New California law could require gig-economy businesses to reclassify contractors as employees

The governor of California recently signed into law a new bill that could threaten the business model of companies that hire independent contractors by requiring those workers to be reclassified as employees.

Assembly Bill 5 (AB5) is intended to offer broader access to benefits and unemployment assistance for gig-economy workers who otherwise are only paid hourly.

“This new law expands these protections for unemployment claims and also imposes a stricter standard of laws,” said Michael Droke, a labor and employment partner at international law firm Dorsey & Whitney in California. “This law is intended to convert thousands of gig-economy workers to employees. While Uber and Lyft come to mind, this law applies to any independent worker in California.”

Some occupations are exempt from the law, including licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, commercial fishermen and licensed barbers and cosmetologists, Droke said.

AB5 applies retroactively to the maximum extent of the law, and companies could face criminal charges if they violate it, he said.

“Many industries rely on independent contractors to deliver products and services, from food delivery to software coding and design,” Droke said. “Those workers will be converted to employees, significantly increasing the cost of the products and services.”

Companies that use the independent contractor model prefer to say they are “engaging independent businesspeople” rather than hiring workers, said Dave Selden, attorney and partner at The Cavanagh Law Firm in Phoenix.

“What the law does is it basically enacts into statute and makes a little bit clearer a California Supreme Court decision from about a year or so ago that… narrowed the definition or criteria for businesses to be able to classify service providers as independent contractors rather than employees,” Selden said. “The new law sets up a test whereby the person performing the service has to be free from the controlling direction of the business in connection with the performance of the work.”

In order to pass the “ABC” test, a worker must (A) be free from the hiring entity’s control and direction, (B) perform work outside of the hiring entity’s core line of business and (C) be routinely engaged in an independently established trade, occupation or business.

In other words, the person doing the work in question has to be able to decide when and where they will do their work, and that work must be separate from the hiring entity’s core purpose.

For example, legislators behind AB5 have suggested that drivers for ride-hailing services such as Uber and Lyft are performing the core function of those businesses — providing transportation — and therefore cannot be independent contractors, Selden said.

“If Uber or Lyft wanted to engage a custodial crew to clean their offices afterward — obviously, they’re not in the office-cleaning business — that could be something that would be much more easily contracted out, because that’s what people customarily do,” he said.

Uber and other companies like it will likely suggest they are not providing transportation but merely offering a platform for people who want rides to connect with people who can provide them, Selden said.

If that is the case, he said, then “all they are is the electronic marketplace that marries the two, kind of like what a newspaper would be like if people were doing classified ads.”

Lyft is taking a hard line against the new classification. The company recently released a report by Beacon Economics that said 300,673 California Lyft drivers would be out of work unless the law is corrected.

“Today, our state’s political leadership missed an important opportunity to support the overwhelming majority of rideshare drivers who want a thoughtful solution that balances flexibility with an earnings standard and benefits,” said Adrian Durbin, director of policy communications at Lyft, after the bill passed. “The fact that there were more than 50 industries carved out of AB5 is very telling. We are fully prepared to take this issue to the voters of California to preserve the freedom and access drivers and riders want and need.”

Selden said, although drivers for ride-hailing services are the most common example, a number of industries benefit from the independent contractor relationship that could be damaged by AB5’s classification system.

“It basically goes back to Economics 101, that if something is more expensive, generally, there will be less of it,” he said. “If a company raises the price of their goods, they’re going to sell less of their goods. Maybe they make more money, maybe they don’t, who knows?

“We’ve made employment expensive because of all these laws that regulate employment and all the various taxes and other things that are incidental to an employment relationship, and as a result of that businesses are looking for alternatives to having employees.”

One prominent example of this phenomenon is the home care industry, which is “growing by leaps and bounds” as the Baby Boomer generation advances into old age, Selden said.

“People would obviously much rather live in their own homes rather than going into an institutional setting, but they may not be able to do their own grocery shopping, or they may need help with cooking, cleaning, bathing, things like that,” he said.

In response, home care businesses are emerging to fill those needs. But home care is a “price-sensitive industry” that could easily be inaccessible for those who need it, Selden said.

The Arizona Health Care Cost Containment System (AHCCCS) pays home care businesses — usually individual, independent contract workers — through an intermediary managed-care organization, and Selden said laws like AB5 would “put an expense squeeze” on those businesses if enacted in Arizona.

Home care companies that engage independent contractors save approximately 30 percent of their operating costs, Selden said.

“You could pay the workers more, and you also can have enough to cover overhead and profit more readily,” he said.

Fortunately — according to Selden — Arizona has been heading in the opposite direction of California.

“We’ve done a number of things in the Arizona law in the last few years to provide greater definition and certainty with respect to how people are classified so that it’s easier for businesses to classify people as independent contractors, and it’d be more difficult for the government to come in and challenge that,” Selden said. “There are some businesses that could not exist unless they had an independent contractor model.”

The distinction between contract work and employment raises an important question: Why would someone give up the potential benefits and protections of a traditional employment relationship to be an independent contractor?

“It’s a mixed bag, because while this [law] is pitched as something that’s supposedly beneficial to the workers, there are a lot of workers who would rather be independent contractors, because they do have flexibility,” Selden said. “They can decide when they want to work.”

The Arizona Legislature took a look at the issue several years ago; AHCCCS was considering reclassifying home care workers as employees.

“The traditional theory of labor unions and the Department of Labor here, is that businesses are out there exploiting workers by classifying them as independent contractors rather than employees,” Selden said.

In fact, he said, legislators were surprised to hear independent care workers testify in favor of the independent contractor model, telling lawmakers they operate their own businesses and have no interest in being employees.

“They give their reasons why they want that kind of flexibility, and… there are some economic benefits to them,” Selden said. “For example, because they’re in business for themselves, they can deduct their expenses, which they would not be able to do if they were an employee. There are a lot of people that want to work that model, and these kinds of laws would take that flexibility away.”

Droke, the lawyer from California, said employers in the state should review their contract relationships, even if they are headquartered somewhere else.

“This law applies to non-California companies who engage independent contractors within California,” he said. “Employers who knowingly violate the statute could be subject to criminal penalties.”

Droke said he expects other states to enact similar legislation, but Selden said he does not expect Arizona to be one of them.

Between its pro-business governor and legislature, active involvement from chambers of commerce and a burgeoning tech industry, Arizona has its feet firmly planted in the gig economy, Selden said.

“I think this may be one of the many aspects in which the laws of Arizona will provide an economic competitive advantage to the legal environment in California and will be one more reason that Arizona can use to try to attract businesses from California, because they can operate here with more flexibility and fewer regulations and less cost than the expenses being imposed by laws like this in California,” he said.