The Assault on Franchising Continues

Lewitt Hackman

Lewitt Hackman

In the last year, we reviewed three attacks on franchising, questioned whether franchising was in the crosshairs of federal regulators and legislators, and concluded that the answer was yes.

However, a bigger threat to franchising is now upon us. The Protecting the Right to Organize Act of 2021 (PRO Act) is now winding its way through Congress. If passed, franchising in the United States as we know it could very well be on course for elimination.

To reiterate, in September 2020, three House of Representative members urged the Federal Trade Commission (FTC) to step up investigations of franchisor practices because of recent abuses by a relatively small number of franchisors in the sales of their franchises. Then, in November 2020, the FTC held a hearing on the possible mandatory inclusion of Financial Performance Representations (FPRs) in Franchise Disclosure Documents (FDDs). And, in April 2021, U.S. Senator Catherine Cortez Masto of Nevada issued an 87-page report, “Strategies to Improve the Franchise Model: Preventing Unfair and Deceptive Franchise Practices.” The report concluded that the “four areas where franchise complaints are most problematic, (1) unfair and deceptive contracts that give nearly all control to the franchise corporation; (2) a lack of honesty and transparency in the financial disclosure documents; (3) costly kickbacks and overpriced goods; and (4) fees charged for limited or no actual benefit” … “were the hallmarks of a franchise model that operates to strip small business owners of their wealth.”

Notwithstanding these pronouncements, it appears that no measurable action has yet been taken by the FTC or Congress. However, passage of the PRO Act may dwarf the impact of these prior attacks.

The PRO Act has two principal components: adoption of a federal “ABC Test” to determine if workers are employees rather than independent contractors, and adoption of a federal standard that could render franchisors the joint employers of their franchisees and their franchisees’ employees.

1. The ABC test assumes every worker is an employee rather than an independent contractor, unless the hiring company can prove: (A) the worker will be free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact; (B) the worker will perform work that is outside the usual course of the hiring entity’s business; and (C) the worker will be customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

A franchise relationship might not satisfy component “A” of the test and a franchisee could be deemed an employee of a franchisor rather than an independent contractor if the franchisor exercised a type or degree of actual control over the franchisee or the franchisee’s employees not customarily exercised by a franchisor to protect the franchisor’s trademarks, service marks and/or trade dress.

2. The current joint employer standard provides that a business will be deemed a joint employer only if it possesses and exercises substantial, direct and immediate control that meaningfully affects matters relating to the employment relationship.

The PRO Act conversely provides that joint employment can exist if the purported joint employer has direct or indirect control over the essential terms and conditions of employment, or reserved authority to control those terms and conditions. Some franchisors’ systems policies and procedures indirectly control franchisees’ employees’ activities and as a result, franchisors could once again be sued for the employment practices and policies of their franchisees notwithstanding the fact that the franchisees control the hiring, firing, discipline, wages and when and where work will be performed.

The International Franchise Association (IFA), which protects and promotes franchising by educating lawmakers and the public about the franchise business model, says:

“. . . the PRO Act’s ABC test language is so broad that it would likely define franchisees as employees of their brand, instead of the owners that they really are. This would eliminate the distinction at the heart of franchising — and the opportunities and incentives within the business model.” And, according to the IFA, the new joint employer standard would “effectively turn franchise owners into middle managers and increase legal liability for franchise brands.”

The PRO Act passed the House with bipartisan support; however, it’s unlikely the Act will pass through the Senate without Democrats first eliminating the filibuster, which requires 60 votes to invoke cloture on legislative matters and prevents parties with a small majority from voting partisan bills into action. Nevertheless, the assault on franchising continues.

Barry Kurtz is the Chair of our Franchise & Distribution Practice Group, and a State Bar of California Certified Specialist.

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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