Plenty New on the Franchise Legal Front, Says WSJ

This posting was written by John W. Arden.

The year 2010 was another litigious one for the U.S. franchising “industry,” providing important new legal developments and trends, according to an article in The Wall Street Journal’s February 14 Small Business report

In a feature story (“Franchisee v. Franchiser: What’s new on the legal front? Plenty.”), reporter Richard Gibson asked prominent franchise lawyer Leonard D. Vines to “review the legal landmarks.”

Vines, a partner in the St. Louis office of Greensfelder, Hemker & Gale P.C., provided the following highlights.

Value menu pricing. Despite protests from franchisees, Burger King was allowed to require franchisees to sell a double cheeseburger for $1, a price franchisees said cost them money. The Burger King National Franchisee Association sued the franchisor, claiming that it had acted in bad faith in setting such a low price. The federal district court in Miami dismissed the action, ruling that Burger King had broad discretion in adopting marketing strategies and that the franchisees failed to show that the double cheeseburger “loss leader” threatened their viability. (National Franchisee Association v. Burger King Corp., CCH Business Franchise Guide ¶14,501) Further details are available in an earlier blog item (Trade Regulation Talk, December 27, 2010).

Franchisees as employees. A decision holding franchisees as employees of their franchisor sent shock waves throughout the franchising community, since an employer-employee relationship would place burdens on the franchisor, such as withholding federal and state taxes, paying for workers compensation insurance, and complying with wage laws. A Massachusetts federal court found that Coverall had misclassified its franchisees as independent contractors. Under Massachusetts law, an individual performing a service is considered an employee unless (1) the individual is free from control and direction in the performance of the service, (2) the service is performed outside the usual course of the business of the employer, and (3) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed. The franchisor failed to establish the second prong of the test—that the franchisees were “performing services that are part of an independent, separate, and distinct business from that of the employer,” according to the court. The franchisor in this case engaged in the same commercial cleaning business as the franchisees. (Awuah v. Coverall North America, Inc., CCH Business Franchise Guide ¶14,349 and ¶14,473) Additional information on this development appears in two previous blog items (Trade Regulation Talk, April 5, 2010 and October 25, 2010).

Various liability. A continuing hotbed of litigation, vicarious liability arises when a franchisor is held liable for the acts of its franchisee towards a third party. “The contention is that since a franchisor exerts so much control over the franchisee’s operations, the franchisee is effectively an agent of the franchiser, and as a result [the franchisor] should be held liable for the acts or omissions of the franchisee.” Vicarious liability can pose a dilemma for franchisors, says Vines. “If they exert too much control, they might be held liable for the franchisees’ conduct. If they do not exert enough control, they might be considered complicit, or seen as not properly training and education the franchisee.”

Disclosure. Whether a franchisor is obligated to disclose future business plans to a prospective franchisee has been a recurring issue. In Something Sweet v. Nick-N-Willy’s Franchise Co. (CCH Business Franchise Guide ¶14,398), a pizza franchisee purchased a carryout outlet, only to find out later that the franchisor intended to discontinue selling those types of franchises. The franchisee brought suit alleging that the failure to disclose this plan was a material omission that violated the Washington Franchise Investment Law. However, a Washington state court found that as long as the franchisor continued to support the carry-out franchises, there was no misrepresentation for failure to disclose plans. “According to this analysis, a franchiser is not obligated to disclose plans to a prospective franchisee if the plans wouldn’t adversely affect the franchisee’s ability to continue operating,” Vines observed. Further information on this case is available in a previous blog posting (Trade Regulation Talk, June 17, 2010).