an employee and not a contractor. The examples provided by the court where a worker would satisfy this prong and be properly classified as a contractor were relatively clear cut: a retail store retaining a plumber or electrician to perform maintenance work at the facility, not a service normally provided by the retailer. As for specialized technical work within an isolated function of an employer’s business, the court said these are not among the types of jobs that would typically qualify, even though these have historically fallen within a gray area. This prong of the test could create differing opinions among courts attempting to interpret the new law.” “New ABC Test for Independent Contractors Sends California Employers Reeling,” www.fisherphillips.com, July 2, 2018. “As an example of how the new test will work, assume a bridal store enters into an independent contractor agreement with a seamstress to alter dresses for customers, with the seamstress working from her home, not the store. Here, the store is at risk of failing to satisfy at least parts (A) and (B) of the test. Under part (A), the worker is likely not free of the shop’s control, as the store likely requires the seamstress to alter dresses as customers request, deliver altered dresses on time per store requirements, and alter dresses to quality standards set by the store. Under part (B), the seamstress is likely to be performing work within the course of the store’s business, as making alterations is often part and parcel of selling wedding gowns. Therefore, despite the store’s independent contractor agreement with the worker, and absent other circumstances, the store would likely fail in proving that the worker met the new standard for qualifying as an independent contractor, and the seamstress would be presumed to be an employee.” Horton Thomas, Jeffrey S. and Gallagher, Steven P., “Say Goodbye to Independent Contractors: The New ‘ABC’ Test of Employee Status,” www.hrdefenseblog.com, May 7, 2018.
Labor Code Section 2750.3 provides that in the event a court rules that the ABC test cannot be applied then the standards set forth in S.G. Borello & Sons, Inc. shall apply:
“(3) If a court of law rules that the three-part test in paragraph (1) cannot be applied to a particular context based on grounds other than an express exception to employment status as provided under paragraph (2), then the determination of employee or independent contractor status in that context shall instead be governed by the California Supreme Court’s decision in S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (Borello).” Cal. Lab. Code §2750.3(a)(3).
The Borello court held that strong evidence supporting the existence of an employment relationship is the right to discharge at will without cause. The court listed additional factors to be considered, including:
“(a) whether the one performing services is engaged in a distinct occupation or business; (b) the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision; (c) the skill required in the particular occupation; (d) whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work; (e) the length of time for which the services are to be performed; (f) the method of payment, whether by the time or by the job; (g) whether or not the work is a part of the regular business of the principal; and (h) whether or not the parties believe they are creating the relationship of employer-employee. (Tieberg, supra, at p. 949; Empire Star Mines, supra, 28 Cal.2d at pp. 43–44; see Rest.2d Agency, § 220.) ‘Generally, . . . the individual factors cannot be applied mechanically as separate tests; they are intertwined and their weight depends often on particular combinations.’ (Germann, supra, 123 Cal.App.3d at p. 783.)” S. G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341, 350-351, 769 P.2d 399, 404, 256 Cal. Rptr. 543, 548, 1989 Cal. LEXIS 975, *15-17, 54 Cal. Comp. Cases 80.
We note that there is a business-to-business exception wherein the standards of Borello shall apply; however, please note that all of the criteria outlined in Section 2750.3(e)(1) must be demonstrated. Section 2750.3(e) provides:
“(e) Subdivision (a) and the holding in Dynamex do not apply to a bona fide business-to-business contracting relationship, as defined below, under the following conditions: (1) If a business entity formed as a sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation (‘business service provider’) contracts to provide services to another such business (‘contracting business’), the determination of employee or independent contractor status of the business services provider shall be governed by Borello, if the contracting business demonstrates that all of the following criteria are satisfied: (A) The business service provider is free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact. (B) The business service provider is providing services directly to the contracting business rather than to customers of the contracting business. (C) The contract with the business service provider is in writing. (D) If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration. (E) The business service provider maintains a business location that is separate from the business or work location of the contracting business. (F) The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed. (G) The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity. (H) The business service provider advertises and holds itself out to the public as available to provide the same or similar services. (I) The business service provider provides its own tools, vehicles, and equipment to perform the services. (J) The business service provider can negotiate its own rates. (K) Consistent with the nature of the work, the business service provider can set its own hours and location of work. (L) The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code. (2) This subdivision does not apply to an individual worker, as opposed to a business entity, who performs labor or services for a contracting business. (3) The determination of whether an individual working for a business service provider is an employee or independent contractor of the business service provider is governed by paragraph (1) of subdivision (a). (4) This subdivision does not alter or supersede any existing rights under Section 2810.3.” Cal. Lab. Code §2750.3(e).
In addition to the business-to-business exception, Section 2750.3(b) provides that the Borello standard will also apply with respect to the following occupations:
(1) Person or organization licensed by the Department of Insurance; (2) Physician and surgeon, dentist, podiatrist, psychologist or veterinarian; (3) Individual with an active license from the State of California practicing in one of the following professions: lawyer, architect, engineer, private investigator or accountant; (4) Securities broker-dealer or investment advisor; (5) Direct salesperson as described in Section 650 of the Unemployment Insurance Code; (6) Commercial fisherman working on an American vessel; and (7) Newspaper distributor working under contract with a newspaper publisher.
Additionally, there is an exception for contracts for professional services. Section 2750.3(c)(1) provides:
“(c) (1) Subdivision (a) and the holding in Dynamex do not apply to a contract for “professional services” as defined below, and instead the determination of whether the individual is an employee or independent contractor shall be governed by Borello if the hiring entity demonstrates that all of the following factors are satisfied: (A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity. Nothing in this subdivision prohibits an individual from choosing to perform services at the location of the hiring entity. (B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession. (C) The individual has the ability to set or negotiate their own rates for the services performed. (D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours. (E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work. (F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.” Cal. Lab. Code §2750.3(c)(1).
Although there are specific requirements for many of the following listed professions, the term “professional services” generally includes the following:
(i) Marketing; (ii) Administrator of human resources; (iii) Travel agent; (iv) Graphic design; (v) Grant writer; (vi) Fine artist; (vii) Services provided by an enrolled agent who is licensed by the U.S. Department of Treasury to practice before the IRS; (viii) Payment processing agent through an independent sales organization; (ix) Still photographer or photojournalist; (x) Freelance writer, editor or newspaper cartoonist; and (xi) Licensed esthetician, electrologist, manicurist, barber or cosmetologist.
Lastly, Section 2750.3(d) provides an exception for real estate licensees and repossession agencies; Section 2750.3(f) provides an exception for the relationship between contractors and subcontractors, provided the specified requirements have been met; Section 2750.3(g) provides an exception for the relationship between a referral agency and a service provider and Section 2750.3(h) provides an exception for the relationship between a motor club and an individual performing services pursuant to a contract between the motor club and a third party to provide motor club services.
The ABC test is also included in the definition of “employee” in the California Unemployment Insurance Code:
“’Employee’ means all of the following: (a) Any officer of a corporation. (b) Any individual providing labor or services for remuneration has the status of an employee rather than an independent contractor unless the hiring entity demonstrates all of the following conditions: (1) The individual is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact. (2) The individual performs work that is outside the usual course of the hiring entity’s business. (3) The individual is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.” Cal. Unemp. Ins. Code §621.
The test shall also be applicable with respect to workers compensation. Labor Code Section 3351 specifically refers to Section 2750.3 and includes in the definition of “employee”: “(i) Beginning on July 1, 2020, any individual who is an employee pursuant to Section 2750.3. This subdivision shall not apply retroactively.” Cal. Lab. Code § 3351.
An article on www.forbes.com states that although the new law is enacted under the Labor Code, “it is clear that the intent is to apply the new test for all purposes, including California tax purposes, since one of the express stated reasons for the new law is the prior loss of tax revenue due to misclassification of employees as independent contractors…the net result is a broad expansion of people classified as employees for California tax purposes, and the employers will almost certainly classify the workers as employees for federal tax purposes as well, since it would be way too confusing to treat them differently for federal tax purposes.” Moore, Schuyler, “California Legislates New Definition of an Employee, and Loan-Outs Are Toast,” www.forbes.com, September 15, 2019.
Although there is an exception for attorneys, Labor Code Section 2753, provides that persons who knowingly advise an employer to treat an individual as an independent contractor will be held liable with the employer if the individual is deemed to be an employee:
“(a) A person who, for money or other valuable consideration, knowingly advises an employer to treat an individual as an independent contractor to avoid employee status for that individual shall be jointly and severally liable with the employer if the individual is found not to be an independent contractor. (b) This section does not apply to the following persons: (1) A person who provides advice to his or her employer. (2) An attorney authorized to practice law in California or another United States jurisdiction who provides legal advice in the course of the practice of law.” Cal. Lab. Code § 2753.
Employers who wish to attempt to avoid the impact of the new law and reclassify their employees to independent contractors should note that, “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.” “Assembly Bill No. 5 – California Enacts New Independent Contractor Status Analysis,” www.aalrr.com/newsroom-alerts-3577, October 11, 2019.
In May of 2019 there was a published opinion that held that the ABC test should be applied retroactively to wage orders. In Vasquez v. Jan-Pro Franchising International, Inc. (9th Cir., May 2, 2019) 2019 WL 19450001, the court expanded the potential liability of employers because it determined that the ABC test should be applied retroactively to wage order claims that existed prior to Dynamex; however, the court withdrew its opinion and certified the question of retroactivity for the California Supreme Court to decide.
In summary, AB 5 codifies into law the ABC test articulated by the California Supreme Court in Dynamex. With respect to the application of the provisions of the Labor Code, the Unemployment Insurance Code and wage orders of the Industrial Welfare Commission, the presumption is that a person shall be considered an employee, as opposed to an independent contractor, unless the employer can satisfy all three prongs of the ABC test.
For more general information regarding the ABC test, please contact either Lawrence Inouye (linouye@shiotani-inouye.com) or Nicole Pearson (npearson@shiotani-inouye.com).