In Franchising, Who Is The Employer, Who Is The Employee, And What Does It Mean?

Rick Farrell

By Rick Farrell

Currently, the franchise industry is facing the question of whether the franchisor, the franchisee or both is the employer of those working at a franchise outlet. Of possibly greater significance is the question of whether a franchisee is actually an employee of the franchisor under the legal definitions of employee and independent contractor. The determination of these two questions will have a major impact on franchise industry practices.

The franchise concept is relatively straightforward: the developer of a business concept and system (the franchisor) provides the right to another party (the franchisee) to use that system to sell products or services to consumers, using the trademark of the franchisor for a fee. A franchise agreement between the franchisor and the franchisee, along with additional policies and procedures imposed by a franchisor, define and govern the relationship. These documents typically include substantial employee performance requirements.

Co-Employers
A franchisee was considered to be the employer, at least by the franchisor, until recently. However, over time the provisions of franchise agreements have become more detailed, and frequently onerous, often covering virtually every aspect of employee performance. The result has been a reexamination of the employment aspects of franchising by both federal agencies like the National Labor Relations Board (NLRB) and by the courts.

The NLRB authorized legal complaints to be filed in July 2014 in response to complaints by McDonald’s employees over conditions of employment at franchised restaurants. These complaints are to be filed against both McDonald’s franchisees and against McDonald as co-employers. The NLRB’s concept of co-employers is not new. However, the NLRB’s past interpretation of co-employers was largely decided by examining whether a single entity (the franchisee) had “direct and immediate control” over the essential terms and conditions related to employment. In filing these complaints against McDonald’s the NLRB has now indicated that it is seeking to expand the totality of circumstances test to include, as co-employers, franchisors retaining significant contractual or practical control over a franchisee’s employees.

The NLRB claims that McDonald’s “exerts a direct and immediate control over the essential terms and conditions of employment of the franchisee’s employees.” As a result, McDonald’s is involved in regular and ongoing labor relations regarding the employees at its franchised restaurants. Since such practices, have become customary in the franchise industry, legal decisions and actions taken by the NLRB against McDonald’s may represent the leading edge of future actions against other franchisors.

Franchisee as Employee
Legal actions claiming franchisees are employees, including class action complaints, have also been filed in several states. Despite the habitual inclusion of statements in franchise agreements that a franchisee is an independent contractor, and not an employee of the franchisor, the courts to date in the cases that have been filed have minimized the legal effect of those contract provisions. The courts pointed to the extensive, and often onerous, contract provisions, imposed policies and procedures and actual practices of franchisors. These practices essentially create an employer-employee relationship as that relationship is defined under the laws of those states in which franchises are operating. These claims have been made so far by 7-Eleven franchisees and by franchisees in the commercial cleaning business. At the present time, those claims have survived attempts by franchisors to have them dismissed.

Where does that leave the franchising industry? First, a decision by the NLRB to commence formal complaints against McDonald’s does not mean that the claims of the NLRB will be successful. However, the filing of such complaints by a federal agency is certainly not a good sign. Second, the attempts of franchisors to dismiss the franchisee as employee legal claims have, at least to date, essentially fallen on deaf ears. The ultimate resolution of these cases, including the ever present settlement possibility, cannot be accurately predicted. What can be predicted is that court rulings in favor of the franchisee as employee concept would be near disastrous for the commercial cleaning, and C-store segments of the franchise industry due to the large number of such franchises and the significant failure rates.

To attempt to address these issues before formal legal rulings occur, franchisors should revisit and revise their contract language, policies and procedures, and actual practices regarding co-employer status, and with regard to creating an employer-employee relationship with their franchisees under various state laws. If franchisors wisely heed the present warnings, franchisees should expect to be provided with amendments to franchise agreements, which they should review very closely with their appropriate advisors.

For more information, visit: http://www.farrelllawgroup.com.