What are AB 5, the ABC Test, the Borello Factors, and How Might They Affect You?

Some of the most popular discussions regarding the law AB 5 involve Uber and Lyft. On August 10, 2020, a California Superior Court judge confirmed that Uber and Lyft could no longer classify their workers as independent contractors in violation of California law, Cal. Labor Code 2750.3[1]. However, this law affects much more than Uber and Lyft drivers. What is AB 5, and how might it affect you? This article discusses the various tests concerned with classifying workers as independent contractors or employees.

Why is worker classification important? For companies, the difference from one to the other is paying significantly more money for a worker and being subject to a host of state and federal laws. For workers, the difference is having employee rights and benefits, such as workers compensation entitlement if hurt on the job and protection from discrimination and retaliation.

To a hiring entity/employer, an independent contractor is generally less costly than an employee because it does not require workers’ compensation insurance, unemployment insurance or tax obligations. Additionally, an independent contractor is not entitled to many benefits afforded by the California Industrial Welfare Commission Wage Orders and the California Labor Code. These entitlements, for non-exempt employees, include meal and rest breaks and overtime pay, and reimbursement for necessary work-related expenses[1a].

On the other hand, an employee requires an employer to pay into workers compensation and unemployment insurance funds, as well as to pay or withhold certain taxes. Importantly, an employer must comply with a host of state and federal laws surrounding work conditions, work hours, meal periods and rest periods[2].

When a company can pay less for work because it misclassified its workers, it is giving itself a competitive advantage over other companies that properly classify their workers and pay all the appropriate costs associated with having employees. The misclassifying company would be violating California’s anti-competition laws and engaging in “unfair competition”[3].

Can’t all companies just hire independent contractors to avoid paying costs associated with hiring employees?

In order to correctly classify a worker as an independent contractor, a hiring entity must meet certain criteria, including not exercising too much control over the way the worker performs the work, among others. A lot of companies cannot meet these criteria. Therefore, the companies must classify the workers as employees.

If a company incorrectly classifies an employee as an independent contractor to avoid paying for an employee, the company could be subject to significant penalties and interest as well as back pay.

Individuals and companies that knowingly misclassify their workers as independent contractors may be subject to "a civil penalty of not less than five thousand dollars ($5,000) and not more than fifteen thousand dollars ($15,000) for each violation, in addition to any other penalties or fines permitted by law" per California Labor Code section 226.8.

What are the current criteria a company must meet in order to classify its workers as independent contractors?

The ABC Test

The California law at issue in the Uber and Lyft cases, AB 5 now California Labor Code section 2750.3, discusses the “ABC test”. Companies must comply with the ABC test in order to classify a worker as an independent contractor versus an employee in connection with the Industrial Welfare Commission Wage Orders, unless the situation involves an exception as discussed below. The Industrial Welfare Commission Orders govern wages, hours and working conditions.

If the ABC Test does not apply, generally, the Borello factors should be applied.

The ABC Test is as follows:

(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 for the performance of the work 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.

The second prong of the test is usually where companies are tripped up. In order to meet that test, the independent contractor cannot do work that is related to the company’s business. Examples of meeting the second prong include:

(a) a retail store hiring an outside plumber to repair a leak in a bathroom on its premises or

(b) a retail store hiring an outside electrician to install a new electrical line[4].

Examples of not meeting the second prong are:

(a) a clothing manufacturing company hiring work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that the company will sell[5];

(b) a bakery hiring cake decorators to work on a regular basis on its custom-designed cakes[6].

If companies get past the second prong of the test, they must also meet the third prong: that the worker is in business for herself or himself. In the examples given above, the plumber must have their own plumbing business that they advertise and offer to other customers. Otherwise, they are merely an in-house plumber employee of the company that hired them.

The Borello Factors

AB 5/Labor Code section 2750.3 provides exceptions to the ABC test for the following occupations:

• A person or organization licensed by the Department of Insurance.

• A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California.

• Actively licensed lawyer, architect, engineer, private investigator, or accountant.

• A securities broker-dealer or investment adviser or their agents and representatives licensed with various agencies.

• A direct sales salesperson as described in Section 650 of the Unemployment Insurance Code.

• A commercial fisherman working on an American vessel (through January 2023 unless the Legislature extends this time).

• A newspaper distributor working under contract with a newspaper publisher (through January 2021 unless the Legislature extends)[7].

These occupations must comply with a different standard, the Borello Factors, which are as follows:

(1) whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result. The Borello Court referred to this as the “principal test” of an employment relationship.

(2) whether the hiring party has the right to discharge at will, without cause.

(3) whether the one performing services is engaged in a distinct occupation or business.

(4) the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision.

(5) the skill required in the particular occupation.

(6) whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work.

(7) the length of time for which the services are to be performed.

(8) the method of payment, whether by the time or by the job.

(9) whether or not the work is a part of the regular business of the principal, and

(10) whether or not the parties believe they are creating the relationship of employer-employee.[8]

These factors are typically evaluated in combination.

Additionally, the Borello Factors are applied to professional services contracts, business to business contracts, construction subcontractor contracts, and referral agency contracts, if certain other criteria are met.[9]

Companies may want to review their worker structure periodically or when their organizations undergo changes in the number of workers or hours of operation. This re-review can help ensure continued compliance with the law. Periodic review of worker structure can also help companies determine whether they can shift to independent contractors and save money.

Independent contractors may want to re-evaluate whether their arrangements comply with current law.

[1] Uber and Lyft appealed the Court's decision, and oral argument is scheduled on October 13, 2020. Since the Court of Appeal likely will not issue its decision prior to the election, the decision to allow Uber and Lyft to continue classifying their workers as independent contractors likely will be up to voters in November.

[1a] See e.g., IWC Order 4-2001, Cal. Lab. Code section 2802.

[2] See e.g., Fair Labor Standards Act, California Labor Code, Industrial Welfare Commission Orders, Title VII of the Civil Rights Act of 1964, Fair Employment and Housing Act.

[3] Cal. Business and Professions Code section 17200 et seq.

[4] See, e.g., Enforcing Fair Labor Standards, 46 UCLA L.Rev. at p. 1159 cited in Dynamex Operations W., Inc. v. Superior Court of L. A. Cnty., 4 Cal.5th 903, 959-60 (Cal. 2018)("Dynamex")

[5] (cf., e.g., Silent Woman, Ltd. v. Donovan (E.D.Wis. 1984) 585 F.Supp. 447, 450-452; accord Goldberg v. Whitaker House Coop, Inc. (1961), 366 U.S. 28, 81 S.Ct. 933 ) cited in Dynamex

[6] (cf., e.g., Dole v. Snell (10th Cir. 1989) 875 F.2d 802, 811 ) cited in Dynamex.

[7] Cal. Lab. Code section 2750.3(b).

[8] S.G. Borello Sons v. Department of Industrial Relations, 48 Cal. 3d 341, 350-351 (Cal. 1989)("Borello")

[9] Cal. Lab. Code section 2750.3(c), (e), (f), (g)

This article is for educational purposes only and does not constitute legal advice. It may be considered attorney advertising.