Many independent contractors complained of dire consequences when Assembly Bill 5 (AB5) became effective in California on January 1, 2020. Following intense lobbying and public relations campaigns, independent contractors in 15 industries now have been added to AB5’s list of freelancers who are eligible for an exemption from California’s extraordinarily onerous version of the so-called “ABC” test for independent contractor status. The new version of AB5 was signed into law by the Governor of California last Friday, September 4, 2020.  However, except for those fortunate industries and service providers now eligible for exemption from the ABC test, the new law, Assembly Bill 2257 (AB2257), only tweaks AB5 and is essentially unchanged in any meaningful way for the overwhelming number of companies and freelancers doing business in California. But as noted below, there are strategies that can be used by many companies in an effort to comply with AB2257.

When AB5 became effective on January 1, 2020, it dramatically expanded upon the application of the 2018 Dynamex decision by the California Supreme Court. Dynamex changed settled law in California that had been based on a test issued by that same court nearly 30 years earlier in a case called Borello, which considered all factors relevant to the classification of workers as either independent contractors or employees. In contrast, AB5 considers only three factors, and all three must be met to establish independent contractor status.

The decision in Dynamex was limited to so-called “wage order” claims and did not apply across-the-board to all types of independent contractor claims in California including overtime and expense reimbursement claims. AB5 changed all that, making the ABC test (instead of Borello) universally applicable to virtually all types of claims in the areas of labor, employment, unemployment, and workers compensation law for all industries except those that were eligible for the exemption. Thousands of companies that thought they were in compliance with California law under Borello were told by the state legislature and governor: the rules have changed – even if you invested time and money developing your business in this state, you’ll need to begin to make freelancers and all other independent contractors your own employees if you want to continue to operate here.

AB5 Exemptions

AB5 carved out from the ABC test certain freelancers in about 50 industries, as we described in our blog post of September 11, 2019 entitled “How to Operate in California with Independent Contractors after AB5 Bill is Signed into Law.” Those industries included:

  • A limited number of professionals (doctors, dentists, psychologists, veterinarians, lawyers, architects, engineers and accountants);
  • broker dealers, investment advisers, direct salespersons, private investigators, and commercial fishermen;
  • a limited number of professional service providers (marketing contractors, human resources administrators, travel agents, graphic designers, grant writers, fine artists, enrolled tax agents, and payment processing agents);
  • media professionals (still photographers, photojournalists, freelance writers, publication editors, and newspaper cartoonists), provided they limited their contributions to no more than 35 per year;
  • licensed insurance agents, real estate salespersons, repossession agents, estheticians, electrologists, manicurists, barbers, and cosmetologists;
  • selected construction subcontractors and motor club service providers;
  • selected referral agencies (graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, and yard cleanup) that met 10 specific requirements; and
  • business-to-business contractual relationships that met 12 specific conditions.

AB2257 Adds Exemptions and Clarifies Others

In addition to the 50 or so industries exempted under AB5, AB2257 now exempts from the ABC test a group of freelance positions from another 15 industries, including independent contractors providing the following types of services:

  • recording arts
  • music
  • performing arts
  • landscape architecture
  • translation of documents
  • copy editing and illustrations
  • registered professional forestry
  • real estate appraising
  • home inspections
  • insurance underwriting inspections, auditing, and risk management and loss control
  • manufactured housing sales
  • international and cultural exchange services
  • competition judging
  • digital content and feedback aggregation
  • teaching of master classes by specialized performers for limited periods of time.

Under AB5, freelance writers, photographers, photojournalists, editors, and cartoonists were exempt if they submitted content no more than 35 times a year.  AB2257 eliminated this arbitrary numerical limitation.

In addition to expanding the number of industries eligible for exemption, AB2257 modified AB5’s business-to-business exception. However, many companies may view this exemption as essentially unchanged. It still contains 12 specific requirements, all of which must be met, no matter how marginal one or more may be. Therefore, many business-to-business independent contractor relationships still may be unable to take advantage of this exemption merely because they cannot satisfy only one of the requirements.

Sixteen industries were listed in AB5 as eligible for the so-called “referral agency” exception with regard to individuals providing the following services: graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, and yard cleanup. AB 2257 added to the list of exemptions for independent contractors using referral services, including those providing wedding planning and wedding services, event services, interpreting services, youth sports coaching, caddying, and consulting.  The term “consulting” is defined to mean “providing substantive insight, information, advice, opinions, or analysis that requires the exercise of discretion and independent judgment and is based on the individual’s knowledge or expertise of a particular subject matter or field of study.”  The new law also offers an exemption to individuals using referral agencies in an unspecified number of additional industries.  AB2257 states that those covered under the referral services exemption “shall include, but are not limited to,” the specific types of services listed above.

At the same time, however, AB2257 specifically states that the referral agency exemption is not available to independent contractors providing services in:

  • “industries designated by [two designated state agencies] as a high hazard industry,” and
  • ten other industries, some of which have been targeted by regulators, legislators, and class action lawyers in California (janitorial, delivery, courier, transportation, trucking, agricultural labor, retail, logging, in-home care, and construction services other than minor home repair). AB5 had listed 10 specific requirements that referral agencies had to meet to qualify for the exemption. AB2257 now lists 11 conditions. While a few of the original 10 requirements in AB5 have been slightly clarified, only a few referral agencies will likely be able to satisfy all of the requirements to qualify for the exemption.

The continuing infirmities of AB5/AB2257

Many independent contractors were not granted exemptions even though they provide services similar to the types of freelancers that AB2257 specifically carves out from the strict ABC test.  For example, while licensed psychologists are exempted as professionals, other licensed professionals who provide mental health therapy (such as licensed marriage and family therapists, social workers, professional clinical counselors, and educational psychologists) were not included. Nor are physical therapists, occupational therapists, or speech pathologists included.

Similarly, there is no rhyme or reason why independent contractors in 65 specific industries are eligible for an exemption from the ABC test, yet contractors engaged in providing services in hundreds of other industries are not. This type of legislation lends credence to the belief that AB2257 unfairly favors some industries, thereby provoking outrage and a feeling that certain independently established professions, trades, occupations, and businesses were unjustifiably overlooked.

In a reasoned article entitled “Complexity Is the Cost of California’s Worker Classification Law,” which appeared in Law360 on October 24, 2019, Professor Edward Zelinsky of Cardozo Law School concluded that many of the exemptions in AB5 (most of which have been continued in AB2257) are “opaque” and “ambiguous.” For example, Professor Zelinsky notes that the exemption for individuals performing marketing services only applies if they engage in “work [that] is original and creative in character and . . . depends primarily on the invention, imagination, or talent of the [individual].” As noted in the Zelinsky article, at least until a body of case law develops over a number of years, “it will often be unclear whether marketing activity is creative enough or imaginative enough to qualify the marketer as an independent contractor for purposes of this … exemption.”

Professor Zelinsky also examined a few other equally “opaque” and “ambiguous” exemptions, including the professional services exemption, where a business must show that the professional service provider “customarily and regularly exercises discretion and independent judgment in the performance of the services.”  He commented, “at least for the short run, and perhaps for the long run, this open-ended standard will entail substantial interpretative ambiguity, leaving the boundaries of the exemption unclear.” The same can now be said for AB2257’s definition of “consulting” services – litigation will likely as to whether the individual’s services “requires the exercise of discretion and independent judgment.”

As Professor Zelinsky concluded: “AB5 [now AB2257] does not make the law of employee status clearer, simpler or more uniform.  Indeed, [it] makes the law more complex and less uniform than it was before.”

A further example of the lack of clarity is the legislature’s inclusion of the language “including but not limited” in the business-to-business exemption. Does that mean all other B2B relationships other than those expressly excluded are now eligible for this exemption, or will some argue that the list is illustrative in nature instead of open-ended? This will likely create years of litigation over which other B2B relationships are now covered by this exemption.

Another key deficiency of the AB2257 exemptions is that many require that every one of a long list of specified conditions be met.  Few business-to-business contractors and few referral agencies, however, can realistically satisfy every single one of the conditions for an exemption from the ABC test.  Thus, these exemptions are essentially unrealistic for most companies in those types of businesses.  The California legislature could have followed the lead of other states that have set forth an equally comprehensive list of factors for independent contractor status, but only require that a specified number of the factors be met.[1]

By creating such rigid exemptions, the Legislature overlooked the fact that many businesses in a particular industry may operate differently than others.  The Legislature also overlooked the fact that while some of the specified conditions may be essential in determining whether an independent contractor or employment relationship exists, such as whether the service provider is free from direction and control in connection with the performance of services, some of the specified factors are marginal at best.

Thus, AB2257 is more complex than the Borello test it supplanted.  It is under-inclusive in the types of professions and industries it exempts from the ABC test and overly rigid in terms of requiring businesses and contractors to fit into a fixed, multi-factor business structure if they wish to qualify for an exemption from the ABC test.

Operating in California with independent contractors after AB2257

An exemption from AB2257 is not a “get-out-of-jail-free” card; those businesses carved out from the Dynamex ABC test must still comply with the multi-factor Borello test.  Many businesses in industries that obtained a carve-out still will be governed by the ABC test (and not Borello) if they are unable to satisfy any of up to a dozen specific requirements.  Thus, those businesses covered by Borello need to structure, document, and implement their independent contractor relationships in California consistent with that multi-factor test, which is similar in many ways to most of the varying tests for independent contractor status under the major federal laws and a majority of state laws.

For some companies that will be governed by the ABC test in California, establishing all three prongs of the ABC test may be untenable.  But the ABC test may well be interpreted by the courts in California in a manner that legally permits a number of companies to continue to use independent contractors.  In that regard, few courts have yet to issue decisions applying Dynamex and the Supreme Court of California has yet to apply any of the three prongs in any case.  Therefore, while it will undoubtedly be more challenging now to structure, document, and implement an independent contractor relationship for a business governed by the ABC test in California instead of the multi-factor Borello test, it still can be accomplished by certain types of businesses.  Indeed, California is not the only state with an ABC test – no less than 20 states have variations of that test for independent contractor status, although most of the ABC tests are applicable only to unemployment insurance or workers’ compensation claims.

Many companies that have sought to enhance their compliance with both a multi-factor test and an ABC test have resorted to an enhancement process such as IC Diagnostics™, which elevates a company’s level of compliance with applicable state and federal laws by restructuring, re-documenting, and re-implementing IC relationships.  This compliance approach can be accomplished in a customized and sustainable manner without changing a company’s business model.

A process such as IC Diagnostics™ also can be utilized in an effort to meet the specific requirements under AB2257 for selected professional service providers, business-to-business contracting, and referral agencies. In addition, this process can be used to suggest changes to an existing business model that falls outside of AB2257 altogether.

Companies operating in California and elsewhere with independent contractors also should enhance and update their arbitration clauses with class and collective action waivers.  In doing so, they can most effectively limit class and collective action lawsuits, as we discussed in detail in an article we published in the Daily Labor Report by Bloomberg Bureau of National Affairs.

Written by Richard Reibstein and Janet Barsky

[1] See, e.g., Florida test for IC status under the state’s workers’ compensation law, where 4 of 6 factors may be met to qualify for IC status.  Fla. Stat. 440.02. See also Wisconsin’s unemployment insurance test, where meeting six of nine conditions will establish independent contractor status. Wis. Stat. §108.02(1) (bm).