United States: Recent Decisions Are Eroding The Economic Bedrock Of The Economy

Last Updated: October 21 2016
Article by Craig R. Tractenberg

Craig R. Tractenberg authored The Legal Intelligencer article, "Recent Decisions Are Eroding the Economic Bedrock of the Economy."

According to U.S. Court of Appeals for the Third Circuit decisions, franchising is an economic "bedrock of the American economy," and recent class action labor law decisions are eroding that bedrock. This is an opinion shared by many franchise professionals and a growing number of jurists. The ­dissenting opinion of Third Circuit Judge Robert E. Cowen in Williams v. Jani-King of Philadelphia, Inc. (3d. Cir. 2016), argues the essential question in these labor cases is "whether 'franchise-system controls" make a franchisor the employer of its franchisees ... ." Cowen criticizes the court using "the very thing that defines franchising—the 'uniformity of product and control of its quality and distribution'"—to be used to put at risk this critical and generally beneficial sector of our economy."

The issue in Jani-King is whether those people who signed franchise agreements and were given franchise disclosure documents after making an investment in their own business are properly classified as employees or independent contractors. The courts generally look at the controls ­imposed by the franchisor, and if the controls are too rigid, then some courts conclude that the controls similar to that of employment and conclude the franchisor is an employer. With that conclusion, franchisors are then liable for withholding taxes, unemployment, workmen's compensation obligations, among other obligations of an employer. Although the circuit court did not address the merits of the case, only class certification, the concept that trademark and brand controls suddenly can result in morphing a business investment into an employment relationship is entirely contrary to the purpose of the FTC rule governing disclosures in connection with the offer and sale of franchises.

But Jani-King is not an isolated case. In Ochoa v. McDonald's, the U.S. District Court for the Northern District of California recently certified a class of more than 800 current and former employees of a McDonald's franchisee in the San Francisco Bay Area to pursue wage, overtime and maintenance of uniform claims against the franchisor, McDonald's USA LLC and its parent corporation, McDonald's Corp. Although the court had previously entered summary judgment in favor of McDonald's and against the plaintiffs on claims that McDonald's was directly liable as a joint employer with the franchisee, the court held that there were issues of fact regarding whether McDonald's might be indirectly liable as a joint employer if the franchisee was the ostensible agent of McDonald's. In other words, a court could find joint employment if the employees were cloaked with such authority that they believed they were employees. Even though the court recognized that ostensible agency requires reasonable belief and reliance, the court nevertheless refused to acknowledge that subjective belief of the employees ­constituted such individualized issues such that class treatment was improper. The court overcame this barrier to class treatment by holding that the ­franchisor's common course of conduct—namely ­uniformity ­inherent in the franchise system regarding brand, product and trademark controls.

The danger of these decisions is the failure to distinguish controls necessary to preserve a brand from controls over the workers. The cases effectively hold that class litigation against franchisors by franchisees and the workers of ­franchisees are proper because the franchisor has controls over the feel and look of the place of business, while asserting no control over the ­working conditions, pay, scheduling or other personnel decisions of the workers. Franchising has been giving opportunities to realize the American dream for decades. Only recently have courts concluded that franchisors deserve a nightmare of suddenly being an employer for hundreds of employees of their ­franchisees, or even the franchisees themselves who had lawyers and other professionals parse and negotiate their ­franchise documents in accordance with the FTC Act requiring ­pre-sale ­disclosure and state law registration of business opportunities or investments.

Various theories exist why decades of successful franchising is now being attacked. Different pressures are being exerted by several actors. Academics and others argue that franchising is not a level playing field where the ­franchisee has as much rights as the franchisor, and so the playing field needs to be changed. Another argument is that workers in franchisee-owned businesses cannot effectively bargain without the franchisor's involvement, so that involving the franchisor in collective bargaining will be beneficial to all concerned. In other words, without McDonald's at the table, the food workers cannot unite to unionize the 
labor force.

Until the courts, and perhaps the legislatures sort this out, franchisors can be ­proactive by making changes in their ­systems. Consider adding provisions to franchise agreements and operating manuals suggesting that franchisees have their employees sign a statement ­acknowledging that they are not employees of the ­franchisor. The statements should also affirmatively state the name of the employer and that the employer is an independent franchisee. Such a signed statement may act as an estoppel against claims that the franchisor is the employer. Franchisors should continue to require their franchisees to prominently display signs that "This location is independently owned and operated by _______, a franchisee."

Attacks asserting joint employment and vicarious liability will continue to plague the franchise industry without creating any value for the claimants or the consumer. Eventually, under the weight of well-reasoned judicial decisions, legislative correction and the political process, these issue will resolve themselves. We hope for the benefit of the industry, it is resolved sooner or later. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Craig R. Tractenberg
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