What You Need to Know About the AB 5 “Business-to-Business” Exemption

California Assembly Bill 5 (“AB 5”), which codified significant changes to the test for independent contractor status, has caused substantial upheaval for California businesses.  As the statute will likely result in significant litigation over the next several years, California companies are scrambling to guard against its impact where possible.  One potential avenue to do so is the statute’s “business-to-business” exemption.  This alert discusses the requirements businesses must understand if they are to satisfy the criteria of the exemption.

Exemptions from AB 5 Are Narrow

The California Supreme Court’s 2018 decision in Dynamex Operations West, Inc. v. Superior Court (“Dynamex”) turned the decades-old test for independent contractor status on its head.  As disruptive as Dynamex was, however, the sponsors of AB 5 assert that the Supreme Court did not go far enough to distinguish “genuine independent contractor” relationships from relationships they felt should fall within the ambit of employment.  Analysis, Senate Cmte. on Labor (Jul. 10, 2019), p. 6.  AB 5 is their intended fix.  Businesses must therefore expect that AB 5 will be construed broadly in favor of workers and narrowly as to the rights of employers and businesses.

AB 5 is complex and contains several exemptions and exceptions from coverage.  Businesses will carry the burden of proving that their worker relationships satisfy these exemptions.  As noted, courts will likely construe the exemption criteria strictly and narrowly, favoring workers over businesses when ambiguities arise.

The “Business-to-Business” Exemption Is Perhaps the Narrowest AB 5 Exemption

One of the exemptions in AB 5 is for bona fide “business-to-business” contracting relationships.  The statute describes these as relationships in which a “business service provider” provides services to a “contracting business.”  It is arguably the narrowest exemption in the statute, with approximately a dozen separate criteria.

Satisfying the “Business-to-Business” Exemption Criteria

For the “business-to-business” exemption to apply, all of the following conditions must be met:

  • The “business service provider” (i.e., contractor) must be free from the control and direction of the “contracting business entity” in connection with the performance of the work, both under the contract for the performance of the work and in fact.

What this means for businesses: Control is measured both by the terms of the agreement with a contractor and by the actual practice between the contracting business and the contractor.  This means that, even where the contract contains no terms imposing control, if the contracting business actually exercises significant control, the worker will be viewed as an employee.  Likewise, even if the contracting business imposes no control in practice, where the contract contains terms imposing significant control, the worker will be viewed as an employee. 

When measuring the extent of control, consider the following questions: Is the work usually done under the direction of the contracting business or by a specialist without supervision?  Is the method of payment hours-based or job-based?  Does the contracting business use a form contract or do contractors negotiate contracts with different terms?  Who supplies the tools and instrumentalities used to perform the work?  What is the opportunity for profit or loss depending on the contractor’s managerial skill?  Does the contracting business have the right to terminate the contract at will without cause or repercussions?  Does the contractor have the right to terminate the contract at will without cause?  Does the contracting business place any requirements on the performance of the work by the contractor, e.g., requiring a particular uniform?  Does the contracting business place conditions on how frequently the contractor must accept jobs?  Does the contracting business determine the means by which the contractor performs the job?

  • The business service provider is providing services directly to the contracting business, rather than to customers of the contracting business. 

What this means for businesses: Like many aspects of AB 5, this provision is ambiguous and the remainder of the statute and legislative history provide little clarity.  In the legislative history, the statute’s sponsors do indicate that “an independent contractor and … client [should] have a direct relationship, communicate directly to resolve any questions or concerns, and use the structure of the contract to resolve any disputes.”  Analysis, Senate Cmte. on Labor (Jul. 10, 2019), p. 10.  As a result, every effort should be made to ensure that all contracts and services are between the contracting business and contractor, even if the work is performed at the site of a customer of the contracting business.  If the work is performed by the business service provider at the site of a customer of the contracting business, there should be an arm’s length contract between the contracting business and the customer for the contracting business to provide such work.  To the greatest extent possible, all communications should also be between the contracting business and contractor, not the contractor and the customer.

  • The contract with the business service provider must be in writing.

What this means for businesses: All independent contractor relationships must be formalized in a written contract document.

  • The business service provider has all required business licenses or business tax registration.

What this means for businesses: Businesses must be able to prove that their contractors have all required licenses.  This means that, when businesses enter into relationships with contractors, businesses should consider requiring each contractor to submit proof of all required licenses.

  • The business service provider maintains a business location that is separate from the business or work location of the contracting business.

What this means for businesses: The “business-to-business” exemption will not apply for any contractor with the same location or address as the contracting business.

  • The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed. 

What this means for businesses: A contractor will only qualify for the “business-to-business” exemption if the work he or she is performing is the same work he or she usually performs in the course of his or her business.  For example, the “business-to-business” exemption will not apply if a contracting business engages a dry cleaner to provide gardening services, even if the two entities are completely legitimate, independent, full-scale business operations.  Closer questions will arise: for example, a moving truck hired to haul waste, instead of furniture.  Does the “usual course of business” mean transportation services, generally?  Or only transportation of furniture?  AB 5 provides no clarity on these nuances.  Plaintiffs will try to take advantage of these ambiguities and businesses facing these sorts of questions should seek the guidance of legal counsel.

  • The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the contracting business.

What this means for businesses: The “business-to-business” exemption will not apply if the contractor’s only customer is the contracting business.  Contracting businesses seeking to satisfy the exemption will want to ensure—at the outset of the contracting relationship—that the contractor has other customers and sources of revenue.

  • The business service provider advertises and holds itself out to the public as available to provide the same or similar services.

What this means for businesses: To qualify for the “business-to-business” exemption, contracts should be between legitimate, full-scale businesses.  Where possible, avoid contracting with a single individual or “fly-by-night” operations.  Contracting businesses should consider requiring contractors to submit business cards or other marketing materials establishing that the contractor holds itself out to the public as available to provide the services for which it is being engaged.

  • The business service provider provides its own tools, vehicles, and equipment to perform the services.

What this means for businesses: Where a contractor cannot supply its own tools, vehicles, equipment, and other instrumentalities used to perform the work, the “business-to-business” exemption will not apply.

  • The contractor can negotiate its own rates.

What this means for businesses: The legislative history of AB 5 indicates: “[I]f a company does not permit its ‘independent contractors’ to set their own rates, or only permits rate setting in a narrow band, such claims of independent contractor status should be met with skepticism.”  Analysis, Senate Cmte. on Labor (Jul. 10, 2019), p. 9.  To satisfy the rate negotiation requirement, contracting businesses will need to provide evidence of rate negotiation or unique contract terms.  This might take the form of differing rates and other terms in contracts with differing contractors for the same or similar jobs.  Records of negotiation (e.g., emails or contract drafts) could also serve as proof.  Businesses that simply set rates for contractors on a “take-it-or-leave-it” basis will have a difficult time satisfying this criterion.

  • The contractor can set its own hours and location of work.

What this means for businesses: It is unlikely that this requirement would prevent a contracting business from setting deadlines for completion of an overarching job or project.  Certain projects may have other external restrictions on the time or location of work (e.g., jobs at a specific customer site, jobs where work must be performed during daylight hours, or jobs where the customer can only provide access at certain times or locations).  But contracting businesses should avoid setting their own, separate, internal hours or location requirements.  Contracting businesses should also consider at the outset of a contracting relationship what forms of evidence (e.g. work records) they may require from contractors in order to prepare to prove satisfaction of this criterion.

  • The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required.

What this means for businesses: AB 5 and its legislative history provide no context, explanation, or reasonable basis for this criterion.  It appears to exist to distinguish the “business-to-business” exception from the “construction subcontract” exemption (see our separate Alert on the construction subcontract exemption here).

  • The “business-to-business” exemption does not apply to an individual worker (as opposed to a business entity) who performs labor or services for a contracting business.

What this means for businesses: Contracting businesses seeking to satisfy the exemption should contract only with a contractor formally registered as a business entity (e.g., as a corporation, LLC, partnership, or sole proprietorship) with the California Secretary of State or other equivalent state business registry.  Contracts with individual persons will not satisfy the “business-to-business” exemption.

Satisfying the “Business-to-Business” Exemption Does Not Guarantee that Subcontractors Can Be Treated as Independent Contractors

It is important to understand that businesses falling under “business-to-business” exemption are not necessarily free to continue treating workers as independent contractors.  For an employer who meets the exemption’s criteria, the status of any subcontractor relationships will still be evaluated under the preexisting “Borello” standard.  The Borello test relies on thirteen or more separate factors, most of which revolve around the extent of control a hiring entity exerts over a contractor.  Even before Dynamex, courts found many subcontractors to be employees under the Borello standard.

Satisfying the “Business-to-Business” Exemption Does Not Immunize a Company from Joint Employer Liability

Separate from the question of independent contractor status, the California Labor Code provides that certain business relationships (e.g., temporary employment agencies and their clients) share joint employer liability for the wages and workers’ compensation insurance of workers.  See Cal. Labor Code § 2810.3.  AB 5 expressly states that the “business-to-business” exemption does nothing to alter or supersede that provision of the Labor Code.  In addition, a company can face common law joint employer liability if it shares or codetermines essential terms and conditions of employment for employees of another business.  Even where the “business-to-business” exemption applies, businesses should thus be careful to avoid assuming such a level of control over the employees of another company.

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The “business-to-business” exemption is complex and contains many as-yet untested provisions, but provides California businesses with an important option for guarding against the impact of AB 5’s “ABC” test.  Where satisfying the criteria of the exemption is a possibility, businesses are encouraged to seek the advice of legal counsel.

This AALRR publication is intended for informational purposes only and should not be relied upon in reaching a conclusion in a particular area of law. Applicability of the legal principles discussed may differ substantially in individual situations. Receipt of this or any other AALRR publication does not create an attorney-client relationship. The Firm is not responsible for inadvertent errors that may occur in the publishing process. 

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