Defining independent contractors: How will AB5 affect your business?

Martin Fox-Foster
Martin Fox-Foster
Director of Coverage & Insurance

Many businesses use independent contractors in their operations on a daily basis. A new law which Governor Gavin Newsom signed on September 18, 2019 – Assembly Bill 5 (AB5) – looks to change that by codifying the ABC test handed down by the California Supreme Court in the recent case of Dynamex which distinguishes employees from independent contractors.

AB5 goes into effect until January 1, 2020 and will apply retroactively to certain claims arising under the California Wage Orders and will apply on a go forward basis to ALL independent contractors. While it has generally been perceived as a Bill targeted at the Gig economy and large firms like Uber and Lyft it has potentiality far-reaching effects for the entire State and there are clear insurance implications too. This has implications for all types of businesses from those who employee drivers as Independent Contractors to Domestic Workers if nothing else because it codifies what may have already been the law in California around who can correctly be classified as an independent contractor.

Dynamex ABC Test

The California Supreme Court’s April 2018 Dynamex decision established a presumption that workers are employees unless the hiring entity demonstrates that the worker:

A. is free from the control and direction of the hiring entity in connection with the performance of the work;

B. performs work that is outside the usual course of the hiring entity’s business; AND

C. is customarily engaged in an independently established trade, occupation, or business. 

AB5 expands this test beyond Wage Orders to provisions of the Labor Code and Unemployment Insurance Code.

Exemptions

There are certain occupations, industries, and business relationships which are carved out in AB5 from the ABC test. Although those exemptions are not automatically deemed independent contractors but instead those exempted classes must be assessed under a more flexible multifactor test. The exemptions include the following:

Gig Economy firms lobbied hard for exemption status but did not secure it. Governor Newsom has though indicated that he is open to any proposals from the large Gig firms ahead of the January 1, 2020 deadline to provide assurances around Gig workers which would lead them to amending AB5 to create a third class of workers between employees and independent contractors. If that cannot be achieved Gig Economy firms intend to push for a Ballot measure to remove AB5 in the 2020 November elections.

Retroactivity

AB5 is declaratory of existing law with regard to violations of the Labor Code relating to Wage Orders such as meal and rest breaks, overtime, and minimum wage. This means that workers can bring claims with the full backing of AB5 for any such violations that occurred over the past 4 years based on the statute of limitations under California’s Unfair Competition Law.

Importantly employers are not permitted to reclassify employees to independent contractors due to the bill’s enactment – AB5 explicitly stops employers from doing so as the intention of the Bill is to expand those workers with the rights of employees and not diminish their numbers.

Reclassification of independent contractors to employees still requires someone to enforce these rights – either the worker or City Attorneys who have the right to enforce AB5’s classification standards by bringing actions for injunctive relief against errant employers to prevent them from continuing to misclassify independent contractors as employees. That said, employers would do well to will to take a hard look at the classifications under the ABC test. That review may reveal the need to reclassify workers as employees, or alternatively, to implement structural or policy changes to bolster compliance. For example, hiring entities may start requiring independent contractors to present evidence of an independently established corporation with its own clientele. Entities with workers that fall into any of the exempted categories still need to examine their classification under the multifactor tests laid out in the law.

Insurance Implications

Employers should consider the financial implications of AB5 for the increased insurance premiums associated with these new employees in terms of increased health benefit costs, increased workers compensation premium, increased employments practices liability and increased employee benefits liability premiums.

Beyond this though AB5 will also lead to Workers Compensation audits looking at independent contractors and potentially reclassifying those workers to employees for Workers Compensation purposes which is another avenue of enforcement that employers should be aware of.  The Workers Compensation implications of AB5 to not go into effect until July 1, 2020.

Given the law’s retroactivity, it is likely to open a floodgate of lawsuits for which there may not be coverage under Employment Practices Liability policies if they are solely focused on Wage and Hour issues which some policies exclude or provide a sub-limit for the cost of defending it only. This increase in law suits will likely effect an already difficult market for Employment Practices Liability coverage in California and lead to increased pricing and restricted terms especially for those employers with a concentrated California workforce. To combat the threat of such lawsuits and to demonstrate best practice risk management Employers should consider implementing arbitration agreements with class action waivers. Employers should also evaluate an effective communication strategy if and when they decide to reclassify workers under the new law.

More than likely there will be additional twists and turns to AB5 before its implementation date and even past it but employers should be talking to their trusted insurance experts and employment attorneys well ahead of January 1, 2020 to ensure they are prepared for its implications.

For more information, please contact your G2 advisor or G2 Insurance Services at 415.426.6600 / connect@G2insurance.com.

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