California AB 5: Likely next steps, wait-and-see mode, unanswered questions prevail among small fleets, leased operators

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Updated May 14, 2021

"It’s not a good vibe right now," said Raman Dhillon, CEO of the California-headquartered North American Punjabi Trucking Association. He was talking about his group's membership's response to the news last week that a three-judge panel of the Ninth Circuit Court of Appeals had struck down a lower court's injunction against application of California's A.B. 5 contractor law and its ABC test's application to trucking.

The original suit that was ruled on had been brought by the California Trucking Association, who told Overdrive it is planning to request what's known as an en banc review, a reconsideration from the entire panel of judges in the Ninth Circuit. As previously reported, from the April 28 ruling on the injunction, CTA has 14 days to seek rehearing. If that request is denied or if the rehearing fails to change the view of the court, it will be a mere seven days from the denial or failure before the injunction lifts.

"The community is scared right now of what’s going to happen," said Dhillon about his organization's membership, who nonetheless remained in wait-and-see mode. "We have about 70,000 owner-operators in California," a bulk figure cited by the CTA attendant to their litigation. "There’s a big chunk of them who are Punjabi" and members of Dhillon's group. He estimated as many as half of the state's owner-operators could be from the Punjabi-American community. Many are leased, furthermore, and it's in those traditional, exclusive-lease relationships between carriers and owner-operators that A.B. 5 poses the greatest threat to what are otherwise legitimate, long-federally-recognized business relationships

[Related: Trucking law -- your rights under the Truth in Leasing regulations

It's not just California carriers or state-domiciled owner-operators that are in the crosshairs of the ABC test's B prong, requiring carriers and contractors to be in essentially separate areas of business. As the Owner-Operator Independent Drivers Association put it in its brief filed with the Ninth Circuit, in support of the injunction remaining in place, "for tens of thousands of interstate owner-operators and small-business motor carriers that regularly cross the California border — small-business truckers critical to the interstate motor carrier industry —AB 5 could be fatal."

Transportation attorney Greg Feary of the Scopelitis, Garvin, Light, Hanson and Feary firm notes jurisdiction depends on many factors, but could extend to any worker that has "enough operational nexus with the state of California to be subject to its jurisdiction under AB 5." The enough part of that has been the subject of past litigation, he added, and court rulings. "Certainly, contractors whose business is domiciled in California and work picking up loads in the state have enough to be considered a California worker." 

What if 40% percent of your loads pick up in California, but the other 60% are in Nevada? "It could be that Nevada has a greater interest in applying their employment laws than California" but that determination will only ever be made in any state on a case by case basis with a close look at the facts.

Independents with authority may not be entirely out of the woods themselves, particularly if they're doing a majority of business in the state with brokers that are affiliated with asset-based carriers. As Joe Rajkovacz of the Western States Trucking Association has likewise pointed out, the B prong of the ABC test is interpreted by some watchers as problematic for an even partially asset-based (owning trucks themselves) business when it comes to any independent contractor relationship there, including a contractor's work for an affiliated brokerage. Dhillon told Overdrive he'd heard from some of his carrier members similarly situated who had gone to great lengths to disentangle brokerage and carrier sides of the house in anticipation of AB 5 enforcement. 

Carriers setting up brokerages of late are "trying to put a different city on the brokerage" for their place of business, Dhillon said. "They have to keep it so separate" rather than establish an obviously affiliated company. 

There are other pivots carriers of all sizes have been exploring, said everyone we spoke to.

dollar sign, state of california signThe principal calculation owner-operator-leasing carriers are making in choosing whether to do business in California given AB 5 comes down to whether it's worth the cost, said transportation attorney Greg Feary.Top-line evaluation includes carriers asking these questions, Feary said: "In my current model, can I do business in California? Do I want to? And is it financially worth doing?" Plenty have long made the decision that it's not, for a variety of reasons, but for those who move otherwise, there's potential to utilize the business-to-business (B2B) exemption within A.B. 5 itself. It's difficult, though, for any carrier with traditional exclusive-lease arrangements to meet. 

The B2B exemption from the AB 5 employment law requires the carrier's contractor relationships to meet all 11 factors listed therein. Most of the factors might be simply satisfied in non-forced-dispatch lease contracts, such as what Greg Feary called "one of the boxes to check" in the requirement of the contractor to be a business entity, for instance an LLC or corporation or other business type separate from a single individual doing a job. 

Other boxes among the 11 factors are harder to check when it comes to a traditional lease agreement, like the requirement that the contractor be at least publicly non-exclusive in working for the entity he/she is contracted to. Rajkovacz said Western States has been looking out for ways to help members satisfy this portion of the test by offering advertising services for contractors. This could be as simple as maintaining a website for the business that faces the shipping public. Or it could be what Rajkovacz called a "business-card type of ad. ... If all the Ts are crossed and the Is are dotted, it’s a usable exemption," he said. But for traditional lease arrangements it's not going to work in most cases, he believed.

Motor carrier authority application processing services offered at WSTA continue to be in high demand since last week's court ruling. "We’re just seeing record business on the authority side," he said, and "more and more we’re doing conversions from LLCs to S Corps." (A word to the wise from Rajkovacz: "Once you become an S Corp," don't just pay yourself pennies to avoid tax withholding. "You have got to pay a competitive market-based salary to yourself and do the withholding." You'll get yourself in trouble with the IRS if you don't.)

"We’re looking at all the angles" for members who utilize contractors in any form, he said, to answer this question: "How do we help them build an affirmative defense" when challenges arise through state enforcement or litigation? 

[Related: Building personal payroll: A step toward tax savings, better finances]

Then there's the so-called "two check" approach to compensation, where a truck owner collects employee wages for driving and his business gets a rental fee for use of the equipment. This might seem to work for companies with the ability to pivot in that direction with leased owner-operators, said Feary. There are, however, risks. "There's some viability to it," Feary said. Most models he's seen assume "you're going to pay the contractor as if he’s an employee roughly one-third of the amount you paid him under the 1099 – the remaining amount you paid him would be considered to be rental of the truck."

About those risks? There's everybody's favorite government agency again. "The IRS has weighed in on that and, depending on the area of the country you're in, some divisions ... are more flexible than others. Some IRS offices see that as not being a proper truck-rental structure. Others see it as perfectly fine." Since the two-check model isn't pervasive in trucking, "it’s hard to read whether the IRS would read that across the country as an acceptable structure."

If you don’t do it right, the two-thirds paid to the business with a 1099 tax form "would be subject to the wage deductions, with penalties and interest," Feary added. "In this area, there’s a lot of different ideas being kicked around and the discussions are accelerating a lot because of the decision" April 28 from the Ninth Circuit. 

Should the injunction be lifted, whether with an adverse ruling after an en banc hearing or a denial of that hearing or other scenario (CTA could request a stay pending an appeal to the Supreme Court that may or may not be granted), the state's Division of Labor Standards Enforcement's audits of companies will be the "tip of the spear" on application of the rule in trucking, said Feary.   

For motor carriers, adverse rulings on classification could then "open up a cascade of problems" from penalties levied by DLSE itself to further actions related to unemployment and tax withholding, even state income tax issues if a former contractor who's now an employee "wasn't filing his taxes," said Rajkovacz.  

Only the largest of motor carriers, Rajkovacz believes, might be able to absorb such added costs, and many have already fled the state anticipating eventual enforcement of AB 5, he said, backed up by Overdrive reporting. "Many of them have cut their losses" already and stopped leasing owner-operators in California. 

[Related: ABC test laws are coming: Can the owner-operator model survive?]

Of the groups Overdrive reached out to for this story, only the Teamsters Union showed favor for AB 5's application to trucking broadly, though the union didn't respond directly to specific questions. Port Division Director Ron Herrera offered this statement: “With the 9th Circuit’s decision, we have state law protections to fight misclassification and make clear that these drivers are employees, not independent contractors, entitled to the same rights and protections as any other employee." 

It's not hard to find some support for AB 5 among independents with authority and other small, asset-based carriers, too, who see the problem of misclassifying employee drivers who do not own their own equipment as rampant. Commenting at Overdrive's Facebook page, one independent owner noted he was "glad to see this" under news of the Ninth Circuit's ruling against the injunction. "So many bust their tail maintaining authority and all the headaches that go along with it only to be undercut by megas with lease ops working for pennies on the dollar." 

It's not always large carriers with lease-purchase programs that draw the competitive ire of smaller carriers/independents. Dhillon told the story of a 10-truck owner, six of whose trucks are sitting idle because because every prospective driver they seem to come across wants to be a contractor, not an employee, while driving company equipment. Drivers "just leave when they tell them that they’d pay them and do the withholding on the W2." 

To a carrier like that, "competing with someone who is paying 1099 to his employees is very hard," he said, given the contractor treatment allows the company to avoid its share of taxes. "Many want [AB 5] to be implemented."

Rajkovacz fully acknowledges the problem. "Fundamentally the only reason a driver would insist" on a 1099 over a W2 is "that they have no intention of paying their taxes." Yet he feels it's a tax cheat that could easily be enforced if government agencies truly wanted to. AB 5, he and so many others feel, is a step too far. It risks carpet-bombing a legitimate business model in lease contracting with owner-operators, whose terms are governed in part by federal law, when the weapon the state really needs is already in its pocket, a hammer for the "more systemic problem in trucking, the 1099'ing of employees" who own no equipment.

If Feary is right, the CTA's request of an en banc review from the Ninth Circuit should be expected on or before before Wednesday, May 12. --Jason Cannon contributed to this report.

[Related: 1099 company drivers? You don't need an ABC test for that]