Is a "loan-out" LLC or Corporation exempted from California's AB 5 law?
Updated: Nov 10, 2020
After my last blog post a couple weeks back, in which I argued that film producers could not rely on AB 5's business-to-business exemption to classify workers as contractors, I got an earful from a number of film producer clients who claimed that many of their workers had rebelled against my interpretation and the notion that AB 5's ABC test applied to them.
This is a somewhat strange reaction given that AB 5 was designed to protect workers from being misclassified as contractors and therefore being denied such employee protections as minimum wage, overtime pay and workers' compensation. It is often presumed that producers would be the ones angling for workers to be classified as independent contractors, but in the entertainment business, it appears that it is the workers (i.e., actors, directors, cinematographers and others) who are clamoring for it. Reasons for this vary --- some workers want to have more freedom in choosing how and when to work while others fear that the increased costs of classifying them as employees would lead to reduced job opportunities or cause film production to relocate to other states. Whatever the reason, producers are facing pressure from individual workers to classify them as independent contractors.
But before we revisit the question of whether the "business-to-business" exemption permits film producers to classify workers as contractors, let's look again at AB 5.
AB 5 and the Dynamex case. The expressed intent of the California Legislature in enacting AB 5 was to codify the California Supreme Court's Dynamex case  in which the court ruled that Dynamex Operations West, Inc., a nationwide package and document delivery company had misclassified it's delivery drivers as contractors rather than employees for purposes of the applicable state wage order governing the transportation industry.  The court ruled that such a misclassification posed "a very serious problem depriving the federal and state governments of billions of dollars in tax revenue and millions of workers of the labor law protections available to which they were entitled." 
Addressing the problem, the Dynamex court applied a much more rigorous standard for classifying independent contractors than the standard it applied in the court's 1989 Borello decision.  In Dynamex, the court said that a worker could be properly classified as an independent contractor only if the contracting entity established the following:
(A) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact; (B) that the worker performs work that is outside the usual course of the hiring entity’s business; and (C) that 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.
This standard is now law under AB 5 and its application to a typical film production scenario means that the film production workers, who are generally always under the "direction and control" of the producer, should be classified as employees. And while certain vocational workers and professionals are expressly exempted from AB 5's test, film production workers are not among them.
So what about the business-to-business exemption? Under the business-to-business exemption, should a "business service provider" formed as an llc or corporation perform services to a "contracting business," the employee or contractor status shall not be determined under AB 5's ABC test but instead under the Borello test, but only if the contracting business satisfies all twelve (12) of the identifying criteria of a bona fide business-to-business relationship.  However, the first of the twelve criteria is that the worker 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."  As noted above in reference to part A of the ABC test, it is unlikely that a film producer would ever be able to satisfy this freedom of control portion of the standard, which would mean that a film producer could rarely rely on the "business-to-business" exemption to protect the producer from misclassification claims.
Section 4 and the Loan-out entities exemption. However, it appears that Section 4 of
AB 5 and the use of loan-out entities may allow producers to classify workers as contractors. Section 4 of AB 5 amends Section 605(d) of the Unemployment Insurance Code to read::
606.5 (d) In.circumstances which are in essence the loan of an employee from one employer to another employer wherein direction and control of the manner and means of performing the services changes to the employer whom the employee is loaned, the loaning employer shall continue to be the employer of the employee if the loaning employer continues to pay remuneration to the employee, whether or not reimbursed by the other employer.” 
(Emphasis added.) In other words, it appears that the AB 5 may not apply in circumstances where producers can prove that workers meet the requirements of a “loaning employer." Although the law is untested and will remain subject to interpretation until litigation involving it comes before the courts, producers who wish to classify workers as contractors under Section 4 should at least meet the following requirements to best protect themselves from misclassification:
The producer and worker should have written agreement between the film company and the loan-out company that complies with the above requirements. The agreement should be in the form of a “loan-out” agreement with the loan-out company stipulating that the worker is an employee and pledging the services of said employee,
The producer should only pay the loan-out company and never pay the worker directly.
The loan-out company should be an LLC or a Corporation, and not a sole proprietorship.
The producer should insist on seeing the articles of the loan-out company as stamped by the State and verify that the loan-out company has active status. Both can be done online for a California entity.
The loan-out company should have a separate address from that of the producer.
The producer should insist on receiving a copy of the loan-out company's business license.
The loan-out company should have a written employment agreement with its workers.
Producers engaging loan-out companies should include in their engagement agreement a provision in which loan-out companies warrant that they have met each of these requirements.
It is unknown whether the courts will agree to this interpretation of Section 4. However, this section appears to provide a defensible way for producers to classify workers as contractors.
Proper classification of workers is the responsibility of the contracting entity and not the worker, so it is incumbent on the film producer to find a legitimate rationale for classifying workers as contractors. It is not enough that workers's wish to be treated as such.
 Dynamex, 4 Cal. 5th at 913-14, 416 P.3d at 5. State wage orders “impose obligations relating to the minimum wages, maximum hours, and a limited number of very basic working conditions (such as minimally required meal and rest breaks) of California employees.”Id.
 Id.at 913, 416 P.3d at 5. In enacting AB 5, the Legislature echoed the Court’s concerns inDynamex.SeeAB 5,supranote 3, § 1(b) (inDynamex, “the Court cited the harm to misclassified workers who lose significant workplace protections, the unfairness to employers who must compete with companies that misclassify, and the loss to the state of needed revenue from companies that use misclassification to avoid obligations such as payment of payroll taxes, payment of premiums for workers’ compensation, Social Security, unemployment, and disability insurance”). The Legislature also noted the much broader harm that the “misclassification of workers has been a significant factor in the erosion of the middle class and the rise in income inequality.”Id.§ 1(c).
 S. G. Borello & Sons, Inc. v. Dep’t of Indus. Relations, 48 Cal. 3d 341, 769 P.2d 399 (1989). UnderBorello, the principal factor in distinguishing an employee from an independent contractor is “whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired,”id.at 350, 769 P.2d at 404, but a number of other, intertwining factors are considered, the weight of which depends on the “particular combinations” that are presented in that case,see Dynamex, 4 Cal. 5th at 922, 416 P.3d at 11.
 Id.§ 2750.3(e)(1). The twelve criteria are: “(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[; and] (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.”Id.
Lindsay Spiller is the founder of Spiller Law, a San Francisco business, entertainment, and estate planning law practice. Mr. Spiller is a San Francisco business lawyer who serves clients throughout California and particularly in San Francisco and Los Angeles. You may find more information about Spiller Law's business legal services at https://www.spillerlaw.com/business-law.
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