Franchising On The Precipice: Unknowns In Transition

Fox Rothschild LLP

Fox Rothschild LLP

Change is coming, but will it be a welcome change or a harbinger of woe?

Over the last 8 years or so, the ever-changing landscape of employment laws has arguably posed an existential threat to franchising. The franchise business model may not make sense if franchisors are legally defined as the employers of their franchisees or joint employers of their franchisees’ employees. But what is an “employee” and who is a “joint employer?”

Question 1: Joint employment – Will a Biden DOL defend the Trump regulation, will it enforce the economic realities standard, and/or will it demarcate a safe harbor for franchising?

During the Obama administration, the Department of Labor adopted a joint employment standard advocated by the DOL’s Wage and Hour administrator, Dr. David Weill. The new “economic realities” standard diverged from the long-standing control test by incorporating additional factors, including such things as the ultimate source of the business and who controls the business model. The NLRB adopted the new standard and began enforcement actions against large franchisors, insisting that the franchisor was the joint employer of its franchisee’s employees. Panic ensued.

Enter the Trump administration. Although the economic realities standard remained the official test of joint employment, enforcement actions directed at franchisors had ebbed during the Obama administration. That lull continued through the first three years of the Trump administration. Finally, in late 2019, the DOL rushed a rule making process and reverted to the control standard joint employment test, even adding a specific exclusion for franchise relationships. Franchisors exhaled.

But wait! Several state Attorneys General challenged the new regulation in New York et al v. Scalia, and the court invalidated the regulation on procedural and substantive grounds. The administration has appealed that ruling, but no decision will be forthcoming until after the changing of the guard at the DOL. In the meantime, the Trump DOL is rushing through another rulemaking process, but whether there is time to do so (and whether that process would withstand another challenge) is an open question.

I admit my crystal ball is no clearer than anyone else’s, and much depends on Biden’s appointments to DOL posts, but here’s my prediction: the Biden administration will (a) abandon its appeal of the Scalia ruling (that’s a no brainer in my book); (b) not defend the result of the Trump DOL rulemaking process if/when it is challenged; (c) revert to the economic realities standard for assessing joint employment; but (d) create a narrow safe harbor for franchisors. My prediction of a safe harbor may be overly optimistic, but it’s based on the mild retreat in enforcement against franchisors in the later stages of the Obama administration.

Question 2:     Misclassification: Will the ABC standard be codified in federal law, will more states adopt the ABC standard, and will courts widely determine that federal laws preempt state employment laws?

Just as the Trump administration was engaging in welcome rulemaking on the joint employment standard, California courts were taking an opposite direction in misclassification cases. Courts opined that, under California state law, an entity was the employer of a worker unless the relationship could satisfy all three tests of worker independence. The so-called ABC test included considerations of (A) the worker’s freedom from control or direction or putative employer; (B) whether the worker performs work outside of the putative employer’s business; and (C) whether the worker is customarily engaged in an independent business of the same nature as the work performed. The franchise industry could not satisfy any of these prongs, and certainly not all of them. Panic returned.

Panic increased as the ABC test was codified in legislation in California (the infamous AB-5 legislation), the California trial court suggested that the opinion announcing the ABC standard should be applied retroactively, other states adopted similar ABC tests, and bills proposing federal codification of the ABC test were introduced in Congress.

A dim light of relief appeared in a ruling by a federal district court in Massachusetts. The court acknowledged that the ABC standard could not be harmonized with federal laws applicable to franchising, specifically the FTC Franchise Disclosure Rule and the Lanham Act – both of which rely on a degree of control over the franchisee/trademark licensee. Federal law preempted state law, the court concluded; thus, the Massachusetts employee classification law did not apply to franchise relationships. A few other courts have adopted this rationale and similarly exempted franchises from state ABC laws. Preemption may rescue franchise systems from state ABC standards, but if the standard is codified in federal law, it’s an entirely different matter.

Panic has not ebbed.

My humble prediction, with much trepidation, is that (a) the ABC standard will not be the subject of successful federal legislation; (b) more states will adopt the ABC classification regime, some (not California) with exemptions or variations that are more franchise friendly; (c) while additional courts will agree that federal franchise laws preempt contrary state laws, the principle will not expand as expeditiously or widely as needed to calm the franchise industry; and (d) many franchisors will be faced with difficult, if not impossible, decisions in ABC states.

On balance, the challenging times may end with a COVID vaccine, but not for franchising.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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