Last month, Governor Gavin Newsome signed AB-5 into law, now codified as new Labor Code §2750.3. Section 2750.3 governs the classification of independent contractor employment status (vs “employee”) in California. The new Labor Code section expressly adopts the California Supreme Court’s heavily employee biased shift in then existing law as expressed in its 80-plus page April 2018 Dynamex decision.1
1 Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 90.
2 Most notably business operating in the “gig” economy like Uber. The Dynamex case involved drivers for an on-line food delivery service.
3 This means any business, in any form, whether sole proprietorship (individual), partnership, corporation, LLC, trust or other organization.
Ever since the Dynamex ruling, and now its codification in AB-5 (Labor Code §2750.3), we have been hearing grumblings from the business community in the nature of, “This is the death of small business and independent contracting in California.” Nonsense. While some business in California will be heavily hit and may need to re-structure their operations2, most will adapt to operate in compliance with the new law and survive/thrive, although operating costs may be higher.
But what cannot be done is to “stick your head in the sand” and ignore the new rules of the road. There are still independent contractors in California, and they can still be used extensively in business. However, businesses must: (A) Understand the new employee classification laws and how it may apply to their operational structures; and (B) Be proactive in addressing their potential issues and not simply wait for a costly enforcement action.
NEW LEGAL CONSTRUCT
Everyone is an Employee and not an Independent Contractor. Ok – that’s an exaggeration. However, New Labor Code §2750.3(a)(1) provides, in pertinent part:
“… 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 …”
What does that mean? It means that the starting position and analysis by the EDD and FTB, per statute, is that everyone paid by a company3 for his/her services/labor is an employee and not an independent contractor, with all of the employee rules, regulations, statutes, and code requirements applied, including withholding, wage/hour (including minimum wage), benefits, sick pay, training, safety, and similar applicable “employee” classification requirements.
That is, of course, “unless” the hiring company “demonstrates” (meaning that the hiring company has the burden of proof to show) ALL THREE prongs of the following 3-prong test:
(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.” §2750.3(a)(1)(A). This means the hiring company must show that the services are pursuant to a written contract providing for the independence of the contractor, AND that the services were actually performed by the contractor independent of the company’s control or direction. In most cases, this could readily be shown.
(B) “The person performs work that is outside the usual course of the hiring entity’s business.” §2750.3(a)(1)(B). Now there’s the rub for many businesses. It will probably be the source of most litigation under Section 2750.3. Are a company’s contract administrative professionals rendering services outside the “usual course” of the company’s business – probably. Does a company’s independent contractor commissioned salesperson satisfy this prong – probably not. If the independent contractor renders the service which the company offers to the public – it will definitely not satisfy this prong. This is a determination that must necessarily be made on a case-by-case basis and should be made with the assistance of qualified HR and legal professionals.
(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.” §2750.3(a)(1)(C). Basically, it’s the company’s burden to prove that the contractor regularly offers his/her business services to other companies. If a company’s “independent contractor” only works for that company (e.g., a “captive” outside salesperson) this prong will most definitely not be satisfied.
Finally, there are a number of exceptions to the application of this new construct, with respect to which the pre-Dynamex classification determinations (S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341) apply. Some of these exceptions are absolute and others require some showing of proof on the part of the hiring company.
Some of these “absolute” exceptions include: licensed attorneys, doctors, accountants, engineers, architects, and real estate salespersons. An example of an exception that requires a showing of proof by the hiring company is a “professional services” contract (a defined term) that requires a showing of 6 separate indicia of an independent contractor. There is also a B2B exception that requires a showing of proof.
HOW THE PRUDENT COMPANY PROCEEDS
An adverse determination of the classification of a company’s independent contractors as employees can be devastating for the company. It has been known to put more than one company out-of-business. The assessment can include the amounts for unpaid employment tax, unpaid withholdings, interest and a 30% penalty on the unpaid withholding amounts. Multiply this by all of a company’s IC’s, account for an eventual audit by the IRS, throw in the personal liability of the responsible person at the company for the unpaid withholdings, interest and penalties, and this can be the perfect storm to derail a once thriving business.
As a result, it is highly recommended that any business that uses independent contractors to any significant extent have their business structure and operations reviewed by qualified HR and/or legal professionals.
Even if the determination is made that the company can continue to classify its service providers as independent contractors, it would be prudent for the company to have all of the required documentation to prove such classification. Those documents will require a written agreement with the contractor structured for, and containing, all of the terms necessary under prior law (i.e., Borello requirements).
In addition, this new written IC agreement should contain all of the items necessary to “prove” the classification under Section 2750.3. In particular, the agreement should contain representations and warranties from the contractor as to the matters showing proper classification as a contractor, documents attached to the agreement in support of those representations and warranties, and possibly even an insured indemnification by the contractor for an adverse ruling by the EDD, FTD or otherwise. It is important to obtain all of these things from the contractor at the time of contracting for the mere fact that the contractor may be nowhere to be found, or become uncooperative, when the EDD/FTD comes around for their audit.
If the determination is made that some or all of a company’s independent contractors should be re-classified at employees per Section 2750.3, a company does not simply have to throw up its hands and take everyone in as an employee. There are various strategies, from the very basic to the rather sophisticated, that can be used to address these issues depending upon the specific factual situation presented. © 2019 Lee R. Goldberg. All Rights Reserved.
Your qualified HR and legal professionals will have the guidance necessary to help you navigate the employment arena now made a bit more complex by the Dynamex decision and the requirements of Section 2750.3. The worst decision for a business though is to do nothing, ignore the new laws and wait for the inevitable enforcement action. While the sky is not necessarily falling, it might if you do not adapt to the new employment laws in California.