On September 10, 2019, the California State Senate passed Assembly Bill 5 (AB 5) effectively requiring certain workers previously operating as independent contractors to be considered employees. Governor Gavin Newsom is expected to sign the bill into law following State Assembly approval. Resultant employee reclassification will require employers to adhere to previously inapplicable labor laws and potentially cause disruptive changes to the gig economy.

Background

The expanding gig economy relies on the ability of companies to employ certain workers as independent contractors, rather than employees. As such, these workers are not entitled to, and employers need not provide, certain protections and benefits under federal and state law. The unanimous decision by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (2018) (Dynamex) upended the previous classification standards used by such companies by more clearly delineating between when a worker must be classified as an employee instead of an independent contractor. The revised standards provided a framework to assess the employment status of workers such as the drivers alleging misclassification in Dynamex, delivery service providers and ride-hailing drivers that have widely been treated as independent contractors in recent years.

The Bill

AB 5 codifies the Dynamex decision and clarifies its application. Dynamex imposed a three-pronged test to determine employment status. For a worker to qualify as an independent contractor, the worker must (1) be free from the employer’s control in the performance of work for that employer, (2) provide a service not central to the employer’s business and (3) regularly perform similar work independent of the employer. Failure to meet any of the three criteria qualifies the worker as an employee and thus entitles them to the protections of the California Labor Code, the California Unemployment Insurance Code, and the wage orders of the California Industrial Welfare Commission.

The bill carves out a significant number of exempt industries and employees effectively limiting the scope of the Dynamex decision. Among these exceptions, are lawyers, engineers and accountants licensed in the State of California, and securities broker-dealers and investment advisors registered with the Securities and Exchange Commission, Financial Industry Regulatory Authority or the State of California.

Pending Governor Newsom’s approval, the bill will take effect on January 1, 2020.

Our Take

Limiting the ability of an employer to classify workers as independent contractors if the workers provide a service central to the employer’s business represents the most significant shift from previous classification standards, and will likely significantly extend employee status to workers. Whether a service is in fact central to the employer’s business will be an interesting question of fact. For example, ride-hailing companies expected to be affected by the bill have responded by arguing that their drivers do not perform a primary business function and thus are not employees, instead painting their businesses as principally technology platforms. Employee misclassification suits are likely to arise from workers as well as state and city enforcers.

California’s initiative is likely to have follow on effects around the country. New York State passed a minimum wage law for ride-hailing drivers in 2018 and could revisit additional legislation following California’s success. Washington and Oregon likewise experienced movement toward similar legislation and could be closely watching the new law. In California, a coalition of companies dependent on contractor workers have promised to continue to battle the new requirements by lobbying for an additional bill that exempts their businesses and those like them.

More broadly, the bill changes the game for companies built on the gig economy model. Shifts in the operating and financial models of ride-hailing, delivery, app-based services and other similarly situated companies could follow.

Beginning January 1, 2020, employers will need to reclassify workers using the new standards. State minimum wage and other wage and hour laws, health care subsidies, social security contributions, workers’ compensation, paid time off and numerous other benefits will extend to workers formerly classified as independent contractors. However, employers will not be obligated to consider these workers employees for purposes of complying with federal law governing employee benefit plans, such as nondiscrimination testing requirements.

Special thanks to Shearman & Sterling Legal Assistant Anna Stillman for her contribution to this client publication.