The brokerage model for complying with California’s AB5 got another vote as the most likely solution in a research note published by Cowen transportation analyst Jason Seidl.
Seidl held a private roundtable discussion with unidentified executives who are likely to be affected by the state’s restrictive law on independent contractors, as well as an attorney. After the roundtable, Seidl published his report backing the brokerage model, in which a trucking company transitions to being mostly a brokerage and brokers freight into independent owner-operators. But those independent owner-operators would need to get their own authority and insurance if they are now driving under the banner of a company providing those necessities.
The other most likely option for complying with AB5, Seidl wrote, is making drivers employees, a step that was most visible in a recent decision by Universal Logistics (NASDAQ: ULH).
Going to the brokerage model isn’t easy if a company is smaller, Seidl wrote. “Panelists pointed out that smaller carriers with less legal and financial wherewithal are likely to remain non-compliant and face penalties or move to other states altogether, creating an opportunity for larger carriers to take share,” he wrote.
The two-check model, under which a driver becomes an employee of a third party (like TransForce) and leases a truck to the carrier, was described by Seidl as “less popular.” The business to business exception that is part of AB5 was said to be “difficult to qualify for.”
AB5’s primary hurdle for trucking is its B prong, which says a worker can be defined as an independent contractor if he or she “performs work that is outside the usual course of the hiring entity’s business.” A trucking company hiring an independent owner-operator to move freight runs the risk of not complying with the B prong.
The issue has loomed for the state’s trucking sector after a U.S. Supreme Court decision in June effectively ended an injunction that had kept the law away from California trucking. AB5 is now fully in place for the state’s truck companies.
But the Cowen panel also revealed that the California industry in the short term is more concerned with new regulations from the California Air Resources Board (CARB) that will hit the drayage community.
The transition to cleaner drayage trucks, to take effect at the start of 2023, has a potentially greater impact than AB5, according to the panel. The most pressing change is the rule that drayage vehicles must be model year 2017 or later as of 2023. It’s a follow-up to a 2018 rule that vehicles needed to be 2014 models or later.
“Panelists shared that the [CARB] rule … is the largest regulatory burden on the horizon,” the report published by Seidl after the roundtable said. “While used truck prices are starting to decelerate, our panelists stated that truck pricing is still up more than 30%. This will likely put more pressure on the truck market in California,” the assumption being that owners of trucks who are seeing their trucks move into the banned category will look to the used truck market for replacements.
In a follow-up interview with FreightWaves, Seidl talked about the fallout from the enormous backup at the Southern California ports that took months to ease. “What we’ve seen over the last 18 to 24 months, combined with AB5 and CARB, is that shippers are just sort of fed up with the West Coast ports and freight that already has been diverted will not likely divert back,” he said.
As a result, the one stock-related comment in his report is that the loss of freight moving into the Southern California ports might be negative “for someone like Union Pacific (NYSE: UNP).” He added that “we remain cautious on the magnitude of the shift, with ocean rates to the West Coast slipping rapidly and the potential resolution of labor issues on the horizon.” But what he referred to as “alternative energy points” can be boosted by new infrastructure development elsewhere as well as lower warehousing costs.
On AB5, Seidl told FreightWaves that the rule will “weigh a little heavier on the smaller drayage-type carrier. The large ones are going to have the wherewithal and the knowledge to meet compliance.”
In his report, Seidl laid out numbers on what AB5 compliance will cost the drayage community. “Complying with AB5 will entail increased costs for drayage carriers that will be ultimately passed on to shippers, given the EBITDA margin structure of a drayage business is already only 8-10%,” he wrote. “Drayage carriers cannot absorb significant cost increases.”
But Seidl told FreightWaves that many drayage companies already are in compliance with AB5 because much of their workforce is already made up of employees, not independent contractors. “A lot of the bigger drayage carriers already have a company driver mode built in” he said. And he added that one of the participants said AB5 may make companies “turn more to company drivers.”
Such a step has costs. The Seidl report said moving a contractor to an employee and moving them to a dedicated service would result in a roughly 20% increase in costs, before administrative costs are figured, largely because older vehicles driven by independent contractors would be replaced by newer trucks.
The end result for the bigger companies, though, will be compliance. “Enforcement will prove tricky, but larger carriers will comply nonetheless,” Seidl wrote. He added a somewhat surprising possibility: The Private Attorney Generals Act, which has been seen as a way of enforcing AB5 against trucking companies, might be used by drivers “to dispute AB5 enforcement on behalf of the whole group.”
The bottom-line conclusion for Seidl’s group chat: “Panelists expect some loss of transportation capacity in California and freight moving to other entry points in the country.”