(Reuters) – Drivers working for ride-hailing services such as Uber Technologies Inc and Lyft Inc will be considered employees under California’s new gig worker law, the state’s leading industry regulator said on Thursday.

Shares in Uber and Lyft fell 5.3% and 4.2%, respectively, in early trading, with the new order striking at the heart of the “gig economy” business model of technology platforms like Uber and Lyft that rely on cheaper contract workers.

The decision, by the California Public Utilities Commission (CPUC), which regulates ride-hailing companies across the state, comes six months after a state law took effect that makes it tougher for companies to classify workers as contractors rather than employees. The latter designation exempts them from paying for overtime, healthcare and workers’ compensation.

The CPUC in an order on Thursday said it had to enforce state law, determining that drivers for transportation network companies (TNCs), the industry term for ride-hailing operators, would be considered employees going forward.

“For now, TNC drivers are presumed to be employees and the Commission must ensure that TNCs comply with those requirements that are applicable to the employees of an entity subject to the Commission’s jurisdiction,” the commission said in the document here

The companies have said in the past their drivers were properly classified as independent contractors, adding that the majority of them would not want to be considered employees, cherishing the flexibility of on-demand work.

“If California regulators force rideshare companies to change their business model it would affect our ability to provide reliable and affordable services, along with threatening access to this essential work Californians depend on,” Uber said in a statement.

Uber in December sued to block the new law, known as AB5, arguing that it punished app-based companies and was unconstitutional.

Lyft in a statement called the CPUC’s decision “flawed” and said forcing drivers to be employees will have horrible economic consequences for California.

Both companies pointed to a November ballot initiative exempting them from the law, for which they, together with food delivery platform DoorDash, have earmarked $90 million. Under the companies’ proposal, drivers would receive mileage-based subsidies, healthcare stipends and occupational accident insurance, while maintaining their flexibility as contractors.

Labor unions have sharply criticized the proposal for creating a “new underclass of workers” that lack fundamental protections such as sick pay and unemployment insurance.

California in early May filed its own lawsuit against Uber and Lyft, arguing the companies misclassified their drivers in violation of the new law.

*by Akanksha Rana and Tina Bellon via Reuters*