Franchisors Still Wait For Reprieve From AB-5
By James M. Mulcahy and Allard Chu on October 26, 2020
A hotbed of discussion amongst franchisors has been the concern that their franchisees will be employees of the franchisor under California’s Assembly Bill No. 5 (“AB-5”). As AB-5 has a broad scope and reaches into a variety of industries, developments outside of the franchise model may still shine light on how AB-5 may be interpreted. For example, the court opinions on the State’s action against ridesharing companies Uber and Lyft may affect interpretation of AB-5 for the franchise model.
AB-5, which was signed into law in September 2019, expanded on the “ABC test” used in the Dynamex opinion from the California Supreme Court. Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018). Instead of Dynamex placing the initial burden on the independent contractor to prove she is actually an employee, AB-5 shifted the burden to the hiring entity to disprove that the person was an employee.
AB-5 defines the three conditions of the ABC test for classification as an independent contractor as:
- (A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
- (B) The person performs work that is outside the usual course of the hiring entity’s business.
- (C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”
CA Labor Code § 2775
At the time of enactment of AB-5, franchisors and many other industries noted the broad scope of the language and questioned the extent to which their business model would be implicated.
International Franchise Association Concerns
Early on, the International Franchise Association (“IFA”) explained some of the concerns for franchisors in a coalition letter to the California State Legislature. In particular, the IFA was concerned that AB-5 failed to recognize the uniqueness of the franchise model could lead to problems under Prong A (freedom from control and direction) and Prong B (the work is outside the usual course of the hiring entity’s business) of the ABC test. Franchisees should meet Prong C as they are customarily engaged in their franchise business. Due to the concerns over Prong A and Prong B, the IFA tried to explain why clarification of AB-5 or an exemption for the uniqueness of the franchise model
Under Prong A, which required freedom from control and direction, the IFA noted concerns that a franchisor necessarily exerts some degree of control over the operations and business practices of its franchises. In franchising, the franchisor provides the brand name and a common marketing scheme to the franchisee. The franchisee is given the opportunity to build and develop her own business, but the business is inherently tied to the marketing scheme of the franchisor. In fact, a business is not a franchise according to the California Department of Financial Protection and Innovation without this control or direction. However, it is unclear what the threshold level of control is for application of AB-5.
At the same time, Prong B is a concern as it requires that the work be outside the main business of the hiring entity. The question then becomes what the franchisor’s business is and whether the franchisor and the franchisee are in the same business. It is arguable that a franchisor who only sells franchises operates in a separate industry from the franchisee who implements the marketing and sells products or services to consumers. However, this argument may be implicated by the appellate court’s opinion in the Uber case, as discussed below. The situation becomes much more problematic where the franchisor owns its own company stores alongside their franchisees.
Franchisors Attempt to Seek a Carve Out in AB-2257 But Miss the Boat
Indeed, the concerns with AB-5 led to lobbying efforts by a number of industries for exemptions. Franchisors were one such group seeking clarity that AB-5 would not apply to them.
These efforts across many industries led to the introduction of Assembly Bill No. 2257 (“AB-2257”) in February 2020. AB-2257 maintained the core ABC test from Dynamex and AB-5, but specifically identified industries and professions exempt from the ABC test. Those specifically identified included referral agencies, travel agents, graphic designers, photographers, and digital content aggregators among many others. As the bill worked its way through the Senate and Assembly, franchisors repeatedly lobbied to get an express exemption for the franchise model.
Unfortunately, after six amendments, AB-2257 was approved and chaptered last month without inclusion of the franchise model. Consequently, franchisors continue to remain in limbo as to the extent that AB-5 is applicable to franchises.
Did the Uber appeal actually implicate franchises?
In the background throughout all of this, a seemingly unrelated application of AB-5 may as yet impact its application to franchises. Following enactment of AB-5, the California Attorney General filed suit against ridesharing companies Uber and Lyft for misclassification of its drivers as independent contractors. After the trial court found against the ridesharing companies, the appellate court affirmed against the ridesharing companies just last week, on October 22, 2020.
Although the ridesharing companies are not franchises, some of the arguments may implicate franchising. As part of their arguments against the applicability of AB-5, Uber argued that its business was in a separate and distinct industry than its drivers. To that end, Uber argued that it was a technology company rather than a transportation company. It contended that it serves as an intermediary company connecting drivers and passengers. However, the appellate court affirmed that Uber was in the business of transportation rather than merely technology as its revenue was derived from the drivers transporting passengers.
To that end, there is a resemblance to the potential argument that franchisors are not in the same business as their franchisees because the franchisor solely provides the technology and means for the franchisees to operate. The appellate court’s opinion would seem to heighten the risk of franchisors being subject to AB-5, even if the franchisor did not own any company stores. In this way, the seemingly unrelated Uber opinion may have relevance to how AB-5 does or does not apply to the franchise model.
Unfortunately, recent developments surrounding AB-5 seem to leave just as many questions as they do answers. With the lack of clarity, AB-5 certainly still poses a potential existential threat for the franchise model in California. For now, although not specific to AB-5, franchisors can at least be glad that some caselaw has held that franchisors in the restaurant industry did not exert the necessary control for a joint employer relationship for their franchisees’ employees. See Salazar et al. v. McDonald’s Corp., et al., 944 F.3d 1024 (9th Cir. Oct. 1, 2019) (affirming that McDonald’s was not an employer because it did not “retain ‘a general right of control’ over ‘day-to-day aspects’ of work at the franchises.”). Maybe a similar line of reasoning will aid in arguing that franchisors similarly lack the requisite control of franchisees under AB-5. As AB-2257 has already carved out protection from AB-5 without an exemption for franchises though, franchisors may be left in limbo without additional clarification for the foreseeable future.
This article was prepared by James M. Mulcahy (email@example.com) and Allard Chu (firstname.lastname@example.org) of the Orange County, California law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation firm that provides legal services to franchisors, manufacturers and other companies in the areas of franchise, trademark, trade secret, unfair competition, and distribution laws.
Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.