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Editorial 9 MIN READ

California's AB-5, at the halfway mark

A one-page bill to codify Dynamex has become the year's biggest lobbying fight, and it still has the Assembly floor and the Senate to clear

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 6 sections
  1. What Dynamex did, and what AB-5 would do on top of it
  2. The lobbying perimeter
  3. What the bill looks like in operational terms
  4. The second-order machinery
  5. What remains unclear through April
  6. Sources

alifornia AB-5, the pending classification bill from Assemblymember Lorena Gonzalez, was introduced on December 3, 2018, runs a single operative page, and would put the Dynamex ABC test on a statutory footing by adding Section 2750.3 to the Labor Code. Nothing about it has been quiet since.

The bill has not yet moved to a floor vote. As of this week it sits with amendments being negotiated industry by industry, and the building is full of lobbyists trying to get their clients named in the exemption list before the Assembly takes it up.

What Dynamex did, and what AB-5 would do on top of it

The Dynamex decision is the reason this bill exists. In Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018), the California Supreme Court replaced the multi-factor Borello balancing test, from S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989), with a three-prong "ABC" test for whether a worker is an employee under California's wage orders. Under the ABC test, a hiring entity carries the burden of showing all three: (A) the worker is free from the hirer's control and direction in performing the work, both contractually and in fact; (B) the worker performs work outside the usual course of the hiring entity's business; and (C) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. Miss any prong and the worker is an employee. The decision came down on April 30, 2018, and was unanimous.

Dynamex reached wage orders only. That left open whether the ABC test governed California's broader Labor Code provisions (reimbursement of expenses under Section 2802, meal and rest break enforcement, itemized wage statements, PAGA claims tied to those statutes) and whether it reached the Unemployment Insurance Code, the workers' compensation system, and other state-law regimes that use the word "employee." Lower courts have been splitting on the reach for a year. AB-5 would close that split by statute.

The bill's operative language, as introduced, codifies the three prongs of the ABC test verbatim and extends the presumption of employee status across the Labor Code and the Unemployment Insurance Code, not only the wage orders. The findings section says the Legislature's intent is to "codify the decision of the California Supreme Court in Dynamex" and to "clarify the decision's application in state law." The same findings are explicit that misclassified workers should have access to minimum wage, workers' compensation, unemployment insurance, paid sick leave, and paid family leave. That framing is not accidental. It is what makes the bill expansive rather than merely declarative.

A reader who reviews the December 3 introduced text will notice how short it is. The bill does three things on its face: it adds Section 2750.3 to the Labor Code, it amends Section 3351 of the Labor Code (which defines "employee" for workers' compensation), and it amends Sections 606.5 and 621 of the Unemployment Insurance Code (which define "employee" and "employment" for UI purposes). The rest is findings. That is the bill.

The lobbying perimeter

What makes AB-5 a genuine fight rather than a ministerial cleanup is that prong B is doing almost all the work. Prong A (no control) and prong C (independent trade) mostly track the old Borello factors and are not hard for a sophisticated contracting arrangement to satisfy. Prong B, which asks whether the worker performs work outside the hiring entity's usual course of business, is the one that breaks predictable models.

The clearest example is ride-hail. Uber and Lyft describe themselves in public statements as technology platforms that connect riders to independent drivers. Under prong B, a judge or a labor commissioner evaluating that self-description has to decide whether driving passengers for fares is outside the usual course of the business. Uber's position is that the platform is the business and the driving is not; the obvious counter is that the platform without drivers is not a business at all. That argument runs the same way for DoorDash, Postmates, Instacart, and the rest of the last-mile delivery companies that have built their unit economics on 1099 labor. Their lobbyists are in the Capitol this spring because AB-5 as drafted offers them no path to keep the current model intact under California law.

Trucking is the second big frontier. California has tens of thousands of owner-operator truckers working under lease arrangements with motor carriers. Under prong B, the owner-operator hauling freight for a carrier whose business is hauling freight is in trouble. The California Trucking Association has been telling the author's office that the bill as drafted will force carriers to reclassify owner-operators as employees or force owner-operators out of the state, and that either outcome will raise shipping costs. The trucking industry also has a federal preemption card it intends to play if the bill passes: the Federal Aviation Administration Authorization Act of 1994 (the F4A) preempts state law "related to a price, route, or service" of a motor carrier, and carriers will argue that ABC-test classification hits all three. Whether F4A preemption flies against a state labor-law statute is an open question. Expect a lawsuit inside ninety days of signature.

Franchises are the third. The concern from the franchise bar is not that franchisees will suddenly be deemed employees of their franchisors (the California Supreme Court's own decision in Patterson v. Domino's Pizza, LLC, 60 Cal.4th 474 (2014), already set a more limited standard for when a franchisor is a joint employer of a franchisee's workers). The concern is that prong B will be read to ask whether a franchisee's operations are outside the franchisor's usual course of business, and franchised-brand operations are, by design, the same line of business as the franchisor. International Franchise Association lobbyists have been circulating proposed amendment language that would carve franchise relationships out of Section 2750.3 or, at minimum, preserve the Patterson gloss. Whether any of it ends up in the bill is unclear.

The cleaner carve-out requests, the ones likely to be accommodated, come from licensed professions where the contractor model is structural and uncontroversial: doctors, dentists, architects, engineers, accountants, lawyers, private investigators, direct-sales representatives, real-estate licensees, commercial fishermen, and the subset of creative professionals (writers, photographers, graphic designers) who work project-to-project for many clients in a year. Most of those groups have testified or filed letters. Several will likely be named specifically in the bill before it leaves the Assembly.

What the bill looks like in operational terms

Businesses that contract with workers in California should read AB-5 as pending law and should start reviewing the three prongs now, not after a Senate vote. The practical questions split by category.

For a business that contracts with licensed professionals (the law firm retaining a contract paralegal, the clinic paying a per-diem physician, the architecture practice engaging a specialist consultant), the risk under the ABC test is low if prongs A and C are satisfied and the retention is genuinely outside the firm's usual services. The bill, if signed, will likely include a licensed-professional carve-out in some form. The conservative move is to review retainer agreements for control language (fixed hours, required tools, supervisory structure) and tighten them.

For a business that contracts with workers who do the same thing the business sells (a bookkeeping firm paying 1099 bookkeepers, a cleaning service paying 1099 cleaners, a salon renting chairs to stylists who do the same work the salon sells), the exposure is direct. Prong B fails on the face of the arrangement. The options are to reclassify to W-2, to restructure so the contractor is running a genuinely separate business with other customers of record, or to terminate the relationship. There is no fourth option, and "the worker prefers 1099" is not a defense.

For a business operating a platform that connects customers to workers (ride-hail, delivery, marketplace handyman apps), the bill's practical effect depends on whether prong B is read to the platform's technology-company self-description or to the economic reality the customer experiences. No federal precedent forces a reading. Expect aggressive pretext challenges, expect at least one attempted ballot initiative if the bill becomes law, and do not rely on either to structure current operations.

For a franchisor, the risk is derivative and depends on how prong B is drafted by the time the bill clears the Assembly. The watch item is whether the final text preserves Patterson or silently overrides it.

The second-order machinery

Classification is not one statute; it is the keystone for a stack. Reclassifying a contractor to an employee triggers federal FICA and FUTA obligations, California State Disability Insurance withholding, the Employment Training Tax, and California's Paid Family Leave contribution. It triggers workers' compensation coverage under Labor Code Section 3700, meal and rest break compliance under Wage Order 4 (or whichever wage order applies), itemized wage-statement requirements under Labor Code Section 226, and expense-reimbursement exposure under Section 2802. Every one of those carries its own private right of action and in many cases statutory penalties.

The cost per reclassified worker, once the full stack is priced in, is in the high teens to mid-twenties of percent on top of previous gross pay. That is the number gig-economy CFOs are giving investors this spring when asked about California exposure. It is also the number driving the lobbying budget.

Pass-through entity structure does not save a misclassification claim. A California LLC used as a placeholder to pay an individual who is otherwise functioning as an employee of the hiring entity is treated the same as paying the individual directly. The same is true of a sole-member S-corporation. Single-purpose LLC intermediaries (the "loan-out" model common to entertainment) may survive where the individual has multiple customers, runs a real business, and meets prongs A and C in substance; they will not survive on paper alone. California courts look through these in wage cases and have been doing so for years.

What remains unclear through April

Three things will determine how AB-5 is remembered. The first is the exemption list. A narrow bill that carves out a handful of licensed professions and leaves the gig platforms inside will have a different economic footprint than a bill with twenty named exemptions. Committee amendments between now and the Assembly floor will settle that.

The second is the retroactivity question for Dynamex itself. The Ninth Circuit has certified a question to the California Supreme Court in Vazquez v. Jan-Pro Franchising International, Inc. on whether Dynamex applies to claims predating the April 30, 2018 decision. A ruling on retroactivity will move by a different schedule than AB-5 and will affect pending cases regardless of the bill.

The third is whether opponents move to the ballot. California's initiative process has been the escape valve for industry losses in Sacramento for decades, and the gig-economy coalition has the budget. If AB-5 passes in something close to its introduced form, a counter-initiative in the 2020 cycle is a safe prediction. Any California business reading this should assume the classification question stays live through at least November 2020, and possibly longer.

For business owners who operate in California and use contractors: the read this quarter is that the Dynamex ABC test is already the law for wage orders, AB-5 is likely to extend it to the rest of the Labor Code and to unemployment insurance before year-end, and the window for a clean reclassification is open now. Our companion piece on California's formation and franchise-tax mechanics covers the entity-level costs that come with operating there in general; the classification question sits on top of those and is the live variable for 2019.

Sources

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