Lawful Engagement of Contractors by Local Government Agencies Under California’s AB-5

California Assembly Bill 5, or AB-5, went into effect a year ago. Employers throughout the state and beyond are still grappling with how to lawfully engage independent contractors under the law. AB-5’s applicability to public agencies has been the subject of considerable debate among California lawyers. In September 2020 the California Legislature modified provisions of AB-5 in Assembly Bill 2257 (AB 2257), which clarified the steps public agencies must take when working with contractors.

How AB-5 changed the way California workers are characterized

AB-5 came about following the Supreme Court of California’s landmark decision in Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018). The Dynamex case adopted a new standard, referred to as the “ABC test,” for determining whether an employer can classify a worker as an independent contractor rather than as a employee. In passing AB-5, the California Legislature in part sought to assert its legislative prerogative, while addressing popular concerns regarding the mischaracterization of workers in the state.

The law codified a variation of the Dynamex ABC test in the California Labor Code. The provision requires an individual to be treated as an employee unless  each of these conditions are met:

1. 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.
2. The person performs work that is outside the usual course of the hiring entity’s business.
3. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Cal. Lab. Code § 2775.*

AB 2257 and the partial return of the Borello test

Prior to Dynamex, the characterization of California workers was governed by the so-called Borello test, established in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989). The Borello decision set forth eleven factors for employers—and courts—to weigh when determining whether an individual should be characterized as an employee or an independent contractor.

In September 2020, the California Legislature modified provisions of AB-5 in Assembly Bill 2257 (AB 2257). Among other things, AB 2257 introduced Labor Code section 2776, which provides exemptions from the ABC test. Section 2776(a) provides an exemption for “an individual acting as a sole proprietor, or a business entity formed as a partnership, limited liability company, limited liability partnership, or corporation … contracts to provide services to another such business or to a public agency or quasi-public corporation.” The status of such individuals will be determined by the Borello test, rather than the ABC test, provided that the hiring entity demonstrates that all of the following criteria are satisfied:

1. The business service provider is free from the control and direction from the public agency.
2. The business service provider is providing services directly to the public agency rather than to customers of the contracting business. However, Section 2776(a)(2) notes, “this subparagraph does not apply if the business service provider’s employees are solely performing the services under the contract under the name of the business service provider and the business service provider regularly contracts with other businesses.” As such, in order for public agencies to fall within this exemption, they must ensure that either: 1) all contracted work is being provided directly to the public entity only, and not to the public; or 2) if work is going to be provided to the public, then all contracted workers must affirmatively represent themselves as working under the name of the outside business service provider, and they should be also be clearly demarcated as being non-city staff.
3. There is a written services agreement or contract with the business provider, including any applicable rate of pay, services to be performed, a due date of payments for the services.
4. If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration.
5. The business service provider maintains a business location that is separate from the public agency. The business provider may utilize his/her home as the business location.
6. The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed.
7. The business service provider can contract with other businesses to provide the same or similar services and maintain a clientele without restrictions from the hiring entity.
8. The business service provider advertises and holds itself out to the public as available to provide the same or similar services.
9. Consistent with the nature of the work, the business service provider provides its own tools, vehicles, and equipment to perform the services, not including any proprietary materials that may be necessary to perform the services under the contract.
10. The business service provider can negotiate its own rates.
11. Consistent with the nature of the work, the business service provider can set its own hours and location of work.
12. The business service provider is not performing the type of work for which a license from the Contractors’ State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code.

A path for lawfully working with contractors

Public agencies should study the list of requirements in Section 2776 and ensure that their contracting practices are following the new standards. With careful application of the requirements to an agency’s contracting practices, independent contractors can be safely engaged without risking the unwitting creation of an employment relationship.

Jones & Mayer advises local agencies throughout California on a broad range of legal matters, including employment and contracting. We would be happy to answer your questions about how to best implement the standards set in AB 2257. Please contact Jones & Mayer partner Kimberly Hall Barlow by email at khb@jones-mayer.com or by calling (714) 446-1400.

*Note that AB-5 added the ABC test to the Labor Code by introducing a new Section 2750.3 to the statute. AB 2257 replaced Section 2750.3 with Section 2775.