Independent Contractor Or Employee: Sometimes, Things Are Not As Easy As A-B-C

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The status of independent contractors in California has been hotly debated over the past year, with the landmark California Supreme Court decision in Dynamex and with the resulting debate over California’s Assembly Bill 5.  The ABC test, if ultimately adopted in the Golden State, would reclassify as employees millions of workers who currently operate as independent contractors. The impact on California's economy – the fifth largest in the world – could be extraordinary.

We are convening a teleforum to discuss an overview of the ABC Test; an analysis of the provisions of California’s AB 5; a discussion of the potential impacts on the California and U.S. economy should the bill be passed into law; and options for compliance.


Bruce J. Sarchet, Shareholder, Littler Mendelson P.C.


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Event Transcript

Operator:  Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Labor and Employment Law Practice Group, was recorded on Tuesday, September 17, 2019, during a live teleforum conference call held exclusively for Federalist Society members.    


Micah Wallen:  Welcome to The Federalist Society's teleforum conference call. This afternoon's topic is entitled "Independent Contractor or Employee: Sometimes, Things Are Not As Easy As A-B-C." My name is Micah Wallen, and I am the Assistant Director of Practice Groups at The Federalist Society.


      As always, please note that all expressions of opinion are those of the expert on today's call.


      Today, we are fortunate to have with us Bruce Sarchet, who is a Shareholder at Littler Mendelson and is also a Member of Littler's Workplace Policy Institute. After our speaker gives his opening remarks, we will then go to audience Q&A. Thank you all for sharing with us today. Bruce, the floor is yours.


Bruce Sarchet:  Thanks so much. California is like a bowl of granola, just a bunch of nuts and flakes. But I think the author Wallace Stegner had it right when he said, "California is just like the rest of America, only more so." So what's going on in California in the summer of 2019? Well, what's going on is something we call Assembly Bill 5, AB 5.


On Friday the 13th of September, AB 5 was cast by both houses of our state legislature [and is] now on the desk of our chief executive here, we like to call him "the Gavirner." The Gavirner has until October 13th to either sign or veto the bill, and all indications are he will sign it. Indeed, in a special op-ed in the Sacramento Bee on Labor Day, he expressed support for Assembly Bill 5.


Now, this bill is designed to answer what sounds like a boring legal question whether or not a particular worker is to be classified as an employee or an independent contractor. The allegations are that millions of workers in the gig economy are misclassified as independent contractors, and AB 5 should solve that problem by reclassifying them all as employees. The answer to whether or not someone's a contractor or an employee in AB 5 is we apply a three-part test: ABC test, it's called.


Now, I'll get into the details of that in a moment, but who cares? I mean, who really cares whether or not someone is an employee or an independent contractor? Well, the answer is pretty much everybody, especially the government. The government really cares because it wants to get its taxes. You see, if someone's an employee and you're doing the whole W-4, W-2 bit, well their taxes get withheld every pay period and they get sent into the government. So it's a nice easy way for revenue to flow into the government.


If someone's a contractor and we give them a 1099, then it's up to the individual to make sure that their taxes are paid to the government, a much less and unstable way, shall we say, to get revenue into the government. Also, the government cares because of unemployment insurance, right? We want to make sure unemployment insurance is paid, Social Security is paid, workers' compensation coverage is provided, and on and on.


Also, pretty much every business in the state cares how workers are classified. A lot of the discussion that's been around AB 5 about this gig economy and what would be the impact on transportation network companies, the ride-sharing apps, but pretty much every business issues some 1099s. And so there's a broad concern in California about the implications.


And finally, the trial lawyers. Trial lawyers care about this because if you've been following what's been going on in California, [inaudible 04:04] the past three to five years, we're spending millions of dollars arguing over whether or not workers get their coffee breaks. These wage and hour lawsuits are rampant. They're out of control, and AB 5 and the introduction of this new test, we don't give the lawyers more things to argue over. [inaudible 04:23] support these wage and hour class actions, and I predict more of these private attorney general acts or [inaudible 04:28] claims.


So it's a boring legal question, perhaps, but it's been reported on quite a bit and generated a lot of excitement in the popular media and I think with good reason. AB 5 has the potential to fundamentally change the fifth largest economy in the world. California is now the fifth largest economy. We're going to take, overnight, and reclassify 2 million workers. Now, something's going to happen. There are going to be dramatic effects here. This is probably the most important labor and employment law to come out of federal or state legislature in several generations.


So this ABC test, let's dig into it a little bit. And in order to understand it, I think we need to travel back in time, maybe a hundred years or so. Let's say 1919. The United States is transitioning from an agrarian to an industrial economy, and there's really no labor and employment laws on the books at all. The first ones come as a result of the Great Depression and FDR's New Deal.


California actually beat them to the punch, though. In 1935, we had an unemployment insurance act which predates federal Social Security by two months. But the big three New Deal employment laws are, of course, Social Security, the National Labor Relations Act, and the Fair Labor Standards Act, which you could read those all day and you will not find the answer to the question, “Is a person an employee or an independent contractor?” It just wasn't addressed there at all, so there's very little guidance that develops over the years.


In 1944, the Supreme Court is addressing a question on whether news boys are employees under the NLRA, and they say basically, the word employee "is not treated by Congress as a word of art having a definite meaning. Rather it takes its color from its surroundings in the statute where it appears, and derives meaning from the context of that statute, which must be read in light of the mischief to be corrected and the end to be attained," so not much guidance there.


California Supreme Court similarly doesn't give us much guidance. And in 1989, the Supreme Court in California comes up with a test, at last. It's called the Borello test—and this is based on the name of a company, the Borello Company—and they look at whether or not the business has the right to control the individual. And there are secondary factors as well, but mainly it's a question of control. That remains the standard in California for 30 years. It's not a perfect standard. It's not a great standard, but it's our standard. We live with it.


Then last year, the California Supreme Court, in a case that many on the call I'm sure have heard of, Dynamex. Sometimes, some people call it Dyna-Mex. It looks like it's printed that way, but it's actually pronounced Dynamex. The California Supreme Court, in a unanimous decision 7-0, creates a brand-new test for answering this question: is a worker a contractor or an employee? And they create the ABC test.


They look to Massachusetts, which had adopted the ABC test previously, but basically, the factors are three. A) Is there absence of control? Not only in the contract itself but in reality, in the actual day-to-day application of the contract. So that's the A factor and sounds similar and indeed, it is similar to that Borello test, absence of control. B) The Business is outside the usual course of the hiring entity's business. So if you think about your company and what you do, what's the core thing that you do? Well, let's say it's -- [you] install cable in people's houses in order so that they can get the internet and watch TV. That's the core business. So the installers really probably cannot be contractors under the ABC test because the usual course of your business is putting cable into people's houses. And then C) Is the service providers, the worker, customarily treated as an independent contractor?


Several problems with the Dynamex test, particularly in the B prong. And the California Supreme Court, as brilliant as they may be, struggled with really defining what is an employee and what is a business? They didn't provide much guidance. They basically said well, if you're like a plumber, that's like a contractor. If you're like a seamstress, that's more like an employee. But there's just so many questions that come out of that.


Let's suppose you're a giant retail chain, and you actually have plumbers on staff. And they go from your big box store number one in Bakersfield to your big box store number two in Fresno, and they work on the plumbing. But what if there's a crisis in big box store number three in Sacramento, and you call an outside service, Joe's Plumbing, to come and do the work? Does that person now become an employee because you have previously employed plumbers? And also, what if the seamstress works at home and she has 12 different clients? Does she have to be a W-2 employee of 12 different businesses, or can she actually be a true independent contractor?


Sadly, the Supreme Court in California provided little guidance for these questions. Splitting hairs here, the Dynamex decision was limited to answering the question employee or contractor for purposes of our wage orders here in California. The wage orders, our publications of our Industrial Welfare Commission that discusses -- not discuss, set parameters for such things as minimum wage, overtime, and [inaudible 10:38]. Dynamex did not apply to other provisions of the labor code, did not apply to unemployment, it did not apply to workers' compensation.


The business community went bananas, and they said wait a second. This is brand new law. The Supreme Court here is legislating. That's the job of the Legislature to create new law, and the Supreme Court shouldn't do that. And, indeed, following Dynamex in the summer of 2018, there were discussions while our former governor was still in office, Governor Brown, about what are we going to do with the gig economy here and this new ABC test? But those discussions didn't go anywhere, so we come around to January of this year, 2019.


Now remember, the business community said hey, Dynamex is creating new law and that's the job of the Legislature. Well, be careful what you ask for. The Legislature said you're right. It is our job, and let's do it with AB 5. Let's take Dynamex and make it the law of the state. Put it right in the labor code and have it apply not only to the wage order but to the labor code, to unemployment insurance, and to workers' compensation as well.


So over the past several months, AB 5 has worked its way through the California Legislature. The business community had some efforts of its own to try fundamentally change this, but as a result of the midterm elections back in 2017, Republicans in the California Legislature now have secured what we call a super minority. They can do very, very little. In fact, the super majority of Democrats can basically have its will, and AB 5 continued to work its way through the Legislature and the real debate became over whether or not you would have an exception.


Now, business interest went to their legislators and said hey, can't we do something about it? And anecdotally, I've heard the response was basically go back to organized labor and work out a deal. We'll sign off on anything that organized labor will agree to. Those discussions went nowhere.


Dan Walters is a respected California political commentator, has been for many years, he observed as following, "Organized labor has a powerful lever because if the Legislature doesn't act, the Supreme Court's three-factor test—Dynamex—of who's an employee and who's not remains in effect." So in other words, labor could just sit back and not do anything and they knew that Dynamex was still going to be the law here in California.


So we figured out pretty quickly that ABC test was going to be the law, and the lobbying behind the scenes was to try to get exceptions. In other words, most businesses would be subject to the ABC test, but some would have a carve out. Now this was criticized pretty firmly by State Senator Mike Morrell who's the Vice Chair of the Senate Labor Committee here in California. And this is a quote from the hearing they held on AB 5, this is Senator Morrell. "In all of these carve outs, you are picking winners and losers. So can you walk me through the process of why you are doing it that way and how do you process who wins and who loses? Who gets favoritism and who loses out?"


Unfortunately, that question was really never answered, and ironically, there was even a paper form created in California here where a business could go in or an occupation could go in, an association could go in, fill out the form and explain why they were entitled to an exception from the ABC test. And the form was -- said right on its face, it's going to be given to organized labor for their review and approval.


And at the end of the day, there are seven broad categories of exceptions. I'm not going to go into the detail of them but on outline or bullet-point format, there's some specific professions and businesses which are excepted: what's called professional services, number two; number three, real estate repossession; number four, there's a business-to-business exception; number five, there's construction industry exceptions for the use of sub-contractors; number six, something that's called a referral agency; and number seven, motor clubs, like the AAA. There's not going to be an employer of the tow truck drivers that come out and help you when you're stranded.


So those seven groups are supposedly the winners. Now, who are the losers? Well, those that didn't get exceptions include truck drivers, independent owner operators, that model is going to be subject to quite a challenge here. The gig economy, our transportation network companies and the delivery companies that use independent contractors, they do not get an exception. Franchisor, that's franchisee relationship, no mention there of an exception.


But even those that got the seven exceptions, in my opinion, are not necessarily winners because these exceptions, to write them out, takes tons of legalese. They are densely-worded, and I predict this will be fertile ground for lawsuits. So maybe there's not really winners and losers here but, sadly, losers and losers.


The bill does address when it goes into effect, and the exceptions, the seven categories of businesses and occupations which are excepted from the ABC test, are retroactive, so that looks like good news. And the obligations are prospective effective January 1st of 2020. If you have an exception, then you go back and you use the Borello test again, which as I mentioned wasn't the greatest test in the world.


Indeed, the Senate Labor Committee in its analysis -- formal analysis of AB 5 said that "by retaining Borello, the occupations that are excepted remain in the messy muddle of a failed employment test that has met the needs of neither employers nor workers. Should AB 5 become law, the Legislature will need to revisit the remnants of Borello in the future." Again, maybe not too cynical to say that there are not winners and losers here but [inaudible 17:12].


And it appears that the work is not done. AB 5 was considered by the California Legislature in a very busy session, thousands of bills being created. Sponsor of the bill is Lorena Gonzalez. She's a Democrat from San Diego, and this is a quote from her closing statement to the Senate Labor Committee in the middle of the summer. "We probably won't fix it for everybody this time. We will run out of time, and yet we're not going to get to every situation we dreamed of. I anticipate we'll be working on this for a few years to get to all those situations."


In other words, maybe there's more than seven exceptions yet to come. And one of the problems that I have with this whole idea of exceptions is how do you except from the ABC test something that hasn't been created yet, right? Social media strategist, that's actually a job title in California and in the United States. It didn't exist 20 years ago; it just didn't exist. So how do you create an exception for a job that hasn't yet been invented? It's a real challenge.


There also is in AB 5 what appears to be a provision to address arbitration. Now, if you practice employment law in California and you're dealing with these wage-and-hour class actions, you're familiar with many businesses having binding arbitration of employment disputes. And the idea is you arbitrate one case at a time, one employee at a time, not on a class action kind of a basis. So the bill AB 5 contains the work around to that because it gives authority to the state attorney general in California or to a city attorney in a city with a population of at least 750,000—so that's like LA, [inaudible 19:07], San Francisco, San Diego—the ability to go into court, the city attorney, and get an injunction reclassifying workers from independent contractors to employees.


And indeed, on Friday the 13th, again, the city attorney in San Diego filed a lawsuit against Instacart. Now it's not under AB 5 because it hasn't yet been signed by the governor—it's under our business and professions code alleging unfair business practices—but the timing was obvious and the location, you might think San Diego? Why San Diego? [inaudible 19:42]. But again, San Diego is the home turf of Lorena Gonzalez, sponsor of AB 5. So, perhaps, there's some connection there as well.


The real challenge, I think, and I'm admittedly providing only one side of the argument here and that's the business community's general response here. The challenge and the problem I think with AB 5 is that it's such a blunt instrument, and it's really out of date. It's not attuned to our modern, what you might call algorithm-based economy. Indeed, here's a great quote from our labor commissioner in California. The labor commissioner in California said this: "The technology explosion in the last 20 years has often outpaced the ability of federal and state governments to keep up with private industry advances in conducting business." So explosion of technology, government can't keep up, that's our labor commissioner, and here's the rest of that story.


The labor commissioner said this in July of 2008. Think about the revolution and technology 20 years backwards from 2008 and then think about the changes in the last 11 years. The ability of government to come up with a way to really address these complicated questions by all these new technologies seems to be [inaudible 21:13]. There's got to be a better way to do this. California doesn't seem to be taking advantage of it. We at Littler's Workplace Policy Institute formed Task Force, and we came up with several creative ideas. We issued a 40-page report on August the 8th. I encourage you to take a look at that, including some predictions about what's going to happen as if AB 5 is passed into law and other ideas for possible solutions.


And here's one that I think is my favorite, and that is we need meaningful reform of our labor and employment laws in California. There's a tremendous disincentive in the Golden State to use an employee because all of the paperwork, all of the regulation, all of the hassle that goes into having an employee. If we can simplify and streamline that process and not have to worry about spending millions of dollars arguing over whether or not someone got their coffee break. I mean, please, take your coffee break. It's not that I'm against coffee breaks. That's a good idea, take a break if you've got a repetitive job, if you have a non-repetitive job. But why argue over it and spend millions of dollars on it [inaudible 22:30]. If we can meaningfully reform our labor and employment laws here, eliminate that disincentive to use employees, then I think that would go a long way towards solving our problem.


Is meaningful reform on the horizon? Sadly, I think it might not be. There's a terrific, special article published in The Economist in June of this year; I think it was June 20th. Google it, print it out, take it on your next airplane ride. It compares what we're doing here in California with what's going on in Texas. And one of the takeaways was that in California, the political will for meaningful reform is not there because, again, we've got this super majority of Democrats in our Legislature, a Democratic governor, and the thinking is they can pretty much do what they want and their seats are safe.


In contrast, you might think that Texas, the red side of the equation, would pull through but as The Economist points out, the influx of migrant communities in places like Austin and Dallas, the state is trending a little more purple these days and the legislators there have to be a little bit more responsive. That's a special report, The Economist from June 20th of this year. I would recommend it for you.


So those are my opening remarks. I feel as though you probably might feel like you've been drinking from a firehose here, but there is a lot of information. There's a lot of resources out there including many publications by reputable groups, including our law firm, if you'd like to study this further. With that, I can open it up to our question.


Micah Wallen:  All right. Thank you, Bruce, and while we're waiting for any questions to come in, Bruce, I wanted to ask you, you've obviously been focusing a lot on California. Are there other states that are considering similar actions here? Do you think this is a trend that will go into other states if the governor does sign off on this? Or what do you think will be the result nationally?


Bruce Sarchet:  Yeah, great question, and I do think we'll see this move across the country. New York state has a bill for the ABC test right now, and it looks like that's getting traction. The ABC test is actually used already in a number of states, but primarily, it's for unemployment insurance purposes, not for overtime and meal and rest breaks and so on.


      Oh, The Economist, by the way, there's a great quote from, I hate to keep plugging that article, but they noted "California frequently creates political winds that sweep across the country." Some nice pros there, but I think, indeed, we will see this take hold elsewhere.


Micah Wallen:  I see, and what are these businesses' options for complying?


Bruce Sarchet:  Yeah, so if AB 5 becomes law, I think first thing a business needs to do is a little self-audit, get out all your 1099s and take a look at who you are retaining as contractors and evaluate can we continue to do so? If you're only giving 1099s to five individuals, you might just reclassify them all as employees, but if it's really core to your business, I think AB 5 presents an existential question.


I believe we will see some businesses leave California rather than try to comply with this. The other options are to fight it out in court and to take the position that under the B prong of the ABC test, your contractors don't do something that's core to your business. They are doing something outside the core of your business.


Create something new, perhaps. The subscription-based platforms where the provider of the service gets to negotiate and set their own price, those seem to look a lot more like true independent contractor models than ones where the business itself is always setting the price for the transaction.


I do believe that a number of businesses are going to just do what I call whistle past the graveyard, not change and hope that they don't get sued. That's an approach that is an option and I, based on my past experience, I think that that's an option some businesses will pursue.


      I do also think this is going to drive more automation and more robotics in the workplace. You could maybe move your business across state line, have people do it remotely. In Massachusetts, anecdotally, we understand businesses did leave the state, but they went relatively close, just across state line. In New England, it's a lot easier to do that than it is here out west with our states having a bigger geographic footprint.


      So those I think are the main options that businesses will be looking at here in January.


Micah Wallen:  And what do you think, specifically -- there's been a lot of in the news about how this bill would essentially effect Uber and Lyft drivers. What do you see is a response from those companies? Does this effect the way they do business and what would be their response to that?


Bruce Sarchet:  Yeah, there's been a lot of speculation about that, and the general counsel with Uber came out recently and publicly said in a telephone press conference that they thought they could continue to argue that drivers are not part of their core business. They're a technology in that working platform. They're not a transportation company. So I think they'll continue to pursue that legal defense in court.


There's talk of a possible referendum to put the issue before the voters. In California, we have the ability, if you gather enough signatures, to have a referendum and say to the Legislature, "No, we don't want it done that way."


      There's Supreme Court precedence here that a referendum would in fact stay the application of the law or stop it from going into effect. So if you do that, then on January the 1st maybe the law doesn't go into effect, but then you still have Dynamex as the law. And the Legislature will be back in session, so they could come up with a new idea even if AB 5 is temporarily stopped.


      There's also talk of something along the lines of an initiative to affirmatively try to make new law. If you go back to 2017 in California, we had Proposition 11 on our ballot. This was a proposition funded by a group that was largely funded by -- I shouldn't say largely, but that was funded by private ambulance companies, and the question presented to the voters was if you're sick and you need to be taken to the hospital, should your ambulance driver be able to stop and say no, I got to take my coffee break. And the voters said no, that's ridiculous. They can get their break later, take me to the hospital right now.


Prop 11 passed, and it's just one small industry and one small group of workers, but that's the way we achieved meaningful reform of our wage-and-hour laws in here in California last time, and perhaps, that's the avenue that we'll have to take again. If AB 5 has a dramatic effect on our economy, some are saying the economic impacts could be pretty significant. Then, perhaps, the mood will be right for the voters to actually get some sort of real change here.


Micah Wallen:  All right, [inaudible 30:00] Bruce, I'll put it back over to you. Did you have anything else you wanted to discuss or any closing remarks?


Bruce Sarchet:  Well, I think it's important that businesses remain engaged, that this is not necessarily the end of the story here, and there are going to be opportunities to try to remain engaged in California. It's a real challenging environment for businesses to operate in, and I do believe we're going to see businesses look hard at whether or not they'll continue to operate here. And I've heard this before, "Well, you're just saying, Bruce, the sky is falling. Come on."


Chicken Little, California had heaped on regulation after regulation after regulation making it challenging for businesses to operate, and yet, you're the fifth largest economy in the world, you still continue to grow, so quit worrying about this. I hope they're right. I hope they're right that AB 5 is not this giant cataclysmic event, but I'm afraid that when you reclassify 2 million workers overnight, then there's going to be unintended consequences of this, for sure. Something's going to happen, and I'm not entirely convinced that it's all going to be great.


Micah Wallen:  All right. Well, on behalf of The Federalist Society, I'd like to thank our expert for the benefit of his valuable time and expertise today. We welcome listener feedback by email at [email protected]. Thank you all for joining us. We are adjourned.


Operator:  Thank you for listening. We hope you enjoyed this practice group podcast. For materials related to this podcast and other Federalist Society multimedia, please visit The Federalist Society's website at