Definition of Franchise Relationship Questioned

There is a brewing legal storm within the franchise community about whether franchisees should be classified as independent contractors or employees of the franchisor, and if the latter …

There is a brewing legal storm within the franchise community about whether franchisees should be classified as independent contractors or employees of the franchisor, and if the latter definition prevails it could mean serious consequences for franchisors across the nation. Franchisees that are classified as employees are then entitled to certain rights, protections and remedies, including a refund of all fees paid to the franchisor. A host of conflicting court rulings has issued from the debate, which serves to validate the fact that the definition is in the process of change and franchisors should be prepared. For more on this continue reading the following article from Blue MauMau.

For decades many franchisees have purchased their businesses on franchisors’ premise of “be your own boss,” suggesting that an independent businessperson can control his destiny better than working for someone else.  But critics argue that is a fallacy. In reality, franchise owners are merely leasing a business from a company for a period of time. It is when franchisors over  control the business operations of a licensee that the question then becomes what is the true role of the franchisor.

Based on that history, it should come as no surprise that one of the biggest challenges franchisors are facing today in courtrooms across the country is proving to judges and juries that their franchisees are not in reality employees of the franchisor.

Last month’s American Bar Association Forum on Franchising tackled that hot issue in a session titled “Independent Contractor or Employee? Minimizing Exposure from the Gray Areas of the Franchise Relationship.” With recent court decisions involving Coverall, Jani-King and even Subway in a workers compensation ruling, forum presenters examined just how serious the problem is and what satisfactory solutions are being suggested to correct the alarming problem. 

Although the extent of the control a franchisor exerts over its franchisees is not the only element in courts determining if a franchisor is truly an employer, it is one that is especially troubling. Forum presenters do acknowledge the franchisors’ dilemma in having to exert control of a licensee in order to protect the trademarks and the manner in which franchisees provide goods and services. “A critical component of the success of franchising is uniformity, and that cannot be achieved without establishing standards and enforcing them,” they explained.

Coverall not a one-off decision

Labor/employment attorney Patricia Costello Slovak of Schiff Hardin entered the fray in the forum presentation.  Referring to the 2010 decision of a federal judge in Boston, who ruled that franchisees of Coverall janitorial services were actually employees pursuant to Massachusetts law, Ms Slovak spoke frankly. “Coverall is not a one-off decision destined to be a football in history,” she asserted.

Since that decision, there have been court rulings, state and federal, applying different laws and reaching different conclusions than the infamous Awuah v Coverall decision. Another judge in the same district has also held that franchisees of Jani-King must also be treated as employees pursuant to Massachusetts law. Two courts, applying different state law, one in California and the another in Kentucky, have also reached different conclusions than the Massachusetts courts regarding the status of franchisees, respectively, of Jani-King and Subway.

Nevertheless, there is now “blood in the water,” Slovak and co-presenters John Dienelt of Quarles & Brady and franchisee trial attorney Michael Garner explained in their paper. New cases are being filed by franchisee and employment advocates, alleging their clients are really employees of their franchisor, not independent contractors. These franchisees are entitled to new remedies beyond those normally available in franchise disputes.

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Slovak also cautioned that the Coverall decision was not too different from the exempt/non-exempt fight employment attorneys deal with all the time. “Signing an employment contract that says yes, I am an independent contractor doesn’t necessarily define the relationship.” It is not uncommon for the status of an individual performing services to be questioned. “The analysis is fact specific, based on how the relationship actually works, not only what the parties may have committed to on paper.”  

Slovak said the government has the right to judge if an employee is exempt because it knows it can lose billions of dollars in taxes when non-exempt employees are misclassified.   

Misclassification’s devastating consequences

Forum presenters warn, “If a franchisor’s franchisees are found to have been misclassified as independent contractors, the franchisor faces a panoply of consequences on both the franchise side and the employment side.” Although the consequences will differ by state, generally, on the franchise side, there are disclosure and registration issues; breach of contract issues; and collateral issues as well.

The most striking, and potentially devastating consequence of misclassification of employees as franchisees is the remedy: repayment of all fees paid by the franchisee to the franchisor. There are a number of both common law and statutory grounds on which this remedy can be predicated.

On the franchise side, there are issues of disclosure and registration, breach of contract, as well as collateral. In Awuah v Coverall the Supreme Judicial Court ruled that franchise fees were “special contracts” that required the employee to “purchase the job from the employer” and that were contrary to public policy. Initial and future fees were subject to being refunded. The forum attorneys state, “This conclusion can potentially bankrupt the franchisor. . .”

Another disturbing aspect is that with franchise misclassification cases becoming more numerous and receiving wide attention there is potential viability of fraud or negligent misrepresentation. The forum attorneys acknowledged the difficulties in proving in the face of evidence that the franchisor “knowingly deceived the franchisee into ‘buying a job’ instead of ‘buying a franchise.’” 

In claiming damages, the wronged party is entitled to recover the value of what it bargained for. In industries such as janitorial services where franchisees buy a level of monthly income, the calculation of the benefit is fairly straight forward. If a franchisee bought a franchise that was to give him $10,000 worth of income for a period of 10 years, he would be entitled to that income stream, less expenses. 

Employment consequences can be even more devastating. The most obvious are the reimbursement of minimum wages at $7.25 per hour or higher depending on the state, and overtime pay at time and a half. Other reimbursements allowed are employment tax, including withholding (income tax, FICA, FUTA, and others), unemployment benefits, workers compensation, health insurance and employment discrimination.

It also includes failure to indemnify employees for expenses; unlawful deductions from wages, violations of laws against requiring an employee to purchase goods from the employer, and labor law violations.

Wake-up call: Attorneys must better define “franchise relationship”

Franchise law is relatively young and is still being established, the forum states.  While courts have tried to resolve disputes arising out of the franchise relationship, a game of legal charades has gone on mainly on disputes of vicarious liability and covenants not to compete.

The presenters explain, “An issue in franchising ‘sounds like’ an issue the courts have dealt with in another context, so the courts, by analogy, have applied principles developed elsewhere to franchising.” But now employment law principles regarding joint employers (franchisor and franchisee) and whether franchisees are employees, not independent contractors, have been applied by the courts.

Forum speakers issued a wake up call to attorneys and their clients. “Efforts should begin in earnest to define the franchise relationship in a comprehensive way so that it will be treated as a bona-fide independent contractor relationship.” In doing so, franchise law would then have its own definitions and rules, just as employment law does.

The ABA presenters cautioned that franchising is designed to provide a business opportunity to franchisees that is different from employment opportunities. It is reasonably safe to say that there is nothing inherent in the definition of a franchise that makes it more or less susceptible of being an employment relationship. However, the attorneys questioned whether in some cases in structuring the relationship franchisors crossed a line that puts them into the category of employer.

The attorneys asked, does there need to be state and federal legislation, as Georgia recently enacted to more clearly define the franchise relationship? Or should the most-vulnerable franchisors, such as the janitorial cleaning service companies, abandon franchising in order to stop drawing attention to other sectors? 

Presenters concluded, “That is not a happy solution for the future of franchising and the opportunities it provides for individual entrepreneurship.”

This article was republished with permission from Blue MauMau.


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