The Potential Consequences of California’s AB5

On September 18, 2019, the California governor signed into law a bill that will expand last year’s California Supreme Court decision regarding independent contractor status in California (Dynamex v. Superior Court). The court made it much more difficult for employers to legally classify their workers as independent contractors. Assembly Bill 5 (AB5), which will take effect on January 1, 2020, codifies the ABC test and extends its reach to numerous additional California employment laws.

Under the ABC test, a worker is deemed an employee unless the hiring entity establishes each of the following:

A — the worker is free from the direction and control of the company; and

B — the worker performs work that is outside the company’s main business; and

C — the worker normally performs work in an independent business or trade that is in the same vein as the work he or she is performing for the company.

The reach of the decision will extend beyond California’s wage laws. Benefits will be impacted, including workers’ compensation, paid sick leave, unemployment and other protections under the California Labor Code.

The ABC test on the gig economy (e.g., Uber and Lyft drivers) has been a hot topic in the media. However, AB5 will affect almost all companies who rely on independent contractors in California. Other states, such as Oregon, Washington and New York are expected to soon follow California’s lead and adopt similar ABC tests.

What actions should all employers pursue – regardless of location?

The issue of complying with the independent contractor rules is not new and has been the subject of considerable debate at the federal level. However, this law will create additional issues, and employers should be prepared to assess this impact on their operating models as though the California law was passed in their states. For some employers, this may dramatically influence their business models. Others may take the path that the ABC test can be easily met.

Using census data and status-quo information, it is very straightforward to assess the impact on each company’s business model. What necessary modifications can be made without destroying a current business model? For many businesses, the total cost of reclassifying a worker from contractor to employee — taking into account additional taxes, health care coverage, retirement contributions, workers’ compensation insurance and unemployment insurance contributions — will increase the cost of doing business substantially. In some instances, the cost of complying with AB5 may threaten the viability of the current business model. On the other hand, potential liability for failing to comply with AB5 is significant.

The best approach is to view this as an opportunity to alter the traditional relationship of companies and non-full-time members of their workforce. It is possible to create cost-effective solutions for these individuals and become the employer of choice. Providing low-cost benefit options in the area of health care and disability benefits can be very attractive.

Suppose a person who is currently considered an independent contractor is dubbed a part-time employee. The ABC test might cause the need to alter business models slightly while still being able to keep costs in line with current levels. Typically, part-time employees do not receive the same level of benefits as full-time employees. Why not provide some form of benefits for the potential class of those who may now be deemed as part-time or remain non-part-time?

Also, why not make the business a more attractive option for those who can legally remain as freelancers and who prefer this status and/or are classified as part time, regardless of their preference? Health reimbursement accounts may be an ideal tool for this purpose and can be offered to a class of employees without being deemed discriminatory. Other low-cost items can be offered, combined with a voluntary benefit package with affordable group rates.

Companies must move away from a one-size-fits-all approach that typically does not work well, as evidenced by turnover, negative engagement surveys and increasing costs. Combined with other cultural factors and opportunities, this inflexible approach has influenced the popularity of the gig economy.

If companies want to keep up with the changing workforce landscape and retain the best employees, they must consider alternate benefits approaches. A total compensation program that allows employees to choose the package that best suits their needs — while still maintaining cost efficiency for employers — is a potential solution.

What are the risks for gig workers?

The unintended consequence of new laws is that it applies to all — so even if a current gig worker is thrilled with his/her situation (e.g., like the flexibility, can work in multiple jobs, etc.), they will be lumped together, as the employer will be forced to determine their status. Many workers may not continue to be working on a status-quo basis, and it will force them to make changes or look for other employment opportunities. Other workers may look to incorporate and have their current employers engage their new companies. This will alleviate the burden on the employer but force the gig workers to another status (e.g., employees of their own corporation) that changes their perspective.

What other unintended consequences may emerge?

The gig economy means that business leaders now have the additional external resources that they were never able to have before. This is combined with the technology and company-wide acceptance of the tools and strategies needed to lead a new generation of workers in ways we simply could not have even dreamed of even five years ago. Employers want to be agile and immediately be able to take advantage of opportunities. As a result, the independent and remote workers have the ability to push the boundaries on a project-by-project basis. Companies can, in turn, capitalize on this opportunity and make the workplace a more productive environment. This type of arrangement has created alternate career paths. In an era when it is harder than ever to compete for full-time top talent, flexible work provisions will enhance a company’s employer value proposition and vastly increase the candidate talent pool — an effective way of retaining highly valued employees.

However, passage of a new law could create inadvertent consequences by potentially eliminating this option and take away its competitive advantages.

Conclusion

With competition for talent at an all-time high, a very different labor market where some evaluate their positions with an extremely limited shelf life, increasing costs of health care, other benefits and compliance, the new law in California (and potentially forthcoming legislation in other states) may force employers and gig workers into a different place. Employers must be proactive in addressing these developments, as now they have an even more difficult task of attracting, retaining and motivating all members of their workforce.