Employer Misclassification/Joint Employer

A fundamental aspect of any franchise system are the relationships between and among the franchisor, the individual franchises, and the franchisees’ workers. Two different but similar legal claims seek to impose additional burdens and obligations on franchisors by attacking the notion that franchisors are not the employers of either their individual franchises or their workforces. First, plaintiffs asserting claims of employment misclassification argue that they are not independent contractors but instead employees entitled to all of the rights and protections flowing from such relationships. In franchising, there has been an uptick in cases where franchisees or government agencies have argued that the individual franchisees are the employees of the franchisor—not independent business owners licensing the trademark and methodology of a franchise system. Second, claimants in joint employment cases argue that the franchises’ workers are the joint employees of both the franchise and the franchisor. Such status would make franchisors liable for the employment practices of their franchises.

This article will discuss two cases which illustrate the typical issues around these claims. Before that, though, some context is important. Challenging the legal rights and obligations within a franchise system and its workforce is a by-product of increased state and federal attention on franchising in general. Unsurprisingly, California has led the way. In September 2019, California passed Assembly Bill 5 which codified the “ABC Test” a plaintiff-friendly regime for employment misclassification claims. Other states like Massachusetts and New Jersey are following suit with their own versions. 

Last year, California struck again and passed the Fast Food Accountability and Standards Recovery Act or the “Fast Recovery Act.” The law establishes a “Fast Food Council” to set industry-wide standards for wages, working hours, and other conditions. The law took effect on January 1 and applies to restaurants with more than 100 locations nationwide. Service Employees International Union President Mary Kay Henry called the law’s passage a “watershed moment.” Some worry that these kinds of regulations will spread to other industries within franchising. 

There has been just as much activity on the federal level. In September 2022, the National Labor Relations Board announced a proposed rule expanding the circumstances in which franchisors and their franchisees can be jointly liable for violations of federal labor law. The proposed rule essentially resurrects an Obama-era standard in which a plaintiff would no longer need to demonstrate a defendant’s “direct and immediate” control over the putative employees. Rather, merely possessing the authority—regardless of whether it is exercised—would be sufficient to create joint employment. 

Then, in March and April, the Federal Trade Commission and the Government Accountability Office respectively weighed in. The FTC issued a press release seeking comment on “franchise agreements and franchisor business practices, including how franchisors may exert control over franchisees and their workers.” The FTC went on to say “the promise of franchise agreements as engines of economic mobility and gainful employment is not being fully realized, and the unequal bargaining power inherent in these contracts is impacting franchisees, workers, and consumers.” The GAO followed with a report that franchisees “do not enjoy the full benefit of the risks they bear.”    

Now, let’s discuss two example cases. In Patel v. 7-Eleven, Inc., 618 F. Supp. 3d 42 (D. Mass. 2022), five 7-Eleven store owners sued claiming 7-Eleven misclassified them as independent contractors in violation of Massachusetts’s independent contractor law. 

The contractual relationship between the parties is that of a typical franchisor-franchisee. The plaintiff franchisees promised to pay 7-Eleven an initial franchise and other fees. In return, 7-Eleven granted the plaintiffs the right to operate 7-Eleven franchised stores. The franchisees also agreed to hold themselves out as independent contractors.

The Independent Contractor Law (ICL) is Massachusetts’s version of the “ABC test”. Like the ABC Test, the ICL presumes an entity is an employer of a worker unless it can establish all of the following:

1. a)  the alleged worker is free from control and direction in connection with the performance of the service, both under his/her contract for the performance of the service and in fact;
2. b)  the service is performed outside the usual course of the business of the alleged employer; and
3. c)  the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the work performed.

7-Eleven argued at summary judgment that the plaintiffs failed to meet prong “A” of the test presented because the plaintiffs did not provide services to 7-Eleven. Instead, 7-Eleven provided services to the plaintiffs through training and other support in return for their payment of fees. The plaintiffs, on the other hand, argued that 7-Eleven imposed requirements upon them including working full time in the store, wearing approved uniforms, and other alleged indicia of an employment relationship.

The Court agreed with 7-Eleven. The plaintiffs provided no services to 7-Eleven, and 7-Eleven did not pay them for anything. Mutual economic interest was not sufficient to establish that the plaintiffs performed services for 7-Eleven. On this basis, the Court granted 7-Eleven summary judgment on the plaintiffs’ claim of violation of the ICL. 

This case represents a significant victory for 7-Eleven and other similarly situated franchisors. Defendant franchisors rightfully view the ABC test (and its corollary state statutes) as a difficult standard to meet in proving the lack of an employment relationship. Nonetheless, cases such as Patel v. 7-Eleven provide a possible path to success for franchisors. 

A recent decision by a Regional Director of the National Labor Relations Board ruled that Google and Cognizant—a vendor that supports Google’s YouTube service—were joint employers of Cognizant’s workers. The NLRB Director found that Google “exercise[d] direct and immediate control over benefits, hours of work, supervision, and direction of work. To a lesser extent, Google also exercise[d] control over unit employees’ wages by setting minimum standards.” Looking at the totality of the circumstances, the Regional Director held that Google and Cognizant were joint employers over the workers.

Google has already issued a request for a review of the decision and focused its argument on the workers’ inability to meet the “substantial, direct, and immediate” standard for joint employment, which is the current standard established under the former President Trump’s board. Google also emphasized that the Regional Director failed to properly apply the stricter “substantial, direct, and immediate” standard currently in place. For example, Google alleges the Regional Director’s decision “fails to embrace the full extent of any subsection of § 103.40(c)” and, instead, “included only piecemeal phrases from each subsection and omitted language that conflicts with his conclusion[s].” 

Franchisors should expect continued pressure from private action plaintiffs and government agencies alike. Accusations of worker misclassification and joint employment are but two ways adversaries of franchising can apply such pressure. 

Peter Loh, partner and vice chair of the Distribution & Franchise Practice Group at Foley & Lardner

Peter Loh is vice chair of the Distribution & Franchise Practice Group, Litigation Practice Group Leader for the South Region (Dallas, Houston, Austin, Jacksonville, Tampa, Miami, Orlando, Tallahassee, México City offices), and a first chair trial lawyer at Foley & Lardner LLP. He represents plaintiffs and defendants in complex commercial litigation disputes throughout the country in the retail, tech, finance, energy, and manufacturing sectors, involving claims of breach of contract, fraud, trade secret misappropriation, tortious interference, and violations of the Computer Fraud and Abuse Act (CFAA) and the Fair and Accurate Credit Transaction Act (FACTA). Specifically, Peter has extensive experience representing franchisors. He has litigated against the Department of Labor and Small Business Administration on behalf of national franchise systems in cases involving employment misclassification and the issuance of loans from the Paycheck Protection Program (PPP). While he has extensive courtroom experience, Peter also spends a significant portion of his practice counseling clients on how to avoid litigation, recognizing that clients view it as inconvenient, expensive, and unpleasant.

Brantley Smith, associate at Foley & Lardner

Brantley Smith is a litigation associate at Foley & Lardner LLP. He is a member of the firm’s Business Litigation & Dispute Resolution Practice. Brantley represents public and private companies in a variety of commercial matters, including trade secrets, shareholder disputes, breach of fiduciary duty, and franchise litigation. He has experience in all aspects of litigation matters, including case assessment, electronic discovery, motion practice, depositions, settlement negotiations, trial and appeals.