Executive Summary
Assembly Bill 5 (A.B. 5) is a California law that restricts businesses from classifying workers as independent contractors.
Stricter employee classification laws have momentum, and federal changes could be on the horizon.
This means your fleet may need to be prepared if A.B. 5 becomes the law of the land.
A.B. 5 is based on a California Supreme Court ruling on a case known as Dynamex.
The Dynamex ruling replaces the old classification test with a new ABC test.
Owner-operators leased to trucking companies likely cannot pass this test.
In January 2020, a preliminary injunction was issued that exempts carriers from A.B. 5 while the lawsuit is adjudicated.
The injunction allows motor carriers to continue working with owner-operators until a final decision is reached.
The law has already had significant consequences in California, with fleets announcing a move away from using owner-operators based in California.
The option that seems to be getting the most consideration from carriers to get around A.B. 5 is opening a broker arm. This brokerage relationship will pass the “B” part of the ABC test.
Implement a “two check system.” The first check is to the driver as an employee, and the second check is for the rental of the driver’s equipment. However, there are nuances that make this a problematic solution.
Many owner-operators in Southern California are beginning to establish themselves as LLCs and receive loads from a trucking companies’ brokerage divisions.
The U.S. Department of Labor (DOL) is also proposing new guidelines on employee classification.
Being this is at the federal level, it may not impact the rules of the state-based A.B. 5.
Even with the classification test in the initial DOL proposal being considered more positive for independent contractors, laws similar to A.B.5 are a real threat for fleets.
On November 3, 2020, California voters easily passed Proposition 22, an exemption from AB5 for app-based drivers and couriers.
Prop 22 created a hybrid model between contractors and employees; essentially a “contractor-plus limited benefits” model.
It’s believed that Prop 22 should be a factor in whether the trucking industry remains exempt from AB5 as well.
Your fleet needs to begin thinking about an action plan if A.B.5 style rules were passed federally or in your state.
Introduction
It’s no secret; The government has been aggressive in seeking unpaid taxes and penalties from companies misclassifying their drivers. On top of that, those drivers are also making claims for unpaid wages, including overtime and benefits. The potential tax debt owed to the government, coupled with a driver seeking money owed for misclassification, may end up costing a carrier hundreds of thousands of dollars. These misclassification risks have become even more concerning with the passing of Assembly Bill 5 in California earlier this year.
Assembly Bill 5 (A.B. 5) is a California law that restricts businesses from classifying workers as independent contractors rather than employees. The bill was driven by unions wanting to organize workers. However, many experts believe A.B. 5 will actually increase labor costs, create higher prices for consumers, reduce the quality of service, and, most importantly, reduce workers’ flexibility.
Though California’s law has drawn the most attention, similar legislation has popped up among other states, including New Jersey, New York, and Washington. Likewise, just this month, the Democratic-held U.S. House passed a labor law that would adopt a stricter test nationally to determine whether a worker can be classified as an independent contractor. That bill has a slim chance at passing the Republican-controlled Senate, and President Trump already stated he would veto the bill if it did somehow pass. However, the point remains: stricter employee classification laws, especially those at the state level, have momentum, and federal changes could be on the horizon depending on the results of the election. Your fleet should prepare for the possibility of A.B. 5-type legislation becoming the law of the land.
The History of A.B. 5 (Where did the idea come from, and why?)
A.B. 5 is based on the California Supreme Court ruling on a case known as Dynamex on April 30, 2018. The Dynamex ruling establishes a presumption that workers are employees unless the hiring company can prove otherwise.
Before the Dynamex ruling, the Borello test (in place since 1989) was the standard for determining classification. The Borello test is an 11-prong test that most owner-operators (Independent Contractors) were able to pass. The Dynamex ruling replaces Borello with a new 3-prong test, called the ABC test, to determine if a person can be qualified as an independent contractor.
The three prongs that must be passed of the ABC test are as follows:
A. The worker is free from the control and direction of the hirer in connection with the performance of the work
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 for the hiring entity
*The second prong is the part of the test that owner-operators leased to trucking companies cannot pass.
What Has Happened in the States Looking to Adopt A.B. 5 (Especially in California)
Legal Battles
A.B. 5 was passed in the fall of 2019 by the California legislature and signed by Gov. Gavin Newsom. But in January 2020, U.S. District Judge Roger Benitez issued a preliminary injunction that exempts motor carriers from A.B. 5 while the California Trucking Association’s (CTA) lawsuit against the law is adjudicated. The injunction is an exemption that allows motor carriers to continue working with owner-operators until a final decision is reached in the CTA’s lawsuit against A.B. 5.
In September 2020, The Ninth Circuit heard arguments from the CTA regarding why that preliminary injunction should remain in effect. The court also heard arguments from the State of California and the Teamsters Union, who is fighting the CTA’s case. The court has not given any indication of when it will issue a ruling. Still, its decision will likely have years-long ramifications for carriers and independent contractor drivers that work in the state. Ultimately, the lawsuit could take years to make its way through various courts and potentially up to the U.S. Supreme Court, marking the importance of the Ninth Circuit’s decision to uphold the injunction or not.
After a decision is reached about the temporary injunction, the actual lawsuit itself against A.B. 5 – in which CTA seeks a permanent exemption for trucking – will be heard by the U.S. District Court in Southern California. From there, any decision will likely be appealed to the same Ninth Circuit Court of Appeals that listened to the case and then, potentially, will be taken to the U.S. Supreme Court.
CTA attorneys argue that a 1994 federal law (the Federal Aviation Administration Authorization Act) expressly prohibits states from enforcing laws that interfere with “prices, routes, and services” of interstate motor carriers. The CTA argues that California’s A.B. 5 does just that and should not apply to trucking operations in the state.
Carrier Responses to the IC's in these states
The law has already had significant consequences in California, with large and small fleets announcing a move away from using owner-operators based in California or even contracting them to haul loads in the state. Carriers have had to tell their California-based owner-operators they could no longer contract with them unless they move out of state.
Some fleets are offering their owner-operators a relocation package for those who want to leave California and stay as an owner-operator. Other fleets are giving owner-operators the option to transition to a company driver if they wish to continue operating within California.
Options to Navigate Similar Laws (If They Were to Pass in Your State)
Open a brokerage arm
The option that seems to be getting the most consideration from carriers, and which some already are using, is opening a broker arm to handle their relationships with owner-operators. This brokerage relationship will pass the “B” part of the ABC test because brokers aren’t technically in the same business as either the owner-operator or the carrier. Logistically, it could be challenging to pull off, but many have already gone through with this option.
Two events are necessary to make the freight brokerage model work.
The licensed motor carrier establishes a brokerage operation.
Independent contractors (drivers who own their trucks and contract with companies) secure operating licenses as Licensed Motor Carriers (LMCs).
There is a process with costs involved for each of those entities, but it’s possible with the proper legal advice.
In most locations, the process takes five to six weeks to open a brokerage arm. To avoid liability issues and to carry out the process correctly, it’s important not to connect the brokerage division to the carrier division. Motor carriers should set up a separate brokerage division from the carrier division to avoid cross-over liability.
Many now see the freight broker model as a viable option to avoid employee-based operations if A.B. 5 eventually eliminates the traditional owner-operator model. However, the Teamsters union, which has been using the employer-employee argument for the past decade in driver classification lawsuits, views any move toward a freight broker model as another way to classify drivers as independent contractors and thereby avoid funding employee benefits.
Additionally, the state and federal governments fear losing out on tax revenues due to the independent contractor model, as the burden to pay taxes falls on the contractors. However, companies like ATBS help independent contractors to meet their tax burdens.
Many owner-operator drivers in Southern California are already beginning to establish themselves as LLCs, even if they have just one truck. Those drivers are now receiving their loads from the trucking companies’ brokerage divisions they used to contract with as owner-operators. However, it can be a lot of work for an independent driver to file as a business entity such as a limited liability company, which could be a legal and paperwork burden beyond what an independent driver wishes to face. Unless you have someone to guide you through this, it could be a challenge. To learn more about the cost of obtaining your own authority, click on the link here.
To pass ‘prong B’ of the Dynamex test, a driver would have to have an independently established business or provide trucking services to a non-trucking company. This may be the way out of A.B. 5 for owner-operators.
Implement a two check system
Another potential solution to AB5 is for carriers to pay their drivers via a “two-check system.” Although rare, two-check systems have been around for many years. Under the two-check system, the driver is no longer an independent contractor but a carrier employee. At the same time, the driver has a rental agreement to rent his equipment to the carrier.
The first check is to the driver as an employee, and the second check is for the rental of the driver’s equipment. However, there are nuances that make this a problematic solution.
For example, because the carrier is renting the truck, they technically can put any driver they want in the truck, especially if the primary driver is taking extended time off. Another example is that some believe they can pay the employee driver minimum wage and put the rest of the money towards the truck’s rental. However, it’s likely in this scenario that the IRS will consider this as shielding income. A third issue is that as an employee, the driver can no longer choose when to work, how much they want to work, what loads they want to haul, or any of the other myriad of reasons that drivers choose to be independent contractors instead of employees. There are other potential issues with the two-check system, but these are examples of the more common ones.
Move outside of the state
Suppose the ABC test is implemented on a state by state basis rather than as a federal mandate. In that case, your fleet can either choose to move and be domiciled outside of the state and/or you can tell your contractors to move their principal residence and CDL outside of the state. Under state-specific A.B. 5 type legislation, fleets operating in a state without A.B. 5 can still work with contractors and have them deliver loads into a state that implements an ABC test. However, both the fleet & contractor cannot be domiciled in the A.B. 5 state themselves. Additionally, if a contractor were to deliver a load in an A.B. 5 state, they would need to deadhead out of any A.B. 5 controlled state to pick up their next load.
DOL Releases Text of New IC Rule for FLSA
The U.S. Department of Labor (DOL) is also proposing new guidelines on employee classification, but being this is at the federal level, it may not impact the rules of the state-based A.B. 5.
The guidelines would be the first set out by the DOL under the Fair Labor and Standards Act (FLSA). It appears to be an attempt to get in front of the state by state A.B. 5 laws, but it is still early in the guidelines process.
The new guidelines do have similarities to the ABC test. However, these guidelines are more reasonable and would allow independent contractors to remain classified as such. The DOL defined a checklist of questions to determine whether a worker should be considered an employee or a contractor. While the potential new guidelines may not impact the state level A.B.5 rules, the proposal is still significant for the states who have not yet adopted a state-level law.
The DOL says the proposed rule:
Adopts an “economic reality” test to determine a worker’s status as an FLSA employee or an independent contractor. The test considers whether a worker is in business for himself/herself (independent contractor) or is economically dependent on a putative employer for work (employee).
Identifies and explains two “core factors”: The nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss based on initiative and/or investment. These factors help determine if a worker is economically dependent on someone else’s business or is in business for himself/herself.
Identifies three other factors that could serve as additional guideposts in the analysis: The amount of skill required for the work, the degree of permanence of the working relationship between the worker and the potential employer, and whether the work is part of an integrated unit of production.
Advises that the actual practice is more relevant than what may be contractually or theoretically possible in determining whether a worker is an employee or an independent contractor.
Another key point from the DOL proposal that the American Trucking Associations (ATA) points out in a September 2020 letter to their members is the impact safety measures have on the working relationship. The ATA letter reads “(The DOL Proposal) State(s) that contractual provisions ensuring compliance with legal responsibilities, like safety, should not be considered evidence of control.” This language should help fleets to bring on better & more consistent safety measures across their fleet.
It stands to say that the proposed DOL rule reinforces the goals of an industry that has long relied upon independent contractors in addition to employees, such as company drivers.
According to the ATA, the federal independent contractor rule could lead to more opportunities for owner-operators across the trucking industry. “The department’s proposal aims to bring clarity and consistency to the determination of who’s an independent contractor under the Fair Labor Standards Act (FLSA),” Secretary of Labor Eugene Scalia said in a statement. “Once finalized, it will make it easier to identify employees covered by the act, while respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.”
It’s believed that streamlining the test to identify independent contractors will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.
The Passage of Proposition 22
On November 3, 2020, California voters easily passed Proposition 22, an exemption from AB5 for app-based drivers and couriers who use personal vehicles/transportation to provide on-demand services. Prop 22 created a hybrid model between contractors and employees; essentially a “contractor-plus limited benefits” model. Those limited benefits include:
Minimum Wage: Rideshare and delivery companies must pay 120% of the local minimum wage for each hour a driver spends driving
Stipend Towards Health Insurance: For drivers who usually work more than 15 hours per week
Rest Time: Companies must limit app-based drivers from working more than 12 hours during a 24-hour period, unless the driver has been logged off for an uninterrupted six hours
Hazard Insurance: Provide occupational accident insurance to allow drivers disability payments of 66% of their average weekly earnings during the previous four weeks before the injuries were suffered for upwards of 104 weeks
Other Requirements: Prohibit workplace discrimination and: (1) develop sexual harassment policies; (2) conduct criminal background checks; and (3) mandate safety training for drivers
The passage of Prop 22 will likely cause other industries to push for independent contractor classification, especially given the margin Prop 22 was passed by. Alternatively, other industries may pursue similar models in order to argue that they also fall under the new law set forth in Prop 22.
It’s believed that Prop 22 should be a factor in whether the trucking industry remains exempt from AB5 as well. In a letter to the Court of Appeals for the 9th Circuit, Andrew Tauber, the attorney for the California Trucking Association, says the passage of Prop 22 takes a further whack at the idea that AB5 is a law of “general applicability.” The CTA’s argument is that AB5 was always targeted at trucking and ride-sharing and is even more so with the success of Prop 22. “Now AB5 has been amended yet again and once again rendered even less generally applicable than before,” says Tauber.
Conclusion
Even with the classification test in the initial DOL proposal being considered more positive for independent contractors, laws similar to A.B.5 are a real threat for fleets who work with owner-operators. This is because the DOL proposal is still in infancy and may have little impact on state-level labor laws. The DOL proposal was just issued in September 2020; therefore, many steps will still need to occur before the DOL can get the proposal passed. Suppose the DOL proposal is passed with the same guidelines as initially introduced. In that case, fleets will still need to comply with the employee classification laws in each state they are operating within. As we have seen in California, state laws could be more restrictive, leading you to be held liable for misclassification.
This means your fleet should begin thinking about an action plan if A.B.5 style rules were passed federally or in your state. By getting ahead of it now, you will be able to more seamlessly pivot your business if you are forced to change the way you work with owner-operator drivers. By using some of the strategies we have listed above to work within these more restrictive laws, you should be able to continue operating successfully. New information regarding A.B. 5 and similar legislation seems to come out weekly, so make sure you stay up-to-date on any changes and be prepared.
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