Twelve conditions, all of them. Labor Code section 2776 lets a California business escape the ABC test when it hires another business, like a sole proprietor or an LLC, and have the relationship judged under the more flexible Borello standard. The catch is that the hiring business has to prove every one of the statute’s twelve criteria, from a written contract to the provider’s own advertising. Missing one sends the case back to the ABC test, which many contractor relationships can’t pass.
What does section 2776 do?
It changes the test, not the outcome. Labor Code section 2776 begins: “Section 2775 and the holding in Dynamex do not apply to a bona fide business-to-business contracting relationship.” Section 2775 is the codified ABC test, which presumes a worker is an employee unless the hiring entity proves all three prongs.
When the exemption applies, the statute says employee or contractor status “shall be governed by Borello, if the contracting business demonstrates that all of the following criteria are satisfied.” Borello is the multi-factor test California used before Dynamex, focused on the right to control the work plus a list of secondary factors. A relationship can qualify for the exemption and still be found to be employment under Borello, so the exemption is a better field to play on, not a win.
The firm’s post on the ABC test for independent contractors covers what happens when no exemption applies.
Who counts as a business service provider?
An individual acting as a sole proprietor, or an entity formed as a partnership, LLC, LLP, or corporation. Under subdivision (a), that provider must contract “to provide services to another such business or to a public agency or quasi-public corporation.”
Forming an LLC doesn’t settle anything by itself. Plaintiffs’ lawyers routinely argue that an entity formed at the hiring company’s request, with one client and no independent operations, is a label and not a business. The twelve criteria are how the statute tests whether the business is real.
What are the twelve criteria?
Control comes first. The hiring business must show that the 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.” The last four words do the most damage in litigation. A contract that disclaims control won’t help if the hiring company’s managers schedule, supervise, and evaluate the work. Courts look at what happened day to day, so emails assigning tasks or setting deadlines can matter more than the contract language.
Under the second criterion, the provider must be “providing services directly to the contracting business rather than to customers of the contracting business,” with a limited exception for providers whose employees perform the work under the provider’s own name. That requirement knocks out many relationships at the outset, since a contractor who serves the hiring company’s customers usually can’t qualify.
The independence criteria require a separate business location, which can be the provider’s home, a business “customarily engaged in an independently established business of the same nature as that involved in the work performed,” and the freedom to serve other clients “without restrictions from the hiring entity.” The statute also requires that the provider “advertises and holds itself out to the public as available to provide the same or similar services,” negotiates its own rates, and, consistent with the work, sets its own hours and location.
The paperwork criteria are the easiest to fix in advance. The contract must be “in writing and specifies the payment amount, including any applicable rate of pay, for services to be performed, as well as the due date of payment.” The provider must have any business license or tax registration the local jurisdiction requires. And the work can’t be the kind that requires a license from the Contractors State License Board.
| Criterion group | What the hiring business must show | Where cases usually break down |
|---|---|---|
| Control | Free from control under the contract and in fact | Managers supervising daily work despite the contract |
| Direct services | Services go to the hiring business, not its customers | Contractor deals with the hiring company’s clients |
| Independence | Separate location, established business, other clients, advertising, own rates and hours | Single-client providers with no public presence |
| Paperwork | Written contract with rate and due date, required license, no CSLB-licensed work | Missing contract terms or local business license |
Does the exemption cover the provider’s own workers?
No. Subdivision (b) says that when two bona fide businesses contract under these conditions, whether an individual worker who isn’t a sole proprietor or entity is an employee “of the business service provider or contracting business is governed by Section 2775.” In other words, the ABC test still applies to the people the provider sends to do the work.
That matters for joint employment and wage claims. If the provider misclassifies its own workers, those workers may try to reach the hiring company too. Subdivision (c) adds that the section “does not alter or supersede any existing rights under Section 2810.3,” the statute that makes some client employers share liability for labor contractors’ wage violations. Section 2810.3 can apply even when the business-to-business exemption holds, so a hiring company that uses a provider’s workers inside its own operations should look at both statutes.
How do employers defend a misclassification case under section 2776?
By proving each criterion with documents, and by preparing for the Borello fight after that. The burden is on the contracting business, so the defense file should show the written contract, the provider’s business license, its website or other advertising, its other clients, and how rates were negotiated. Testimony from the provider about running a real business is useful, but documents created before the dispute carry more weight.
Then comes Borello. Even with the exemption in place, a plaintiff can argue that the right to control and the secondary factors point to employment. The same evidence of independence usually helps there too, which is why building the record for both tests at once is efficient. Employers should also be candid about the risk. Relationships with a single long-term individual, doing core work under close supervision, are hard to defend under either test.
When a contractor says they were really an employee
- Put the contract, invoices, payment records, emails and texts with the provider, and any onboarding materials under a litigation hold.
- Calendar the deadline on the demand, Labor Commissioner claim, PAGA notice, or summons, and check the contract for an arbitration clause and the EPLI policy for coverage of misclassification claims.
- Identify the managers who worked with the provider, and don’t change the relationship or cut off work in a way that could look like retaliation.
- Gather proof for each criterion: business license, advertising, other clients, rate negotiations, and the location where the work was done.
- Bring in counsel before responding, revising the contract, or offering to settle.
Misclassification claims often come with wage, penalty, and PAGA allegations attached. The firm’s page for California employment defense lawyers describes how those cases are defended.
Business-to-business exemption questions
Does the contractor need to be an LLC or corporation?
No. A sole proprietor can qualify as a business service provider. Entity status helps show a real business, but it isn’t required, and it isn’t enough. What the statute tests is whether the provider meets all twelve criteria, including independence from the hiring company and a presence in the market beyond that one client.
What if one of the twelve criteria is missing?
Then the exemption doesn’t apply, and the relationship is judged under the ABC test in section 2775 unless another exemption fits. The statute requires the contracting business to show that “all” the criteria are satisfied. That’s why the paperwork criteria, like the written contract terms and the business license, should be fixed before work starts, when it’s easy.
Can we use the exemption for a contractor who works from our office?
It’s difficult. The provider has to maintain a business location separate from the hiring business’s work location, though the provider’s residence can count. Occasional on-site work may be consistent with the nature of the job, but a contractor who works from the hiring company’s office every day will struggle to meet the separate-location and set-your-own-location criteria.
Does this exemption apply to construction subcontractors?
Not if the work requires a Contractors State License Board license. The twelfth criterion excludes that work. Construction relationships have their own exemption in the Labor Code, with different conditions, and should be analyzed separately. Using the business-to-business exemption for licensed construction work is a common mistake.
If a contractor’s claim has landed on your desk
If your company has received a demand, PAGA notice, or lawsuit claiming a business contractor was really an employee, the contract and the provider’s own business records usually decide whether the exemption holds. Rosenberger + Kawabata represents employers defending employment lawsuits and claims through its business litigation practice, including claims involving independent contractor misclassification. Contact Rosenberger + Kawabata online for a confidential consultation, or call (310) 894-6921.
Sources
The statutes are Labor Code section 2775, Labor Code section 2810.3, and Labor Code section 2776, added by Stats. 2020, ch. 38 (AB 2257), effective September 4, 2020.
This post is general information about California and federal employment law as of November 7, 2026. It is not legal advice, and reading it does not create an attorney-client relationship. Employment statutes, regulations, and court decisions change often, and the outcome of any claim depends on its facts. Past results do not guarantee future outcomes.