California’s “Assembly Bill 5” Threatens Unintended Consequences for the Entertainment Industry

Caitlin Hall-Swan is a J.D. candidate, 2021 at NYU School of Law.

If you’re an entertainer, your income comes from “projects” – you take one job here, another there. Actors who work on a film, or musicians who produce an album, typically engage in short term employment rather than signing on as an employee of a big studio or production company.

Because of the nature of entertainment work, loan out companies are a longstanding institution in the entertainment industry. Creative professionals such as actors, musicians, and screenwriters often do business under a loan out entity – typically a single-owner LLC or corporation. The loan out company enters into contracts with studios, production companies, and other creative businesses and agrees to provide – or “loan out” – the services of the entertainer. In this way, the loan out is an independent contractor of the production company while the entertainer is an employee of the loan out.

This structure is mutually beneficial for the entertainer as well as the businesses they service. Entertainers can reduce the amount they pay in annual self-employment taxes because they are employed instead by the loan out entity. The entity also allows entertainers to deduct business expenses, such as the costs of talent agents, managers, or attorneys. In addition, using a loan out protects an entertainer’s personal wealth and assets from liabilities related to the entertainer’s work. Thus, business advisors recommend that creative professionals who make between $75k and $100k per year should form a loan out to engage in employment opportunities.

Employers benefit from hiring loan out entities, rather than individuals, because doing so enables them to sidestep certain employment law requirements. For example, when a production company contracts with a loan out, rather than an individual, it ensures that it will retain copyright ownership of the entertainer’s creative work. Under the loan out structure, after all, the creative worker is classifiable as an independent contractor, rather than an employee of the production company, and the entertainer’s independent contractor status enables the production company to retain complete copyright ownership.

Now threatening the industry custom of the loan out company is a newly passed bill in California: Assembly Bill 5. The new legislation codifies the California Supreme Court decision in Dynamex Operations West. v. Superior Court and modifies the criteria that distinguishes an employee from an independent contractor. Signed into law on September 18, 2019, AB5 is designed to protect gig economy workers from misclassification as independent contractors; the passage of the bill is a win for many California workers (e.g., Uber and Lyft drivers), who now, as employees, must receive basic employment benefits including minimum wage, overtime pay, and healthcare.

The Dynamex test requires that a hiring entity categorize a worker as an employee, unless it can show that (A) the worker is free from the control of the hiring entity, (B) the worker performs work outside the usual course of the hiring entity’s business, and (C) the worker is customarily engaged in a trade, occupation, or business of the same nature as the work performed. AB5 puts the burden on employers to show that each of these requirements are met, which means that employers could get in legal trouble for hiring “independent contractors” who should, according to the Dynamex test, be hired as employees. The entertainment industry is concerned that loan outs will not meet the Dynamex criteria because loan outs (entertainers) do not perform work outside the usual course of the hiring entity’s business (entertainment). In failing part (B) of the test, the entertainment loan out cannot be hired as an independent contractor.

Thus, AB5 may render an entertainer’s loan out company unusable. If production companies and studios might face liability for hiring a loan out as an independent contractor, they may choose to hire creative professionals instead as employees and stop hiring talent through their loan out companies. A company like Netflix, for example, could scale back on hiring independent entertainers and ramp up in-house production. In effect, the loan out company could become obsolete.

The loss of the loan out as a business device would affect tax and liability issues, which in turn could affect compensation structures and production budgets. On that basis, entertainment lawyer Rick Genow has warned that “[t]he economic impact would be somewhat devastating to both talent and the studios.” On the other hand, other commentators, including major talent unions, claim that AB5 will have no effect on the industry use of loan outs. For example, the Screen Actors Guild – American Federation of Television and Radio Artists released a statement advising its members that “AB5 will have no impact on the use of loan outs.” Union claims are substantiated by a business-to-business exemption that is provided in the bill, which states, in part, the following:

“Subdivision (a) and the holding in Dynamex do not apply to a bona fide business-to-business contracting relationship . . . under the following conditions:

(1) If a business entity formed as a sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation (“business service provider”) contracts to provide services to another such business (“contracting business”), the determination of employee or independent contractor status of the business services provider shall be governed by Borello,[1] if the contracting business demonstrates that all of the following criteria are satisfied . . . .”

What continues to give industry workers pause is that there is a stringent list of criteria to be adhered to in order to fall under this business-to-business exemption. It’s possible that entertainment loan out companies may not proceed through the rigors of adherence despite being eligible to qualify for such an exemption. Either way, there still remains the concern that larger studios will seek to avoid any risk by deciding to only hire employees.

Is Hollywood right to be fearful? It’s not clear yet. AB5 isn’t going to change the face of the gig economy overnight, so it is certainly not going to have immediate effects on the entertainment industry. In this case, only time will tell.

[1] The Borello test is a multifactor balancing test to determine whether a worker is an independent contractor or an employee that, before Dynamex, had been in effect since 1989. The test is considered more amenable to “independent contractor” designations than Dynamex because not all of its factors must be satisfied. 

Check out another take on the affects of AB-5 on the entertainment industry here.