A New Landscape for Businesses with California Operations, Thanks to A.B. 5

On September 18, 2019, California Governor Gavin Newsom signed into law Assembly Bill 5, which codifies the “ABC Test” used to determine if a worker is an independent contractor, and which was adopted by the California Supreme Court in its 2018 decision in Dynamex Operations W. v. Superior Court. The new law will take effect January 1, 2020.

A.B. 5, which makes the “ABC Test” statutory law, has effectively changed the employment landscape in California for businesses that either have operations in California, or are contemplating acquiring California-based businesses. As a result, there is a strong likelihood that California targets in complex transactions are not in compliance with the new law.

The ABC Test is broader, harsher and more inclusive than the common law test with which most businesses are familiar. For example, it presumptively considers all workers to be employees. Further, it precludes a worker from being classified as an independent contractor unless the hiring business can meet its burden of proof, by establishing that:

1. the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact;
2. the worker performs work that is outside the usual course of the hiring entity’s business; and
3. the worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

California’s ABC Test does not require that the business control the precise manner or details of the work to make a finding that the business exercised the requisite control over the worker, nor does not take into consideration workers’ own willingness to be classified as contractors.

It is important, now more than ever, for businesses to fully vet California-based targets for worker misclassification issues. This is particularly true for deals covered by representations and warranty insurers, who are increasingly scrutinizing the efforts used by buyers to evaluate the risk of worker misclassification. Misclassification risk assessments should typically include the following information for all workers classified as “independent contractors”:

• A complete list of workers classified as independent contractors;
• Contracts, whether written or oral;
• The existence of any restrictive covenants;
• Job descriptions;
• Hours worked;
• Compensation;
• Nature of the reporting relationship;
• Start date of the assignment;
• Actual or expected end date of the assignment;
• Fee arrangements;
• Equipment and supplies used for the assignment and the owner of same; and
• Whether the worker independently runs their own business that is distinct from the company’s main business.

A.B. 5 appears to be the death knell of convenience for retaining contractors in the Golden State, as well as the advent of a new wave of wage and hour litigation. While there is still room for businesses with operations in California to retain contractors in lieu of hiring employees to perform services, the safe zone for doing so is now miniscule.

Your McDermott team is here to assist with any questions you may have regarding this new employment landscape in California, whether you have business operations in the state or are contemplating acquiring such a business.