Legal Alert: California's Ab 5 Codifies State Supreme Court's Stricter Test for Independent Contractor Status

Legal Alert: California's Ab 5 Codifies State Supreme Court's Stricter Test for Independent Contractor Status

Governor Gavin Newsom signed California Assembly Bill 5 (AB 5) into law on September 18, 2019 and it becomes effective on January 1, 2020. AB 5 codifies the California Supreme Court's 2018 decision in Dynamex Operations West, Inc. v. Superior Court that presumed a worker was an employee under the state Wage Orders unless the hiring entity satisfied a strict independent contractor test. Independent contractor misclassification has always posed substantial risk for companies, and AB 5 will heighten misclassification challenges.

Prior to Dynamex, employers had long applied a multi-factor test from the California Supreme Court's 1989 decision in S.G. Borello & Sons v. Dept. of Industrial Relations that determined independent contractor status from a totality of circumstances; not all factors had to exist to establish an independent contractor relationship. The Borello factors focused principally on the business's control over how the worker completes the job in addition to the following nine factors:

1. client's right to discharge the worker at will, without cause;
2. whether the worker is engaged in a distinct occupation or business from the client;
3. whether - as measured by locality of the work - the worker's occupation typically performs the work under the direction of the client or on the worker's own as a specialist without supervision;
4. skill level required in the worker's occupation;
5. whether the client or worker supplies the tools, instrumentalities and location to render services;
6. the length of time that the worker's services are to be performed;
7. method of payment, whether by the time or by the job;
8. whether the work is part of the regular business of the client; and
9. parties' belief whether they are creating an independent contractor relationship.

The Borello test applied to determinations of employee-independent contractor status in California for 30 years. Dynamex and AB 5 redefined the Borello test and adopted a more rigorous standard to determine independent contractor status. Specifically, AB 5 presumes a worker is an employee unless the hiring business proves the worker is an independent contractor using a 3-part A-B-C test. In contrast to the individualized Borello test, the A-B-C test is designed to simplify independent contractor determination and discourage independent contractor status. If the employer fails any one of the three parts, the worker is an employee.

Under the A-B-C test, the hiring business must prove:

1. the worker is free from the control and direction of the hirer in connection with the performance of the work, both factually and under the contract for the work;
2. the worker performs work that is outside the usual course of the hiring entity's business; and
3. the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

AB 5 expands the reach of Dynamex beyond the state Wage Orders to the California Labor Code, including workers' compensation, and the Unemployment Insurance Code. Consequently, the A-B-C test in AB 5 extends to all businesses in California including the entertainment industry. The obligation of a company to avoid engaging individual direct hires as independent contractors over whom the company exercises control and/or who provide services within the normal course of the employer's business is largely unaffected by AB 5. However, given the more demanding A-B-C test required to show independent contractor status, production companies should review their current individual direct hire independent contractor relationships to assess whether they meet the A-B-C test as it will become more difficult to classify individual workers as independent contractors.

It is unknown how the A-B-C test may apply to entertainment industry loan-outs. If the loan-out entity cannot satisfy the A-B-C test, the loan-out worker may be subject to reclassification as an employee unless the loan-out worker meets any of the exceptions in AB 5. AB 5 contains a series of elaborate occupational exemptions from the A-B-C test but none of them apply to the entertainment industry. In addition to the occupational exemptions, AB 5 excludes bonafide "business-to-business" contracting relationships (B2B) which may apply to industry loan-outs. To satisfy the B2B exception, the loan-out company must establish 12 factors in addition to satisfying the previous Borello test:

1. be free under the facts and contract from control and direction of the contracting client in connection with performance of the work;
2. provides services directly to the contracting client rather than customers of the contracting client;
3. loan-out's contract with the client is in writing;
4. if the work is performed in a jurisdiction requiring the business service provider to have a business license or tax registration, the loan-out has the required license or registration;
5. keeps a business location separate from the client's work/business location;
6. is customarily engaged in an independently established business of the same nature as the work performed;
7. contracts with other client businesses to provide the same or similar services and maintains clientele without restrictions from the client;
8. advertises and holds itself out to the public as available to provide the same or similar services;
9. provides its own tools, vehicles and equipment to perform the services;
10. can negotiate its own rates with the client
11. consistent with the nature of the work, the loan-out can set its own hours and location of work; and
12. does not perform work requiring a state construction contractor's license.

The issue of whether the B2B exception will extend to a loan-out entity is a question of fact and will depend on the specific circumstances relating to the loan-out entity and its relationship with the production company. Even if the loan-out entity falls within the B2B exception, the loan-out must still satisfy the prior Borello test which has applied to entertainment industry loan-out company practices over the past 30 years.

Nonetheless, AB 5 should not impact (a) well-settled law in California that recognizes loan-out workers as "special employees" for workers' compensation purposes [Angelotti v. Walt Disney Co., (loan-out worker considered special employee of production company for purposes of applying workers' compensation exclusivity rule)]; and (b) areas outside of the state Wage Orders, Labor Code and the Unemployment Insurance Code that invoke different legal standards to determine employee-independent contractor status. Although many industry collective bargaining agreements recognize loan-out entities as separate business vehicles through which union members render services to production companies, production companies should review current union and non-union loan-out company practices in the wake of AB 5.

Contrary to some industry media reporting, AB 5 does not portend the end of industry loan-out company practices but it may change how such relationships will be evaluated for certain purposes. Production companies should therefore carefully assess loan-out company and individual direct hire relationships as well as all vendor relationships to ensure that those relationships comply with the A-B-C test or any of its exceptions where applicable. Production companies should also confirm with their Motion Picture Payroll Services Company (MPPSC) that the MPPSC's workers' compensation policy covers loan-out workers as special employees of the production company for workers' compensation purposes.

Production companies should also carefully consider the consequences if their workers are mischaracterized as independent contractors. Misclassification of a worker's independent contractor status exposes the business to significant liability for, among other things, civil suits by injured workers for workplace injuries, penalties for failure to maintain workers' compensation insurance, penalties for misclassified independent contractor status, wage-hour liability for minimum wage, overtime, meal/rest break, and pay stub violations, and failure to pay required employer taxes and employee tax withholdings.

We will continue to monitor the law for any changes and will report on any material developments.

For any questions about this Alert, you may contact:

Joseph Scudiero, Senior Vice-President & Chief Labor Counsel
818-955-4335
⁠jscudiero@ep.com

Scott Bishop, Vice-President, Employment Law
818-955-4336
⁠sbishop@ep.com