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“Franchise model” under threat?

October 22nd, 2014  |  Lisa Milam

By Lisa Milam-Perez, J.D.

Some of the most compelling (and potentially impactful) questions that labor and employment lawyers contend with these days go to the heart of the traditional employment relationship—the very notion of which is teetering on increasingly shaky ground. Who is an “employee” (or “independent contractor,” or “intern”)? Who is the “employer” — i.e., who is liable when an employee’s legal rights are violated? As for the latter, plaintiffs’ attorneys, labor unions, and worker advocates of late have been looking to hold large companies accountable for violations committed downstream by subcontractors, suppliers, staffing agencies, and related entities.

Federal and state agencies have, too. David Weil, the U.S. Department of Labor’s Wage and Hour Administrator, has written of “the fissured workplace,” suggesting (in a provocative tome that predated his April 2014 appointment to the post) that the DOL should focus its enforcement efforts on employers that ostensibly seek to off-load potential liability by deliberately structuring their business organizations and operations accordingly. “[L]arge corporations have shed their role as direct employers of the people responsible for their products, in favor of outsourcing work to small companies that compete fiercely with one another,” notes a teaser for the book. Among the business models deemed suspect: the franchise.

And it’s not just the DOL. NLRB General Counsel Richard Griffin caused quite a stir last August when he said he would authorize complaints against McDonald’s Corp. based on alleged labor law violations by McDonald’s franchisees, under a theory that the fast-food giant is a joint employer of the aggrieved workers. Of course, fast food makes up a sizeable chunk of the franchised industry, and these companies are already feeling the heat of an ongoing, labor-backed drive to raise workers’ wages and secure organizing rights through coordinated national protests and job actions.

State labor agencies and progressive state officials have taken up the cause as well. For example, when New York Attorney General Eric Schneiderman announced last week that he’d filed a $2 million lawsuit against a Papa John’s franchise for underpaying delivery drivers, Fast Food Forward, an “alt-labor” group behind much of the fast-food dust-up, was offered prime real estate in the attorney general’s official press release, with a quote from the group’s organizing director calling the lawsuit “the latest reminder that giant fast-food companies like Papa John’s must ensure that its franchise holders abide by the law and treat workers fairly.”

Fighting back. Facing attack on numerous fronts, the franchise industry has come out swinging. The International Franchise Association (IFA), the industry’s trade group, successfully lobbied California Governor Jerry Brown last month to veto S.B. 610, a bill that would have imposed stronger restrictions on a franchisor’s right to terminate a franchise agreement, among other provisions. Meanwhile, in Washington, IFA members testified at a September House Workforce Committee hearing on “expanding joint employer status”—the primary purpose of which was to lambaste the NLRB’s recent actions in that vein. As for those fast-food protests? The IFA quickly launched a PR counter-offensive, decrying the “union-led” campaign as “part of an overt effort to undermine franchising.”

Franchisee discrimination? Most recently, in a challenge to the city of Seattle’s new $15-an-hour minimum wage ordinance, the IFA filed suit contending that franchises were unfairly taking it on the chin. The organization hopes to prevent the municipality from enforcing the law against small franchised businesses, saying it was a “blatant discriminatory attack” against them. Why? The ordinance classifies franchises as “large employers” if the franchise network collectively employs more than 500 workers nationwide. In contrast, it grants a seven-year phase-in period for other employers with 500 or fewer workers. “Being classified as large businesses would require the small franchised businesses to pay higher wages sooner than other small businesses,” the IFA notes. “As such, they would be at a significant competitive disadvantage, potentially resulting in job losses and closed businesses.” According to the IFA, there are serious questions in play as to whether this “discriminatory treatment of small franchisees was motivated by economic protectionism, animus, and a desire to ‘break’ the franchise model.” The organization has asked a federal court to enjoin the city and require that “all small businesses be treated the same under the minimum wage ordinance.”

Janitors “franchisees”? The franchise industry has reason to be defensive these days, given that these entities have been on the hot seat. But there’s been overreaching on the industry’s part, to be sure. In one long-running Massachusetts case against Coverall North America, a commercial cleaning “franchisor,” the company called its janitorial workers “franchisees” and then misclassified them as independent contractors, in violation of the state’s Independent Contractor Statute. Coverall entered into “janitorial franchise agreements” with the janitorial workers to provide commercial cleaning services to third-party customers. Along with forking over an initial “franchise fee” to enter into an agreement, the franchisees paid additional installments to the company during the course of the contract. Coverall trained the franchisees, provided them with uniforms and identification badges, contracted with and billed customers, and received a percentage of the revenue earned on every cleaning service. It only paid the janitors for their services once the customers paid the company, rather than when they actually performed the work.

Coverall insisted it wasn’t in the cleaning business but rather, the franchising business, and it didn’t “employ” anyone who cleans. This troubled the court. “Describing franchising as a business in itself,” it wrote, “sounds vaguely like a description for a modified Ponzi scheme—a company that does not earn money from the sale of goods and services, but from taking in more money from unwitting franchisees to make payments to previous franchisees.” Quoting Justice Brandeis in a subsequent ruling in the case, the court noted there is a “general feeling that the whole system of paying fees for jobs is unjust.” But it stopped short of holding that the franchise distribution system at issue violated Massachusetts public policy.

A similar class action against Coverall was later brought by “franchisees” in California. In addition to California Labor Code violations, the janitors claimed the company breached their franchise agreements and committed fraud and unfair practices by removing customer accounts from them without cause so that it could resell those accounts to other franchisees. After two years of litigation, the suit culminated in a settlement agreement that included a $475 payment and injunctive relief for each plaintiff and an attorneys’ fee award of nearly $1 million.

The IFA had pushed back during the Coverall litigation as well—deploying its boilerplate language about the “threat to the entire franchise business model” and contending that the court’s holding “brings into question the legitimacy of every business that relies on contractually related firms as sources of revenue.” From the looks of things, it will become an increasingly familiar lament, as these “threats” to the franchise model will only continue to escalate.