Franchisees Seeking Minimum Wage, Overtime Pay ...

Franchisors Wince as Some Courts Re-Label Franchisees as Employees

By James M. Mulcahy on July 22, 2013

Employee misclassification is a potential issue lurking in all industries.

The franchise community was re-cently shaken up following a series of court decisions that relabeled franchisees as "employees" of the franchisor. Jani-King and Coverall North America, two of the largest com-mercial cleaning franchisors, have been defending themselves from labor law claims brought by franchisees seeking minimum wage, overtime pay, and other employment-related benefits.

In March 2010, a federal district court judge in Massachusetts ruled that Coverall franchisees were employees, irrespective of the "independent contractor" classification in the parties' contracts. More recently, on June 8, 2012, the Massachusetts District Court granted summary judgment in favor of a class of Jani-King fran-chisees, finding that the franchisees were employees of Jani-King.

The Massachusetts litigation has led to similar employee misclassification lawsuit filings across the country. Franchisors operating in California can breathe a sigh of relief after the California District Court in Juarez v. Jam-King granted sum-mary judgment in favor of Jani-King, finding that the franchi-sor did not exercise sufficient control over the plaintiff fran-chisees to render them employees. Franchisors also obtained favorable results in the states of Minnesota and Kentucky.

While California may serve as a safe harbor for franchi-sors from employee misclassification liability, plaintiffs' at-torneys in California are still capitalizing on the court's con-fusion over the franchisor/franchisee relationship to attack franchisors. Since 1992, franchisors operating in California have relied on the protections of the California Appellate Court's ruling in Cislaw v. Southland Corp. It held that fran-chisees are deemed agents only if "the franchisor exercises complete or substantial control over the franchisee."

But recent court decisions appear to be eroding the Cislaw stan-dard. Earlier this year, in the case of Patterson v. Domino's Pizza, LLC, an employee of a Domino's Pizza franchisee named Domi-no's Pizza as a defendant in her lawsuit alleging sexual harassment by another employee of the franchisee. Consistent with Cislaw, the trial court found that the franchisee was an independent contrac-tor, and that the franchisee's employee was "not an employee or agent of ... Domino's for purposes of imposing vicarious liabil-ity," and granted summary judgment in favor of Domino's Pizza.

But on June 27, 2012, the California Court of Appeals, surprisingly, reversed and remanded the case back to the trial court for a jury trial on the sexual harassment claims against Domino's Pizza.

Round Table Pizza is another large pizza restaurant fran-chisor that operates in the western United States. Ted Storey, Gen-eral Counsel and Vice President, Business Development, for Round Table Pizza, was recently questioned about the effect the Domino's Pizza case may have on the franchising industry. According to Mr. Storey, "[w]e are occasionally included as a co-defendant in law-suits against our franchisees in either slip and fall or employment cases. We usually have no trouble getting out of these cases by relying upon the decision in Cislaw to persuade plaintiff's attorney to dismiss us from the case or through summary judgment. But the [Domino's Pizza] case has caused me concern because, at least on its face, it appears to erode the Cislaw decision."

Applying an analysis similar to that in the Domino's Pizza case, on July 31, 2012, the California Court of Appeals found that restaurant franchisor Denny's could be held liable for injuries to a patron of one of its franchisee's restaurants on an agency theory. In Terrelle Ford v. Palmden Rests., the plaintiff brought a negligence action against Denny's and its franchisee after being attacked by members of a street gang who were known to frequent the restaurant. The lower court granted summary judgment in favor of Denny's, finding that it could not be held liable for the franchisee's acts or omissions with respect to instituting appropriate security measures at the restaurant because the franchisee was not its agent. The California Court of Appeal reversed.

In its ruling, the appellate court found that the plain-tiff alleged facts sufficient to show that the franchisee was Denny's "ostensible agent." In a losing effort, Denny's argued that "if the law ultimately holds franchisors routinely liable for the wrongful acts of its franchisees and their em-ployees, franchisors will either quit franchising or, at the very least, charge much higher fees.”

The Domino's Pizza and Denny's opinions have served as catalysts for plaintiffs' attorneys to assert agency claims against franchisors previously re-jected by Cislaw. For example, in May of this year, a former employee of a Jack In The Box franchisee filed a lawsuit asserting a panoply of claims arising out of the alleged sexual harassment by one of the franchisee's employees. As in the Domino's Pizza case, the plaintiff included the franchisor as a defen-dant, alleging that the franchisee is, in this case, the agent of Jack In The Box. This case is currently pending before the California Superior Court.

On October 10, 2012, the California Supreme Court agreed to review the Appellate Court's deci-sion in the Domino's Pizza case on the lone issue of whether Domino's Pizza is entitled to summary judgment on plaintiff's claim that Domino's Pizza is vicariously liable for tortious conduct by a su-pervising employee of a franchisee. The California Supreme Court's ruling and analysis will hope-fully provide much needed guidance for the lower courts on the issues of agency and franchising.

How can franchisors avoid liability from their "independent contractor"?

Sandra Trenda, Chief Legal Officer for Great Clips, notes there is "cause for alarm any time courts start to blur the distinction between employee and franchisee." She says that Great Clips, which has more than 3,000 franchise locations, takes action to clarify its position as the franchisor and not employer. "We have to keep these boundaries clear," she says.

In addition to taking affirmative steps to keep the franchisor/employer boundaries clear, franchisors must also spend the time educating the courts on the business of franchising. As Storey, the Round Table Pizza GC and vice president, puts it, "[w]hat I am reminded of when I read the [Domino's Pizza] and Jani-King cases is something that we have all contended with for years in the franchising field — educating the courts on how franchising works.

"We really have to make concerted and focused efforts to educate courts one way or an-other on how franchising works," Storey says. "When you have courts in Massachusetts citing to Jani-King's website to show that Jani-King is in the business of cleaning offices, it makes you question the court's knowledge of franchising.”

In application, however, it may be difficult to keep the boundaries clear when control is an innate part of both franchising and respondeat superior relationships. The Federal Trade Commission distinguishes franchising from mere licensing when the putative franchisor has the "authority to exert a significant degree of con-trol over the franchisee's method of operation.”

Similarly, the distinction between an employee and independent contractor is decided based on the amount of control exerted by the hiring party in the performance of the job. Defining both franchising and employment/agency relationships on the issue of control is conceptually problematic and appears to be difficult for the courts to decipher.

Instead of relying on the courts to make this distinction, those interested in preserving the franchise business model are already addressing this issue with the state legislatures. The state of Georgia has led the way in recognizing the ben-efits of a franchise model, and has recently en-acted legislation to ensure franchise investments are available to its citizens going forward. In April of this year, the Georgia General Assembly unanimously passed House Bill 548, codifying franchisor-franchisee relationships by providing that "individuals who are parties to a franchise agreement shall not be considered employees."

The enactment of House Bill 548 should al-low franchising in Georgia to continue to thrive as a growing economic force in all business sectors. According to Dean Heyl, the Director of State Government Relations for the International Franchise Association, the IFA is diligently work-ing on similar legislation in the states of Dela-ware, Indiana, Massachusetts and Nebraska.

If these misclassification and agency issues can occur in the franchise context - a business model that is defined by the desire to be one's own boss - it can occur in any industry that relies heavily on independent contractors. This includes non-franchised business models, such as quick service gas stations and minimarts, janitorial services, edi-tors, taxicab drivers, commercial trucking, express mail operators, software developers, grocery store sushi chefs, to name a few. In fact, the IFA believes that the court rulings "could bring into question the legitimacy of every business that relies on contrac-tually related firms as sources of revenue."

Until the court and/or legislatures set more defined boundaries for the franchisor and franchisee relationship, we can reasonably expect more lawsuits by aggressive and creative plaintiffs' attorneys as-serting employment and agency theories of liability, coupled with a studied reluctance by trial courts to summarily dismiss these lawsuits prior to trial.

Jim Mulcahy is the founding and manag-ing partner of Mulcahy LLP, a boutique firm specializing in competi-tion litigation, including antitrust, intellectual property, and fran-chise and distribution law. He has more than 30 years of experience, including as general counsel of American Suzuki. A trial lawyer, he has served as a faculty member at the National Institute for Trial Advocacy and for the College of Trial Advocacy.




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