Is a Franchisee an Employee or an Independent Contractor?

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

The Awuah saga continues. Most recently, District Court Judge William G. Young, in Awuah v. Coverall North America, Inc. (D. Mass, No. 1:07-cv-10287-WGY, March 15, 2012), ruled that Massachusetts Coverall franchisees were employees for labor law purposes and imposed treble damages going back six years, holding “the contractual limitation period, two years, does not govern the Wage Act claims.” Coverall’s motion for leave to take discovery and file an expert report was denied.

As we have previously noted, this issue as to the status of franchisees also resonates with disputes over vicarious liability.

In one case sounding in vicarious liability, a Mississippi federal district court held that there was a genuine issue of material fact under Mississippi law as to whether the relationship between a janitorial business franchisee and a franchisor was an employer-employee relationship or whether the franchisee was an independent contractor because conflicting factors in the agreement between the parties supported the existence of both arrangements. Thus, the question was one for a jury to decide, and the franchisor’s motion for summary judgment on the issue was denied. (Hayes v. Enmon Enterprises, LLC, CCH Business Franchise Guide ¶14,647, S.D. Miss. June 22, 2011)

More recently, an interlocutory appeal to the Ninth Circuit was certified by the federal district court in San Francisco to determine whether the issue of a “right to control” was the same for employment classification claims as it was in the franchise context. (Juarez v. Jani-King of California, Inc., CCH Business Franchise Guide ¶14,787, N.D. Cal. February 16, 2012)

Terminated Hotel Franchises: Liquidated Damages or Lost Future Royalties?

The case of Days Inn Worldwide, Inc. v. Investment Properties of Brooklyn Center, LLC (CCH Business Franchise Guide ¶14,756, D. Minn., August 26, 2011) has again raised the issue of hotel franchisors’ rights to lost future royalties—in this case in the context of a default judgment. In Days Inn, the franchisee defaulted three years into a 15-year term by selling the property after failing quality inspections and not paying royalties for the last several months of his hotel operation.

The franchisor sued, won a default judgment, and then claimed the remaining 12 years of royalties, discounted to present value, as damages. The judge disagreed, specifically referencing other case law holding that hotel franchisors were allowed to collect an amount—actually more akin to liquidated damages—equal to only the royalties forsaken during the period it would take them to re-franchise the area. These cases, with showings by the franchisor of how long it took them to re-franchise, generally provided franchisors with damages equal to two years of royalties.

Legal Journals Give New Attention to Income Tax Nexus

The denial of certiorari in KFC Corp. v. Iowa Department of Revenue (U.S. Supreme Court Dkt. No. 10-1340, cert. denied, October 3, 2011) has spawned a new round of legal articles claiming that the issue of economic nexus for income taxes is new. (See, e.g., Gary R. Batenhorst & Adam W. Barney, “The Quagmire of the State Income Tax Nexus in the Wake of KFC v. Iowa Dept of Revenue,” Franchise Law Journal, Vol. 31, Number 3 (Winter 2012); and Scott M. Susko and Meghan J. Schbmehl, “Dealing with a Changing State Tax Landscape,” Franchising World, March 2012.)

Let us remember the late Lew Rudnick’s article about the 1993 Geoffrey case, establishing economic nexus, which he described as jeopardizing the license revenues of Walt Disney, Mickey Mouse, and Michael Jordan. (See Minear and Rudnick, “South Carolina Extends the Reach of State Income Taxes to Franchisors,” Franchise Legal Digest, Fall 1993.)

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Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

Massachusetts Labor Laws Clarified for Franchising Context

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

The Massachusetts Supreme Judicial Court has answered four questions that were certified to it by a federal district court for the District of Massachusetts in a dispute between Coverall, a franchisor of janitorial service businesses, and individuals who entered into janitorial franchise agreements with Coverall.

The federal court had determined in earlier rulings that those individuals who were Massachusetts residents were employees who had been improperly classified as independent contractors by the franchisor. The certified questions related to the calculation of damages for one of the individual plaintiffs in the action.

The first two questions were related and asked:

(1) Whether, under Massachusetts law, a franchisor could lawfully use customer accounts-receivable financing to pay a franchisee who is characterized as an employee under the Massachusetts Wage Act; and

(2) Whether an employer could lawfully withhold wages to an employee if the employer and employee agree that such wages are not earned until a customer remits payment.

The answer to both questions was "no," according to the Massachusetts high court.

The contracts between the parties required the individual to:

(1) Pay an initial franchise fee;

(2) Pay monthly royalty and management fees;

(3) Maintain janitorial bonding, workers’ compensation insurance for himself and any employees, unemployment insurance as required by law, and comprehensive liability insurance, all policies naming Coverall as an additional insured; and

(4) Provide replacement supplies and equipment.

The contract further provided for accounts receivable financing whereby Coverall would pay the individual interest-free advances for amounts billed to, but not yet collected from customers. If a customer failed to pay within 90 days, the individual was required to repay Coverall the advance in the form of a chargeback.

Wage Act

The Massachusetts Wage Act required an employer to pay the wages earned to an employee within a fixed period of days after the end of a pay period, according to the court. Where an employee has completed the labor, service, or performance required of him, by common understanding he has "earned" his wage.

That a Coverall customer did not pay its bill within a week after the pay period did not affect the plaintiff individual’s right to wages he had earned. Since the individual was an employee, the obligation to pay him earned wages rested with Coverall, not with third parties, the court held.

The accounts receivable financing system incorporated into the individual’s contract with Coverall, in which wages were classified by Coverall as advances that could be recouped, violated the special contracts provision of the Wage Act, the court ruled. That provision prohibited a person from exempting himself from the Wage Act’s provisions by a special contract or other means. Coverall was not free to withhold, much less recapture, the employee’s earned wages.

In answering the remaining questions, the Massachusetts court determined that the employees could recover as damages incurred any insurance premiums that they were obliged to pay to Coverall under the terms of their contract. In light of the federal district court judge’s statement that he welcomed other advice about Massachusetts law that was relevant to the case, the court addressed the franchise fees that the individual agreed to pay Coverall in order to enter into what the district court determined to be a direct employment relationship. The Massachusetts court’s view was that such fees constituted "special contracts," not usual between employers and employees.

In substance they operated to require employees to buy their jobs from employers. In that respect, they violated public policy. Examined in the context of the Wage Act, the franchise fees paid by the plaintiff individual did not represent a clear and established debt. To the extent that such fees were paid back to Coverall out of wages earned from Coverall, they represented a prohibited assignment of an employee’s future wages to his employer, the court opined.

The court emphasized that its concerns over franchise fees related to the potentially exploitative nature of payments by an employee to an employer for the purpose of securing employment and noted that it expressly did not conclude that franchise fees violated public policy when they were agreed to by parties who were not in an employer-employee relationship.

The opinion is Awuah v. Coverall N.A., Inc., CCH Business Franchise Guide ¶14,671.

Further information regarding CCH Business Franchise Guide appears here.

Franchisor Was Not “Employer” of Unit Franchisee of Its Master Franchisee

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A franchisor of regional janitorial business master franchisees was not the "employer" of a unit franchisee of one of the master franchisees under the meaning of the Massachusetts Independent Contractor Statute (MICS), a Georgia appellate court has decided.

Reversed was a ruling by a Georgia trial court, granting summary judgment to the franchisee on his claim that he was the employee of the franchisor.

Independent Contractor Statute

Under the statute (M.G. L. c 149, s.148B), an individual performing a service was considered an employee unless:

"(1) the individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and

(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."

Control by Franchisor

The franchisee was sufficiently free from control by the parent franchisor as to satisfy the first prong of the MICS analysis, the court held.

The franchisee performed work pursuant to a contract with the regional master franchisee, which was a separate entity from the franchisor, created by persons unaffiliated with the franchisor. The master franchisee made its own hiring and firing decisions without control by the franchisor.

Although the franchisor had the ability to enforce that contract to protect the franchise brand, its status as a third-party did not make it a party to that agreement in the sense of having control over the franchisee’s work.

Service Outside Usual Course of Business

The second prong was satisfied because the service provided by the franchisee was not in the same scope of business conducted by the parent franchisor.

The parent franchisor’s usual business was establishing a trademark and cleaning system that was then licensed to regional franchisors. The franchisee argued that language on the parent franchisor’s website demanded a finding that the parent’s usual business was providing cleaning services. However, such labels did not overcome the facts that the parent did not market cleaning services and did not invoice or collect payment for cleaning services, the court reasoned.

Independent Businesses

The third prong was satisfied because the nature of the three-layer franchise arrangement necessarily meant that the franchisor and the unit franchisee were engaged in operating independent businesses, the court determined. The franchisor did not limit or control the scope of the franchisee’s services or the continuation of his business.

The decision, Jan-Pro Franchising Int’l, Inc. v. Depianti, appears at CCH Business Franchise Guide ¶14,643.

International Franchise Association Comments on Two Massachusetts Bills

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

The International Franchise Association (IFA) has recently made its views known on two Massachusetts bills by submitting “testimony” concerning the proposals in letters to the state legislature’s Joint Committee on Community Development and Small Business.

In the letters, IFA’s Senior Vice President of Government Affairs and Public Policy, Judith Thorman, expresses the organization’s support for Massachusetts House Bill No. 3513, which would amend the state labor laws to clarify that franchisees are not employees, and voices the IFA’s arguments against advancement of Massachusetts Senate Bill No. 1843, a proposed franchise relationship/termination law.

Franchise as Employment Relationship

House Bill No. 3513, An Act Relative to Clarifying Franchises, “only makes clear that the relationship between the franchisor and franchisee is not one of employer and employee,” according to Thorman. Specifically, the bill, which was filed on behalf of the IFA, would amend the Massachusetts labor, unemployment insurance, and workers’ compensation statutes by including the following (or a very similar) provision:

"Notwithstanding the provisions of this section, an individual who owns a franchise, or is a party to a franchise agreement under which he or she is authorized to sell products and/or services (a) in accordance with prescribed methods and procedures; and (b) under service marks, trademarks, trade names and other intellectual property licensed under such agreement, shall not be considered an employee of the franchisor."

Massachusetts uses a three-pronged “ABC Test” to assess whether an employment relationship exists between individuals and/or business entities. Under the test, an individual will not be considered an employee if:

(A) Such individual has been and will continue to be free from control and direction in connection with the performance of such service, both under his contract for the performance of service and in fact; and

(B) Such service is performed either outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which the service is performed; and

(C) Such 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 problem from a franchising perspective—and the reason for this legislation—is that, while a rational person would think otherwise, an argument can be made that a franchise system fails all three prongs of Massachusetts’ ABC Test,” in Thorman’s view.

For example, “while prong (a) of the test requires the individual to be free from control, both under the parties’ agreement and in fact, under federal law, a franchisor must maintain certain controls over the use of its brand, marks and system, or risk losing trademark rights.”

The proposed legislation would not absolve employers from adhering to Massachusetts law, Thorman continued. Franchisees would remain fully liable to their employees for all appropriate obligations, just as franchisors would continue to be responsible for their employees.

Furthermore, if franchisees were treated as employees under Massachusetts law, “some franchisors will seek to impose the resulting costs on the franchisee, since they are properly the costs of operating the franchisee’s business, Thorman commented.

“Other franchisors will simply stop selling franchises in a jurisdiction that finds them to be ‘employers,’ go elsewhere, and thereby reduce the opportunities for those entrepreneurs left behind.” Both results would fail to promote the legitimate state objectives and punish those who wanted to be entrepreneurs.

Franchise Relationship Bill

“The underlying implication of Senate Bill No. 1843 is that franchisors and franchisees are on opposite sides competing against one another,” according to Thorman. “This could not be farther from the truth. At the heart of franchising is a mutually dependent relationship requiring the franchisor and the franchisee work together to achieve shared success, since neither will be successful without the other.”

Moreover, the proposed language of S.B. 1843 was nothing new and had been previously proposed and rejected in Massachusetts multiple times, according to the letter.

To understand the IFA’s concerns over the proposal, Thorman referenced Iowa's enactment of similar legislation in 1992. As a result of the enactment of a relationship law, “growth of the franchising business model ground to a halt” in Iowa, especially in comparison to the strong growth rates experienced by the surrounding states of Illinois, Minnesota, Nebraska, South Dakota, and Wisconsin during the years following 1992.

The Massachusetts bill would prohibit a franchisor from terminating or failing to renew a franchise, except for “good cause showing which shall include, but not be limited to, the franchisee’s refusal or failure to comply substantially with any material and reasonable obligation of the franchise agreement.” It also would also require written notice of termination or nonrenewal be provided to a franchisee at least 90 days in advance, along with the cause for the action.

The bill would hold any franchisor that developed a new outlet or location that had an adverse impact on the gross sales of an existing franchise liable to the affected existing franchisee for monetary damages, unless certain exceptions applied.

The proposal also imposes an inventory repurchase obligation on franchisors and prohibits franchisors from several types of actions, including: (1) prohibiting the right of free association among franchisees; (2) imposing unreasonable standards of performance on a franchisee; and (3) failing to deal in good faith with a franchisee.

Massachusetts Bill Would Clarify Franchisee Status Under Labor Laws

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A newly introduced Massachusetts bill would amend the Massachusetts labor, unemployment insurance, and workers’ compensation statutes by stating that an individual who owns a franchisee or is party to a franchise agreement would not be considered an employee of the franchisor. House Bill No. 3513 was introduced and referred to committees June 9, 2011.

The introduction of the legislation comes in the wake of Massachusetts rulings involving a franchisor of janitorial cleaning business (Coverall) and allegations that its business model was subject to the coverage of three Massachusetts labor statutes.

In a 2006 decision, Coverall North America, Inc. v. Commissioner(CCH Business Franchise Guide ¶13,491), the Massachusetts Supreme Court held that the purchaser of a janitorial cleaning business franchise, whose relationship with the franchisor differed in some key respects from the typical franchise relationship, was not an independent contractor or even a franchisee, but was an "employee" under the meaning of the Massachusetts unemployment insurance law. Thus, the franchisor was required to pay contributions for the purchaser's reported earnings pursuant to the unemployment statute.

More than three years later, in Awuah v. Coverall North America, Inc. (CCH Business Franchise Guide 14,349), a federal district court held that the franchisor had misclassified its Massachusetts franchisees as independent contractors under the meaning of the Massachusetts Independent Contractor Statute. Instead, the franchisees were employees of the franchisor under the statute, according to the court.

Finally, a federal district ruled in the same case that the franchisor violated the Massachusetts workers’ compensation law and Wage Act by improperly requiring the franchisee-employee to pay for insurance and by failing to pay the franchisee-employee within a week of the weekly or bi-weekly pay period during which the wages were earned (Awuah v. Coverall North America, Inc., CCH Business Franchise Guide ¶14,473).

Further information about CCH Business Franchise Guide appears here.

Status as “Franchisee” Not Relevant to Coverage Under Unemployment Compensation Law

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

Whether a “franchise” agreement existed between a concrete artisan and a dealer under the Connecticut Franchises Act was irrelevant to the issue of whether the dealer was an “employee” of the artisan under the Connecticut Unemployment Compensation Act, according to a Connecticut appellate court.

A trial court decision—upholding a ruling by the Connecticut Employment Security Board of Review that the dealer had been the artisan’s employee—was affirmed.

The dispute began when the artisan terminated its agreement with the dealer and the dealer filed a claim for benefits under the Unemployment Compensation Act. The sole question before the Board of Review was whether the dealer was an employee for unemployment compensation purposes.

To answer that question, the Board applied the “ABC test” set out in the Unemployment Compensation Act. The test provides that individuals who perform services for others are presumed to be employees unless:

(A) The individuals have been and will continue to be free from control in connection with the performance of such services;

(B) Such services are performed either outside the usual course of the business or outside of all the places of the business; or

(C) The individuals are customarily engaged in an independent established trade, occupation, profession, or business of the same nature as that involved in the services performed.

In this case, the Board determined that the artisan failed to satisfy all three prongs.

The artisan argued on appeal that, had the Board applied the franchise statute to the facts, it would have found that (1) a franchise agreement existed between the parties and (2) the ABC test would have been inapplicable.

Specifically, the artisan contended that a finding that a franchise agreement existed between the parties exempted the relationship from the purview of the Unemployment Compensation Act.

The artisan neither cited, not did the court’s research reveal, any legal support for this argument, the court observed. There was nothing in the Act that elucidated the question of whether the existence of a franchise agreement precluded the application of the ABC test.

The Unemployment Compensation Act made no express exemption for franchises, and no such exemption could be implied, particularly when the legislature created numerous exemptions from coverage, the court decided. If the legislature had intended to create an exemption, it would have done so expressly.

The decision is Jason Robert’s, Inc. v. Administrator, Unemployment Compensation Act, CCH Business Franchise Guide ¶14,577.