California Employers Should Review Evolving Worker-Classification Rules


A pending federal rule would make it easier for employers to classify workers as independent contractors rather than employees, but California businesses still must follow the state's more stringent test. 

"Misclassifying independent contractors remains one of the bigger risks facing California employers," said Walter Stella, an attorney with Cozen O'Connor in San Francisco. "A misclassified independent contractor is just an employee by another name," he explained.

Krista Mitzel, an attorney with The Mitzel Group in San Francisco, suggested that businesses review and update their independent-contractor agreements. In addition to worker-classification rules, evolving arbitration and commercial laws may impact such agreements, she said.

Keeping Up with Changes

California's classification laws continue to change. AB 5 took effect on Jan. 1, 2020, codifying a three-pronged "ABC" test to determine worker classification and rendering most workers employees.

The distinction is significant. Employees are entitled to minimum wage, overtime pay and other benefits. Independent contractors are not entitled to such benefits, but they generally have more flexibility to set their own schedules and work for multiple companies.

Certain professionals are exempt from AB 5, and a long-standing multifactor analysis is used to determine their employment status, which primarily focuses on who exerts control over their work.

Furthermore, voters in the state approved Proposition 22 on Nov. 3, 2020, allowing gig-economy companies to classify app-based ride-hailing and delivery drivers as independent contractors if certain criteria are met.

"Everything is still in flux," Mitzel observed. "We have AB 5. We have Prop 22. And we are still looking at how that is going to change the analysis."

She noted that some grocery retailers started outsourcing their delivery services to app-based companies in light of Proposition 22. Other companies have decided that transitioning independent contractors to employees will improve loyalty and retention.

"There isn't one right or wrong way," Mitzel said. Businesses have to analyze the costs and risks associated with making classification decisions, she noted.

Interplay with Federal Law

Under California's ABC test, all three of the following factors must be met for a worker to be properly classified as an independent contractor:

  • The worker 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.
  • The worker performs tasks that are outside the usual course of the hiring entity's business.
  • The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

The U.S. Department of Labor (DOL) recently issued a final rule under the Fair Labor Standards Act that was slated to take effect on March 8. President Joe Biden's administration, however, asked federal agencies to freeze pending regulations to give new leaders time to review them.

The DOL's pending rule significantly differs from California's law. The rule applies an economic-reality test and primarily considers the nature and degree of control over the work and the worker's opportunity for profit or loss based on initiative and investment. Three other factors may serve as guideposts in determining employment status:

  • The amount of skill required for the work.
  • The degree of permanence of the working relationship between the worker and the potential employer.
  • Whether the work is part of an integrated unit of production (or the individual works under circumstances analogous to a production line).

Kartikey Pradhan, an attorney with Kaufman Dolowich & Voluck in San Francisco, noted that Biden's administration may take additional steps at the federal level to make it more difficult for businesses to classify workers as independent contractors. Biden supports a nationwide ABC test, according to his website.

Employers should note that the DOL's rules do not replace state laws on employment classification. "While the department appreciates the desire to achieve uniformity across the various state and federal laws which may govern work arrangements, requests to modify definitions and tests under different laws are outside the scope of this rulemaking," according to the final rule.

Mitzel said the DOL's rules may give multistate employers some peace of mind regarding workers in other jurisdictions and may be helpful guidance if there is a dispute about which state's law applies.

Exceptions to California's Rule

The ABC test applies to the California Labor Code, the Unemployment Insurance Code and the Industrial Welfare Commission wage orders, unless another definition of "employee" is provided. 

Some jobs were carved out of AB 5 from the start, and many freelance journalists, musicians, translators and other workers in California can operate as independent contractors under an amendment, AB 2257, that Gov. Gavin Newsom signed in September 2020.

"Any company that [uses] contractors to provide services should, in consultation with legal counsel if possible, review AB 2257 closely to assess whether such workers qualify as independent contractors," said Matthew Costello, an attorney with Haynes and Boone in Costa Mesa, Calif.

[Need help with legal questions? Check out the new SHRM LegalNetwork.]

He noted that AB 2257 doesn't address the concerns from a number of industry groups, including those in the franchising and trucking industries, that lobbied for exemptions from AB 5.

Stella expects lobbying efforts and legal challenges to continue because AB 5 remains unpopular with many businesses. However, he doesn't think California's ABC test will be replaced anytime soon. "At most, we may see additional exceptions to the law enacted next year."   

Proposition 22

California voters approved Proposition 22, which was supported by prominent ride-hailing and food delivery services. A "yes" vote on the ballot measure meant that app-based drivers could continue to be classified as independent contractors. The measure also requires covered companies to provide drivers with certain benefits and develop anti-discrimination and sexual-harassment policies.

Costello said voter approval of Proposition 22 may spark more meaningful policy discussions about maintaining the benefits that many workers have through their independent-contractor status, while still finding ways to protect workers from being improperly classified as a way to deny them overtime pay and employment protections.

"In the years ahead, Prop 22 may prove to be the beginning of a shift away from the traditional 'either/or' dichotomy of an independent-contractor/employee model," Stella noted. "While people may argue about where the line should be drawn, this middle-ground approach may be the approach of the future for the gig economy."



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