The Potential Implications Of AB-5 On Franchising Due To Uber & Lyft
By James M. Mulcahy and Allard Chu on November 12, 2020
Although California Assembly Bill No. 5 (“AB-5”) and its ABC test were intended to provide protections for gig economy workers, its scope was more a shotgun than a rifle shot. Initially, AB-5’s coverage was far and wide. But with the passage of both Assembly Bill No. 2257 (“AB-2257”) and Proposition 22 (“Prop 22”), a large number of industries have gotten exemptions from AB-5. Even ridesharing and app-based delivery companies—the original targets of AB-5—ended up getting exemptions through Prop 22. Franchisors, on the other hand, have not been able to garner an exemption.
As of yet, there has not been a finding that franchises are necessarily subject to the ABC test. However, there are numerous concerns from franchisors regarding the language of the ABC test. The IFA has recently filed suit seeking a judicial declaration that the ABC test does not apply to the franchise model. Ideally, this suit will resolve the question once and for all as to whether the franchise model is itself at risk in California. If this suit is ultimately unsuccessful, it appears that the best approach for franchisors in California will be to proactively seek a legislative exemption from AB-5. Notably, 21 other states have already enacted legislation to exempt franchising from employment laws.
Preemption Of The Application of The ABC Test
There is a strong argument that the franchising model should not be subject to AB-5 because the California Franchise Investment Law (“CFIL”) contemplates a license for a franchisee to operate a business and, at the same time, for the franchisor to exercise some control over the way the business is operated. AB-5 imposes an employment relationship if a putative employer exercises control. As a result, AB-5 arguably eliminates the distribution model that the CFIL creates, simply by operation of law.
Based on an argument of preemption by the FTC Franchise Rule and the Lanham Act, the International Franchise Association (“IFA”) and a collection of franchisee associations recently filed suit for declaratory relief and injunctive relief.
The IFA argues that the Lanham Act mandates trademark licensors to maintain control over the use of their trademarks. Moreover, it argues that the FTC Franchise Rule recognizes that the relationship between a franchisor and a franchisee is inherently a commercial relationship, and not an employment relationship. The franchise model is inherently about the franchisee “obtain[ing] the right to operate a business that is identified or associated with the franchisor’s trademark . . . .” 16 C.F.R. § 436.1(h)(1). The IFA argues that ABC test from AB-5 is inherently irreconcilable with the federal laws on this as it necessarily converts the franchise model from a commercial relationship to an employment relationship, negating the benefits of franchising.
It will be interesting to see how the State responds to this lawsuit, and whether it responds on the merits of whether AB-5 is applicable to the franchise model. As there has been no action against a franchise model business yet, the State might try to avoid addressing the issue by arguing that there is a lack of standing or that there is no violation or issue ripe for judicial determination.
This lawsuit will hopefully bring some resolution or insight into how the State views the franchise model in light of AB-5 and the ABC test from Dynamex.
Can A Franchisor Be In A Different Industry If It Does Not Own Company Stores?
Still, if a lawsuit were to involve a franchise, the appellate court’s opinion in The People v. Uber Technologies, Inc. et al., Nos. A160701, A160706 (Cal. Ct. App. 2020) (Uber) may shed some light on how AB-5 may be applied.
Of concern to franchisors, the Uber court’s rejection of the argument that rideshare companies are technology company rather than transportation companies appears relevant to an argument from franchisors relating to Prong B of AB-5’s ABC test. As part of the three prongs of the ABC test from AB-5, Prong B requires that the purported employee perform work that it outside the usual course of the hiring entity’s business. Previously, there has been thought that that a franchisor that only sells franchises might operate in a separate industry from the franchisee who implements the marketing and sells products or services to consumers.
To evaluate Uber’s argument, the court looked to Curry v. Equilon Enterprises, 23 CalApp.5th 289 (2018), which determined whether a manager at a service station was jointly employed by a service station operator and Shell Oil Products US. Shell leased the service station to the operator and received all revenue from fuel sales while the operator operated the station and received the profits from the attached convenience store and carwash. The Curry court held that Shell was not in the business of operating fueling stations, but rather the business of owning real estate and fuel.
The Uber court noted that rideshare was distinct from service stations because Uber does not simply lease facilities to an employer without any involvement in employment or compensation decisions. Instead, the court noted that the ridesharing companies were involved in the “day-to-day task of matching riders and drivers each time a user requests a ride, arranging for rider’s payments to be processed, and retaining a portion of the proceeds from each ride.” Uber, slip op. at 39.
Franchisors may similarly argue that they are in a different business. But it will likely be an uphill battle. Franchisors could argue that they are simply providing a franchise system to franchisees and then leaving the ultimate decision making on how to run a business to the franchisees. Franchisors can argue that they do not make any employment decisions for the franchisee. To that extent, franchisors are distinct from their franchisees.
However, franchisors are vulnerable as the common marketing scheme necessarily affects the day-to-day operations of the franchisee and is a sign that it is in the same business. Separately, at least in relation to janitorial franchises, other courts have stated that franchising in and of itself is not a business. See Awuah v. Coverall N. Am., Inc., 707 F. Supp. 2d 80, 81 (D. Mass. 2010).
Consequently, it may be difficult for a franchisor to persuade the court that it operates in a different business than its franchisees. Even if tenable, such an argument would likely be highly dependent on the facts surrounding how the franchise system operates.
A Tangential Mention Of Franchising
As an aside, although the Uber court does not address franchising, there is a tangential use of the term “franchising” in its discussion of Ruggiero v. American United Life Ins. Co., 137 F.Supp.3d 104 (D.Mass. 2015). Uber, slip op. at 36. In evaluating the differences between employees and independent contractors, the court quoted language from Ruggiero on a dichotomy between the two: (1) “cases in which the defendants equip the plaintiffs with the tools, resources, and opportunity to sell or provide the defendants’ products, often earning a commission or percentage of the sales, and essentially franchising their business” and (2) “cases in which the defendants merely give the plaintiffs a license or a product and leave the plaintiffs to their own devices to make a profit from it.”
In evaluating the dichotomy, the Uber court found that rideshare was more likely to fall in the former category and would “thus be considered an employer.” Uber, slip op. at 37. In doing so, the Uber court seemed to conflated employers and franchising. However, as the cases did not actually relate to franchising and only used it as a comparative, this conflation seems more an issue of writing style than dicta for the franchise model.
Still, in light of the dichotomic approach to employees and independent contractors, there is real concern that franchising will be lumped in with employees despite its unique business structure.
Ideally, the IFA’s lawsuit will provide a clear statement from the State as to whether the ABC test of AB-5 implicates the franchise model. Separate and apart from the IFA’s lawsuit, the clearest approach to ensure safe harbor from AB-5 will likely be a legislative exemption for franchising, as we have seen with other industries and AB-2257. Alternatively, the franchising community may attempt a ballot initiative similar to Prop 22 for an exemption approved by the voters. Although the Uber court did not relate to franchising, the court’s rationale does not seem favorable to franchisors escaping liability under AB-5 on the basis of attacking the ABC test.
This article was prepared by James M. Mulcahy (email@example.com) and Allard Chu (firstname.lastname@example.org) of the Irvine law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation and regulatory 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.