The new law AB5 is here. What's in store for the construction industry?

Governor Newsom signed AB 5 into law in September 2019.

AB 5 is a broad, sweeping law that changes the bottom-line test for determining whether a worker is an employee or an independent contractor in California.

This new law has spawned a lot of rumors throughout the construction industry.

In this article, we’re not going to address the rumors one by one. But by sticking to the basics, we’ll try to bring some clarity to what AB 5 really means for our industry.

Here are the five topics we’ll address:

               • AB 5’s effective date.

               • The new “employee vs. independent contractor” test AB 5 puts in place (the ABC test).           

               • What the ABC test replaces, and when it replaces it.

               • The “safe harbor” for working with individuals who are construction subcontractors.

               • The “safe harbor” for working with individuals who are independent construction truckers.

Before we hit these topics, one caveat.

We’ll do our best to outline the fundamentals of AB 5, but Graniterock can’t offer legal advice, and this piece is no substitute for consulting a lawyer to get specific advice based on your particular circumstance.

AB 5’s effective date.

AB 5 goes into effect Jan. 1, 2020. That means the status of every worker in California will be governed by AB 5 on and after that date. There is no such thing as being “grandfathered” into a prior status on the basis of, say, a contract entered into prior to Jan. 1.

The ABC test – the new “employee vs. independent contractor” test AB 5 puts in place. 

AB 5 puts in place a new test to determine whether a worker is an employee or an independent contractor. It’s called the ABC test.

The ABC test was first announced by the California supreme court in last year’s Dynamex decision. The Dynamex decision made the ABC test applicable to wage and hour questions in the state. Under AB 5, the ABC test becomes the default test for all aspects of California employment law.

The ABC test says a worker will be presumed to be an employee unless the person or business hiring that worker can show all three of the following:

               A. 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.

               B. The worker performs work that is outside the usual course of the hiring entity’s business.

               C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The ABC test is a strict test.

The trickiest prong of the test is part B. Under prong B, if you’re hiring a worker, in order for that worker to be considered an independent contractor, you’ll have to show the worker is working “outside the usual course” of your business.

What exactly does that mean? Does an independent plumber work outside the usual course of a general building contractor? Does a water truck driver work outside the usual course of an earthwork contractor?

For now, the best we can do is adopt a common sense approach to these questions.

California courts have yet to interpret prong B. No doubt this will be the subject of legal fights for years to come.

What the ABC test replaces, and when it replaces it. 

The ABC test for determining whether a worker is an independent contractor or an employee generally replaces what is called the Borello test.

The Borello test looks at a laundry list of 11 different factors to determine whether a worker is an independent contractor or an employee. It generally focuses on the degree of control the hiring entity exercised over the worker and whether the worker was engaged in his or her own business.

It’s much less strict than the ABC test – far more workers are found to be independent contractors under the Borello test.

That brings us to one of the basics about AB 5. AB 5 simply dictates the test you apply to determine whether a worker is an employee or an independent contractor.

AB 5 makes the strict ABC test the default test. But AB 5 also spells out a long list of exceptions and “safe harbors.” Under those exceptions and safe harbors, the less restrictive Borello test will apply instead.

Most of the exceptions aren’t relevant to the construction industry.

For example, marketing and human resources professionals, travel agents, graphic designers, fine artists, enrolled agents licensed by the IRS, photojournalists, freelance writers, repossession agents, and licensed manicurists, barbers and cosmetologists – all of these groups will have their employee vs. independent contractor status determined by the Borello test.

AB 5 does, however, spell out two specific safe harbors for the construction industry.

The “safe harbor” for working with individuals who are construction subcontractors.

If you’re hiring an individual who operates as a subcontractor in the construction industry, odds are you want to treat that person as an independent contractor – not as your employee.

As discussed above, under the ABC test, there’s real risk this individual subcontractor would be deemed your employee.

Having that person deemed your employee exposes you to responsibility and potential liability for payroll taxes, workers’ compensation, meal and rest periods, overtime, paid leave, disability insurance, unemployment insurance, misclassification penalties, wrongful termination claims and more.

The only sure-fire way to eliminate that risk, is to take advantage of the construction subcontractor safe harbor – by meeting all of the criteria below – and then to ensure that your working relationship passes the Borello test for independent contractor status.

Here are the criteria you need to meet to take advantage of the safe harbor for hiring an individual as a construction subcontractor:

               1. Your subcontract is in writing.

               2. The subcontractor is licensed by the CSLB and does work within the scope of that license.

               3. The subcontractor has a business license or business tax registration (unless the jurisdiction where the subcontractor is domiciled doesn’t require it).

               4. The subcontractor maintains a business location separate from yours.

               5. The subcontractor has the authority to hire and fire other persons to provide or assist in providing the work.

               6. The subcontractor assumes financial responsibility for errors or omissions in the work (either via insurance, indemnity obligations, performance bonds, or warranties).

               7. The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

If you work with individuals who serve as construction subcontractors, the best business practice will be to meet the criteria of this safe harbor, and to keep a file that documents your compliance. 

The “safe harbor” for working with individuals who are independent construction truckers.

For those of us in the heavy civil part of the industry, AB 5’s biggest effect is its impact on construction trucking. AB 5 appears to render the traditional truck brokering model illegal – or at least fraught with potential liability for those engaged in it after Jan. 1.

The application of the law to construction trucking will be challenged in the courts – at least one major federal lawsuit has already been filed.

But here’s what we know today.

As a licensed contractor using construction trucking, the only sure-fire way to avoid potential employer liability for independent truckers is to take advantage of the construction trucking safe harbor.

As a licensed contractor using construction trucking, here are the criteria you need to meet to take advantage of the safe harbor:

               1. Your subcontract with the construction trucker is in writing.

               2. The construction trucker is a business entity formed as a sole proprietorship, partnership, LLC, LLP, or corporation.

               3. The construction trucker is registered with the DIR as a public works contractor (even if the work involved is not public work).

               4. The construction trucker utilizes its own employees to perform the trucking, unless the construction trucker is a sole proprietor who operates his or her own truck to perform the entire subcontract and holds a valid motor carrier permit issued by the DMV.

               5. You negotiate and contract with the construction trucker, and you compensate the construction trucker directly.

               6. The construction trucker has a business license or business tax registration (unless the jurisdiction where the subcontractor is domiciled doesn’t require it).

               7. The construction trucker maintains a business location separate from yours.

               8. The construction trucker has the authority to hire and fire other persons to provide or assist in providing the work.

               9. The construction trucker assumes financial responsibility for errors or omissions in the work (either via insurance, indemnity obligations, performance bonds, or warranties).

               10. The construction trucker is customarily engaged in an independently established business of the same nature as that involved in the work performed.

Again, the best business practice will be to meet the criteria of this safe harbor, and to keep a file that documents your compliance. 

It’s also important to note this particular safe harbor in AB 5 sunsets on Jan. 1, 2022. Unless AB 5 is amended before that date, the protections of this safe harbor will last only two years.