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Editorial 8 MIN READ

AB-5, three weeks in

California's new classification statute took effect January 1, a federal court froze it for truckers by January 16, and the operating guidance is still being written in real time

The Editors
Staff, Incorporator.org
8 min read Updated
Contents 6 sections
  1. What actually changed at midnight on January 1
  2. The trucking injunction
  3. Retroactivity landed first
  4. The gig-economy ballot effort
  5. What to do this quarter if you run a California 1099 book
  6. Sources

alifornia AB-5 took effect on January 1, 2020, adding Section 2750.3 to the Labor Code and putting the Dynamex ABC test on statutory footing for the Labor Code, the Unemployment Insurance Code, and related wage-enforcement regimes. Three weeks in, the state has one preliminary injunction against enforcement in the trucking sector, a California Supreme Court ruling that Dynamex applies retroactively, and a gig-economy coalition spending its way toward a November ballot measure.

The bill that was pending last spring is the law this winter, and anyone still running a California 1099 book without reading the statute is now out of time.

What actually changed at midnight on January 1

The governing text is Cal. Lab. Code § 2750.3. Subdivision (a)(1) sets the default: for purposes of the Labor Code, the Unemployment Insurance Code, and the wage orders, a person providing labor or services for remuneration is an employee unless the hiring entity demonstrates all three of the ABC prongs. (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 and in fact. (B) The person performs work that is outside the usual course of the hiring entity's business. (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. Fail any prong and the worker is presumed an employee for every purpose named in the statute.

Subdivision (b) through (h) carry the exemptions. The enacted bill is longer than the December 2018 version that ran to one operative page; by the time it passed the Assembly and cleared the Senate on September 11, 2019, it had accumulated roughly fifty named carve-outs. Licensed insurance agents, physicians, surgeons, dentists, podiatrists, psychologists, veterinarians, lawyers, architects, engineers, accountants, private investigators, securities broker-dealers and investment advisers, direct salespeople already covered by Unemployment Insurance Code § 650, real estate licensees under Business and Professions Code § 10032, and commercial fishermen on American vessels (sunset December 31, 2022) are all either fully exempt or routed to the older multi-factor test from S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989). Subdivision (c) carves out bona fide business-to-business contracting relationships that satisfy twelve specific criteria, and subdivision (e) handles referral agencies for discrete services (graphic design, tutoring, dog walking, web design, and so on) again on a multi-factor test.

Two carve-outs have generated disproportionate press. Subdivision (c) sets out the B2B test, and it is strict: the contracting business must be free from control, must be engaged in an independent business of the same nature, must have a business license where required, must maintain its own business location, must actually contract with other customers, and must negotiate its own rates, among other requirements. It is the test a bookkeeping firm, a contract engineer, or an independent consultant will lean on, and on its face it takes real effort to satisfy. Subdivision (b)(2)(B)(x) carves out "a freelance writer, editor, or newspaper cartoonist who does not provide content submissions to the putative employer more than 35 times per year," and that 35-submission ceiling is the line the freelance journalism trade has spent the last six weeks fighting. Contributors to digital publications who filed weekly had to restructure by December 31; some did, some lost the work.

The trucking injunction

The cleanest live challenge is federal and it has already drawn blood. The California Trucking Association sued the state in the Southern District of California, Case No. 3:18-cv-02458, pleading that the F4A (the Federal Aviation Administration Authorization Act of 1994, codified for motor carriers at 49 U.S.C. § 14501(c)) preempts AB-5 as applied to motor carriers. The F4A bars states from enacting or enforcing a law "related to a price, route, or service" of a motor carrier. CTA's theory is that forcing the reclassification of owner-operator truckers to employees dictates the carrier's operating structure and therefore falls within the preempted field.

On December 31, 2019, hours before AB-5's effective date, Judge Roger T. Benitez granted a temporary restraining order enjoining enforcement of AB-5 against any motor carrier operating in California. On January 16, 2020, Judge Benitez converted the TRO into a preliminary injunction, finding CTA likely to succeed on the preemption theory. The state has appealed to the Ninth Circuit. The injunction is narrow (motor carriers only) and procedural (it preserves the status quo while the case moves), but it has meaningful consequences. Owner-operator truckers in the state are, for the moment, still legally permitted to work under their existing lease arrangements, and large motor carriers that had started conversion planning in Q4 have paused those projects.

A second federal suit, American Trucking Ass'ns v. Becerra, is proceeding on related grounds, and a state-court action by the California Trucking Association under the dormant Commerce Clause is pending. None of the three reaches a contractor who is not a federally regulated motor carrier, and none should be read as a general stay. The injunction is truck-shaped.

Retroactivity landed first

On January 14, 2020, the California Supreme Court decided Vazquez v. Jan-Pro Franchising International, Inc., 9 Cal.5th 72 (2020), answering the certified question from the Ninth Circuit: Dynamex applies retroactively. That ruling is not about AB-5. It is about the judicial decision AB-5 codifies, and it governs pending wage-order claims that predate April 30, 2018. For businesses with open PAGA or class actions in the pipeline, the ABC test now reaches back to the limitations period, four years for unfair competition claims under Business and Professions Code § 17200 and three years for most wage claims under Code of Civil Procedure § 338.

The combined effect is that a California business defending a 2017 misclassification claim cannot argue that the pre-Dynamex multi-factor test applied at the time of the conduct. The court has closed that door. The practical consequence is more settlements, at higher numbers, over the next twelve months.

The gig-economy ballot effort

The ride-hail and delivery coalition (Uber, Lyft, DoorDash, Instacart, Postmates) has, since October 2019, been funding an initiative for the November 2020 ballot that would carve app-based transportation and delivery drivers out of AB-5 and replace the ABC test with a bespoke framework (platform-set earnings floor, health-care stipend tied to hours, occupational-accident insurance) in exchange for contractor status. Filings with the Secretary of State as of this writing put the committee's committed spend in the low nine figures. Whether the measure qualifies, whether it survives a legal challenge to its single-subject compliance, and whether voters adopt it in November are three separate questions. None is settled in January.

The operating question for platform companies this quarter is what to do in the meantime. Options are three. First, continue 1099 operations and litigate; that is Uber and Lyft's stated posture, and both companies have told investors they believe their drivers continue to satisfy the ABC test because the platform is a technology business, not a transportation business. The California Labor Commissioner does not share that view, and the first enforcement actions under the new statute are expected within the next sixty days. Second, reclassify to W-2 with reduced driver counts and higher consumer prices; that is what one delivery platform has piloted in San Francisco this month, at limited scale. Third, suspend operations in California pending the initiative; that has been threatened by some of the smaller platforms and practiced by none of them.

None of the three is free. Litigation costs are enormous and the downside includes retroactive back-wage liability if the platforms lose. Reclassification priced at roughly twenty to thirty percent of gross pay (FICA, FUTA, SDI, Employment Training Tax, workers' compensation premium, meal and rest break exposure, Labor Code § 226 wage-statement compliance, Labor Code § 2802 expense reimbursement, paid sick leave) reshapes unit economics in a business that is already unprofitable. Suspension means ceding market share. Investors are asking which number is in the deck, and the answer is usually "we don't know yet."

What to do this quarter if you run a California 1099 book

The conservative read is that every California contractor relationship needs to be documented against § 2750.3 by March 31, and the ones that fail the ABC test need to be either restructured (to satisfy subdivision (c) B2B) or converted to W-2 (with back-dated compliance for the January payroll periods already run). The freelance journalism 35-submission ceiling needs to be tracked at the contractor level; many publishers were caught flat-footed on January 1 and owe corrections.

Businesses operating under one of the professional exemptions (law, medicine, architecture, engineering, accounting, real estate) should confirm that their contractor relationships meet the full exemption criteria rather than the general profession-name test. Subdivision (b) exemptions still require certain structural conditions (business license, independent business, negotiation of rates, direct customer contracts where applicable); the exemption is not self-executing on occupation alone.

Businesses contracting with out-of-state workers who perform work in California have no shelter. The statute reaches any work performed in California regardless of where the parties sit. Remote-work arrangements do not dissolve the question; they distribute it.

Our April 2019 preview of AB-5 covered the bill in the lobbying phase, when the exemption list was still in motion and prong B was doing the analytical work. Most of that analysis holds. The pieces that moved between April and January are the exemption count (up, to roughly fifty), the trucking injunction (granted, narrow), the retroactivity question (resolved against the defense bar), and the ballot effort (funded, pending). The general reading for any California entity that hires contractors is unchanged: assume employee status unless you can document all three prongs or map into a specific exemption.

For a business that sat on its hands through the fall because the statute looked like it would soften, the relevant word at the three week mark is penalty. Labor Code § 226.8 imposes civil penalties of $5,000 to $15,000 per violation for willful misclassification, rising to $10,000 to $25,000 for a pattern or practice. PAGA penalties stack on top. The first enforcement wave has not yet arrived. It will.

Sources

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