Editor's note:U.S. District Judge Roger Benitez issued a restraining order on Tuesday, Dec. 31, temporarily blocking enforcement of AB5 against truck drivers. A hearing on a more permanent injunction is set for Jan. 13, delaying operational impacts feared by California's supply chain.Click here for more on the latest developments.

On Jan. 1, California's Assembly Bill 5 (AB5) went into effect, throwing industries that rely on independent contractors into varying states of limbo. The law introduces a new test to determine what constitutes an independent contractor. In short, any worker performing tasks central to the hiring company's core business will be considered an employee.

The new standard, known as the ABC test, is designed to prevent businesses from skirting overtime and benefits for contract workers who work near full-time hours or contribute as much as full-time employees. Unions, rideshare drivers and the AFL-CIO praised the legislation as a victory for workers' rights.

However, implementing the law is a major shift for California's supply chain, and experts expect it to impact trucking capacity and, ultimately, rates.

From publishing to the gig economy to restaurants, companies across industries are preparing for compliance — some essentially laying off all their contractors in the state. Meanwhile, legal challenges are mounting.

Owner-operators hired as contractors by carriers and shippers accounted for 28% of registered trucks in California as of 2016, according to government data cited in a report commissioned by the California Trucking Association (CTA). Many in the trucking industry are confused about how to comply with AB5, saying the state has provided no guidance and believing the courts will ultimately decide what is correct.

Data from a study by John E. Husing (chief analyst at Economics & Politics, Inc.) prepared on behalf of the CTA.
Matt Leonard / Supply Chain Dive, data from Husing

"Right now it's as clear as mud," Harbor Trucking Association CEO Weston LaBar told Supply Chain Dive.

Part of that uncertainty may stem from disbelief, because the AB5 standard completely changes how employers and contractors operate, said Megan Shaked, a partner at Conn Maciel Carey, a law firm specializing in labor and employment law.

"Some people have a hard time seeing it as black and white," she explained, adding that previous contractor standards had ample room for flexibility. AB5 brings major changes with little wiggle room.

"I think people might read it and say, 'No, no, this can't be right,'" Shaked told Supply Chain Dive.

Inquiries to the state seeking guidance were unsuccessful, Norita Taylor, a spokesperson for the Owner-Operator Independent Drivers Association, told Supply Chain Dive in an email.

"Right now it's as clear as mud."

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Weston LaBar

CEO of Harbor Trucking Association

As the law took effect, the state does not appear to have considered its potential impact on the freight market. There is no public evidence that the bill's drafters considered freight impacts during the legislative process. Multiple AB5 analyses are available on the state legislature's website, but none mention freight capacity.

Four California state agencies — the California Department of Transportation, the Employment Development Department, the Governor's Office of Business and Economic Development, and the California Department of Industrial Relations — all confirmed to Supply Chain Dive that they did not study the law's impact on freight capacity.

For carriers wondering how to comply, one possible avenue for further clarification is the lawsuit filed by the CTA, which seeks an injunction to maintain the status quo until the case is heard in court. The injunction hearing was scheduled for the morning of Dec. 30.

To comply or not to comply

Without formal government guidance, figuring out the best way to comply in an industry where contracting has been standard operating procedure for decades is not easy. Legal experts in California's trucking economy have identified five paths, each with varying degrees of legal certainty.

1. Move to an all-employee fleet

Joe Rajkovacz, director of government affairs and communications for the Western States Trucking Association, suggested the only "surefire" strategy is to make drivers full-time employees. Other legal experts agreed with that assessment.

However, many stakeholders are currently avoiding this option because they hope AB5 will be preempted by federal law, allowing them to continue operating with their current workforce structure.

This approach has other drawbacks for trucking companies. Full-time employment is more expensive due to associated costs like workers' compensation — a benefit that has already appeared in multiple lawsuits against carriers where contractors sought to be classified as employees. Increased costs per driver for carriers mean higher rates for shippers.

LaBar said few in the industry are taking the full-time employment approach. Other possibilities, while potentially more feasible, offer less clarity on legality. Multiple legal experts said that without further guidance or new legislation, these approaches will be tested as AB5 cases make their way through the courts.

2. Move to a co-employment or leased employment model

In this scenario, a third party would hire drivers and handle HR tasks such as payroll and hiring. Drivers would still be full-time employees, but not of the trucking company.

Hiring through a staffing agency is a similar solution, but Shaked advised carefully considering this option because "co-employer rules" could shift liability for these employees.

"This is certainly a good time to carefully review any consulting agreements or independent contractor agreements you might use," Shaked said.

3. Seek the business-to-business exemption

One of the exemptions written into AB5 allows contract work between two businesses. To achieve this, both carriers and drivers would need to make changes.

Carriers would have to establish a brokerage division separate from their trucking operations. Meanwhile, drivers would have to change their status from sole proprietors to S corporations. In theory, since the broker is not asset-based, drivers would be able to pass the test and be classified as contractors.

"The reason we're cautious about this is that we're well aware that the California Employment Development Department (EDD) has audited our brokerage members and issued rulings that subcontractors/owner-operators are employees of the broker, so we've seen this behavior from the EDD in California," Rajkovacz said.

This change requires drivers to have their own insurance and licenses and operate as independent small businesses. The model theoretically provides drivers with the ability to drive for multiple companies, but they would now also become companies subject to state and federal laws, LaBar said.

"'Can we get around AB5 by having every contractor create an LLC?' I hear that question a lot. The answer is that it may not be sufficient on its own," James Fessenden, an employment partner at Fisher Phillips, told Supply Chain Dive.

4. Move out of California

Some larger trucking operations are asking contractors to relocate to the nearest headquarters outside California. But these companies could still violate AB5 if they send drivers across state lines into California for work, LaBar said.

5. Do nothing

Some trucking companies are doing nothing until they hear the outcome of the injunction, then implementing plans, LaBar said. Others believe federal law preempts and plan to do nothing — preparing to fight it in court.

None of the legal experts consulted by Supply Chain Dive recommended this option, mainly because even before AB5, misclassification cases in California carried unique financial risks.

"California has what I call cascading penalties. That means if you violate labor law in one area, it often triggers two, three, or even four different types of penalties," Fessenden said. He explained that a $5 wage difference could, in some cases, trigger an employer owing thousands of dollars in fines. Multiplied by hundreds of workers, the risk of noncompliance is far more severe than simply paying unpaid wages.

"California will bear the burden of [AB5], including the capacity shortage it will cause and the prices it will push up."

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Keith McCoy

Director of marketing at Prime Inc.

Adding to the complexity, AB5 is retroactive, reaching back up to four years depending on the specific penalty, Fessenden said, adding, "California is making it so expensive and risky to do business in the state."

Impact on capacity

With AB5 enforcement beginning in January, its impact on trucking capacity and rates in California (and beyond?) is a serious concern for stakeholders. Morgan Stanley listed AB5 as a headwind for the freight industry, potentially creating "supply-side constraints" that push prices up. A similar situation is brewing in New Jersey, where the state legislature is considering Senate Bill 4204, which would implement a version of California's ABC test.

A report prepared for the CTA by John E. Husing (chief analyst at Economics & Politics, Inc.) — attached to the CTA's recent injunction request — indicates trucking companies will struggle to cope with the new financial obligations brought by the legislation.

"The result will be to restrict the flow of freight nationwide, because it restricts the trucking services a key manufacturing, agricultural and trade state provides to the nation," the report reads. Husing said AB5 will drive up freight prices around the state.

"California will bear the burden of [AB5], including the capacity shortage it will cause and the prices it will push up," Keith McCoy, director of marketing at Missouri-based trucking company Prime Inc., told Supply Chain Dive last month.

LaBar said the impact on capacity may not be immediate, but depending on the progress of pending court cases, it could reshape the state's freight landscape in the coming years.

"This is very complex," Rajkovacz said. "They're playing with people's livelihoods."

It is precisely these seemingly unstudied consequences that lead some legal experts to anticipate swift legislative action in January.

Shaked said that while she is not aware of specifics in Sacramento, "there are indications that a follow-up bill — I don't know if I should call it a cleanup bill, because I'm not sure if it's clarifying or expanding — but I expect this is not the last we hear of AB5."