On September 18, 2019, California’s Governor, Gavin Newsom, signed into law AB 5, which expands the reach of who is an employee, as opposed to a contractor. Certain provisions of the new law are retroactive, while others go into effect on January 1, 2020. Therefore, for those studios that have been or plan on using contractors to support their business, it is prudent to re-assess the proper classification of those individuals now in light of the new law.
California Law Presumes that an Individual Providing Labor or Services for Remuneration is an Employee
AB 5 states that a person providing labor or services for remuneration “shall be considered an employee” unless the hiring entity can demonstrate otherwise. To prove that the person is not an employee, the hiring entity must demonstrate the following:
(A) 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.
(B) The person performs work that is outside the usual course of the hiring entity’s business.
(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Thinking about indie studios, there are a number of types of contractors that are often used: graphic design, software development, marketing, sound, etc. These individuals will likely be regarded as performing work within the usual course of the studio’s business and, therefore, presumptively employees.
There Are Significant Financial Consequences if Contractors are Re-Classified as Employees
Employees are entitled to a variety of benefits, that an employer often must provide, and to which contractors are not entitled, such as: workplace protections; workers’ compensation insurance; Social Security; unemployment insurance; disability insurance; minimum wages; rest breaks; meal breaks; overtime; paid sick leave; paid family leave. Moreover, employers must pay to the state premiums for workers’ compensation, unemployment and disability insurance, must pay payroll taxes, and must pay into social security. The business expense to indie studios of re-classifying contractors to employees could be significant.
AB 5 creates aggressive new enforcement mechanisms for violation of the law. Businesses violating the law could be subject to injunctive relief, prosecution by California’s attorney general, or prosecution by city attorneys (if the city has more than 750,000 residents), or by city prosecutors. Of course, private civil actions by aggrieved persons (i.e., mis-classified individuals) remain another form of enforcement that violating businesses could face.
There Are Some Exemptions from AB 5 that Will Allow Certain Individuals to Remain Classified as Contractors
Professional Services Exemption
Important for indie studios is the “professional services” exemption, which applies to, among other services that are described in the law:
- Marketing, provided the work is original and creative in character and the result of which depends primarily on the invention, imagination, or talent of the employee or work that is an essential part of or necessarily incident to any of the contracted work.
- Graphic design.
- Fine artist.
- Payment processing agent through an independent sales organization.
An indie studio engaging these service providers can treat the service provider as an independent contractor provided the studio can show:
(A) The individual maintains a business location, which may include the individual’s residence that is separate from the hiring entity.
(B) If the work performed is more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession.
(C) The individual has the ability to set or negotiate their own rates for the services performed.
(D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours.
(E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work.
(F) The individual customarily and regularly exercises discretion and independent judgment in the performance of those services.
Bona Fide Business-to-Business Exemption
There is also an exemption for “bona fide business-to-business” contracting relationships. As with the professional exemption, the hiring entity must demonstrate that the exemption is satisfied. The hiring entity must prove the following:
(A) The business service provider is 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.
(B) The business service provider is providing services directly to the contracting business rather than to customers of the contracting business.
(C) The contract with the business service provider is in writing.
(D) 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.
(E) The business service provider maintains a business location that is separate from the business or work location of the contracting business.
(F) The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed.
(G) The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity.
(H) The business service provider advertises and holds itself out to the public as available to provide the same or similar services.
(I) The business service provider provides its own tools, vehicles, and equipment to perform the services.
(J) The business service provider can negotiate its own rates.
(K) Consistent with the nature of the work, the business service provider can set its own hours and location of work.
(L) The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code.
Indie Studios Relying on Contractor Relationships Should Re-Examine Each Contractor to Assess Whether an Exemption Applies
Each relationship is specific and there is no one-size-fits rule for placing some categories (by description of services) of workers in the “contractor bucket” and others in the “employee bucket.” But, here are some issues to consider:
- Ad buyers likely will not satisfy the “marketing exemption” as their engagement often does not include creation of the content;
- Contracts with those who arguably are “graphic artists” or “fine artists” should articulate, in writing, that the person meets the criteria;
- Studios should require delivery of proof that an individual has a business license before hiring the individual;
- Putting all independent contractor agreements in writing may become a new best practice (note a written contract is required for the business-to-business exemption to apply);
- Increased diligence into a business entity’s operations may be necessary to establish (and later prove) that the business-to-business applies; and
- Many contractor functions that an indie studio relies on may not fit into the professional services exemption, and so the studio should perform a careful analysis of the business-to-business exemption before engagement.
These are but a few issues to consider moving forward. But, given the increased focus on workers’ rights and independent contractors in California, it is prudent for companies using the services of Californians to consider carefully whether they have properly classified those relationships.