California Assembly Bill 5: Should Technology Specialists Working for Californian Companies Be Wary of the Novelty?
In September 2019, the California Assembly Bill 5 (the “CA AB 5”) was adopted, which amended the state labour code. Many believe that the Bill amends the State law significantly, affecting the situation with foreign technology specialists who work for Californian companies remotely.
CA AB 5 has been the subject of intense media attention and fertile ground for discussions on law and economics for experts at all levels: Forbes writes that “[n]o one knows the far-reaching impact of this legislation yet”; National Public Radio describes how companies in California “are scrambling to figure out how to comply”; the New York Times reports, quoting one of California’s most successful freelancers, that “[e]veryone’s scared in California.”
Ultimately, the Bill introduces a number of changes to California labour law, the most important of which is establishing criteria by which it can be determined whether there is an employment relationship between a company and the person who provides services to it, as well as introducing liability for the misclassification of employees. The novelties have caused a lot of discussion regarding the impact of the new law on the functioning of such giants as Uber and Lyft, as well as the potential negative effects on numerous freelancers.
So, what does the entry into force of CA AB 5 entail and why are we talking here about Ukrainian professionals and sole proprietors?
Of Cucumbers and Migrants
This story began almost thirty years ago in the outback of California, when a group of migrants sued the owner of the cucumber plantations where they worked as so-called “share farmers”. The contract stipulated that the farmers were independent contractors; Mr Borello, the owner of the plantations, provided all the necessary equipment, and the farmers pledged to collect cucumbers in exchange for a share of their sales.
Despite some other circumstances and provisions of the contract, according to which the relationship between the parties was not that of employment, the court concluded that the farmers were employees since the owner of the plantations had sufficient control over their work. The court’s decision (S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal. 3d 342) served for many years as a guideline for determining whether certain legal relationships can be classified as employment. Among the factors taken into account were the method of payment and the presence of other customers.
The Changing Landscape of Gig Economy
Almost thirty years later, the economic environment in California and around the globe became completely different. The time of gig economy offers both advantages and challenges. On the one hand, the new landscape gives greater freedom to producers and a wider choice to consumers. On the other hand, there are more risks and greater social insecurity. And, of course, the issue of classifying people working for a company as employees or contractors has become much more relevant. In 2018, the Supreme Court of California had something to say.
The Dynamex case began with a lawsuit filed by courier drivers against a delivery company (Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal. 5th 903). The drivers worked for Dynamex as employees, but they were reclassified as independent contractors due to the financial optimisation carried out by the company, despite the fact that the essence of the work did not change. The court sided with the drivers, having developed a three-element test which is now used to determine whether a relationship should be classified as employment.
The presumption is made that a contractor is an employee unless the following elements can be proven by the employer: (i) the person is not controlled by the employer, in contract or in fact, (ii) the person performs work that is outside the scope of the ordinary activity of the employer and (iii) the person regularly engages in the same activities that they do for the employer. In some cases, the now outdated Borello test still applies, such as to doctors, lawyers and architects.
CA AB 5, adopted by California lawmakers, is essentially a codification of law that was developed by the Supreme Court of California. The Bill amends the Labour Code, mainly changing the definition of an employee in the light of the Dynamex decision, transplanting the criteria outlined above into the text of the Code. In other words, these rules have been part of the California state law since 2018 but have only now been codified with the adoption of CA AB 5.
Starting January 1, 2020, all employers must bring their businesses in line with the new regulation. Otherwise, they run the risk of incurring a fine of USD 5,000 to 25,000, plus unpaid taxes.
Offshore Outsourcing and Ukrainian Contractors
For us, the core issue is the application of the CA AB 5 standards to individuals who work for Californian companies remotely in other countries (without leaving their homeland) and receiving payment through modern payment systems. This practice is called offshore outsourcing and, in fact, exploits the enormous inequality in the development of countries; what seems like a ridiculous salary for a Californian developer would be an incredibly tempting offer for an IT professional from India or Ukraine. Some of our colleagues believe that the legislative changes directly affect Ukrainian sole proprietors who provide services to Californian companies, but this isn’t the case.
In fact, the California labour laws, including CA AB 5, simply do not apply to relationships between Californian companies and Ukrainian sole proprietors. At least two arguments can be made to justify the inapplicability of the California Labour Code.
Firstly, US law, according to the general and long established rule in the EEOC case (EEOC v. Arabian American Oil Co. (1991) 499 US 244), applies only to the US territorial jurisdiction and is not subject to extraterritorial application (meaning the possibility of applying American law to a territory that is not part of the US), unless otherwise expressly specified in law. Neither CA AB 5 nor the California Labour Code indicates that they can be applied to relationships with non-residents located in other countries.
As for labour standards, the Wright case may shed some light on this issue (Wright v. Adventures Rolling Cross Country, Inc. (2013) C-12–0982 EMC, N.D. Cal. Apr. 24). In that situation, a group of employees from a company dealing with active tourism demanded the application of the California labour laws to them in terms of the minimum wage and paying for overtime hours when they performed their work abroad, in particular in Italy and Greece. The court sided with the employer, confirming that the presumption against the extraterritorial application of the law applies to labour standards.
Secondly, working in the US demands authorisation, according to the Immigration Reform and Control Act 1986, by means of submitting an I-9 form. This procedure does not apply to workers not physically present in the US. Thus, Ukrainian citizens who provide services to a California-based enterprise as sole proprietors located in Ukraine do not need to receive authorisation from U.S. Citizenship and Immigration Services. If the Labour Code applied to such persons, a rather grotesque conflict would have arisen between federal law, according to which the persons concerned are not employees, and state law, according to which such persons are.
Finally, CA AB 5 also provides for a special exception, namely provision (2)(e), which removes sole proprietors from the new regulation. However, not everything is so simple with this exception. Firstly, the Borello test can still be applied to sole proprietors, which enables one to quite effectively identify employees who are filed as contractors. Secondly, CA AB 5 establishes that the use of the Borello test is possible only if a number of conditions are met (put simply, a test before another test), among which are the following: that the contractor’s place of work does not coincide with the customer’s place of work, that the contractor has other customers, and the payment method in question. Thus, sole proprietors who really conduct independent professional activities may benefit from some additional security due to this exception.
CA AB 5 mainly affects the giants of the modern gig economy, such as Uber and Lyft. Freelancers in California may suffer from the new law, but it is obvious that they will not be the main target of the authorities.
In any case, the new definition of an employee is intended to protect those who breathe life into the modern globalised economy and receive the least profit from it: low-skilled and low-income workers. As the Supreme Court noted in the Dynamex case, if the employer does not incur social expenses (medical insurance, health insurance, etc.) for their employee, filing them as a contractor, all of society bears those expenses. Ultimately, the new law applies the so-called duck-test: if a person performs the functions of an employee and is treated precisely as an employee, then such person is an employee.
At the same time, evidently, US lawmakers are primarily concerned with protecting their own residents and citizens, and therefore, for Ukrainian sole proprietors and contractors, the rules of the game have not changed much with the adoption of CA AB 5.
Contact us if you have questions about establishing presence or R&D office in Ukraine, or structuring relationship with Ukrainian employees and contractors.
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