Update:U.S. District Judge Roger Benitez issued a restraining order on Tuesday, Dec. 31, temporarily blocking enforcement of Assembly Bill 5 (AB5) against truck drivers. A hearing for a more permanent injunction is scheduled for Jan. 13, delaying operational impacts feared by the supply chain operating in the state.Click here for more details on the latest developments.

On Jan. 1, 2020, 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 for determining what constitutes an independent contractor. In short, any worker performing tasks that are 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 avoiding overtime pay and benefits for contract workers who work near full-time hours or make contributions equal to those of full-time employees. Unions, rideshare drivers, and the AFL-CIO have praised the legislation as a victory for workers' rights.

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

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

According to government data cited in a study on AB5's impact conducted for the California Trucking Association (CTA), owner-operators hired as contractors by carriers and shippers accounted for 28% of registered trucks in California as of 2016. Many in the trucking industry are confused about how to comply with AB5, saying the state has provided no guidance and suggesting that the correct approach will ultimately be decided by the courts.

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

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

Megan Shaked, a partner at Conn Maciel Carey, a law firm specializing in labor and employment law, said the uncertainty may stem partly from disbelief because the AB5 standard drastically changes how employers and contractors operate. "Some people have a hard time seeing it as black and white," she explained, adding that the previous contractor standard had enough leeway. AB5 brings major changes with almost no leeway. "I think people might read it and say, 'No, no, this can't be right,'" Shaked told Supply Chain Dive.

Norita Taylor, a spokesperson for the Owner-Operator Independent Drivers Association, told Supply Chain Dive via email that inquiries seeking guidance from the state have been unsuccessful.

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

— Weston LaBar, CEO of the 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 bill drafters considered freight impacts during the legislative process. The state legislature's website has multiple analyses of AB5, but none mention freight capacity.

Four California state agencies — Caltrans, 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 have not studied 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 requests an injunction to maintain the status quo while the litigation proceeds. The injunction hearing was scheduled for the morning of Dec. 30.

Comply or not comply

In an industry where contracting has been standard operating procedure for decades, figuring out the best way to comply with AB5 without formal government guidance is not easy. Legal experts in California's trucking economy have proposed five paths with varying degrees of legal certainty.

1. Convert to an all-employee fleet

Joe Rajkovacz, director of government affairs and communications for the Western States Trucking Association, suggests the only "foolproof" strategy is to make drivers full-time employees. Other legal experts agree with this assessment. However, many stakeholders are currently avoiding this option because they hope AB5 will be preempted by federal law, which would allow them to continue operating with their current staffing 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 seek to be classified as employees. Increased costs per driver for carriers mean higher rates for shippers.

LaBar said few in the industry are adopting the full-time employment approach. Other possibilities, while perhaps more likely, offer less clarity in terms of legality. Multiple legal experts said that without further guidance or new legislation, these approaches will be tested as AB5 cases move through the courts.

2. Convert to co-employment or leased employment models

In this scenario, a third party would hire drivers and handle HR matters 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 advises careful consideration of 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 be using," 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. The theory is that since the broker is not asset-based, drivers would 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 decisions finding that subcontractors/owner-operators were 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 to operate as independent small businesses. The model theoretically offers drivers the opportunity to drive for multiple companies, but they would now also become a company that must comply with 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 companies are asking contractors to relocate to the nearest headquarters outside California. But these companies could still violate AB5 if they send drivers back into California to work, LaBar said.

5. Do nothing

Some trucking companies are waiting to see the outcome of the injunction before implementing plans, LaBar said. Others argue that federal law preempts AB5 and plan to do nothing — ready 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. It means if you violate labor law in one area, you often trigger two, three, or even four different penalties," Fessenden said. He explained that a $5 wage difference could, in some cases, trigger employers owing thousands of dollars in fines. Multiply that by hundreds of workers, and the risk of noncompliance becomes much more severe than just paying unpaid wages.

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

— Keith McCoy, Director of Marketing at Prime Inc.

Adding to the complexity, AB5 has some retroactive effect, reaching back up to four years depending on the specific penalties, Fessenden added, "California is making it so expensive and risky to operate a business in the state."

Impact on capacity

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

A report prepared by John E. Husing (Chief Analyst at Economics & Politics, Inc.) for the CTA, filed as an attachment to the CTA's recent injunction request, indicates that 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, limiting trucking services from a key manufacturing, agricultural, and trading state to the rest of the country," the report states. Husing suggests AB5 will lead to higher freight rates in the state.

"California will bear the burden of [AB5], including the capacity shortage it will cause and the higher prices it will drive," 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 outcome 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 these seemingly unstudied consequences that lead some legal figures to expect swift legislative action in January. While not knowing the specifics in Sacramento, Shaked said, "There are indications that follow-up legislation — I don't know if I should call it a cleanup bill because I'm not sure if it will clarify things or just expand — but I expect this is not the last we hear of AB5."