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The Continued Evaluation of the Franchisor-Franchisee Relationship

According to the Washington Examiner, an estimated 80% of franchises are privately-owned and legally separate businesses from the franchisor. However, a couple of high profile cases have government and franchise industry officials seeking to further clarify the role franchisors play in the running of franchisees’ units.


Throughout the modern history of franchising, franchisees selected a franchise for a pre-established business model and support from a franchisor. But, for the most part, it has been the sole responsibility of the franchisees to run their business in compliance with the laws and regulations of their area, as well as keep their employees happy. It’s the “for the most part” that is now under the microscope.


The Court Case Ruling

Many people who keep track of the franchise industry know of the complaints filed to the National Labor Relations Board (NLRB) – the primary federal labor law enforcement agency – by a number of McDonald’s workers between 2012 and 2014. The complaints covered a range of items about working conditions in restaurants that the workers felt weren’t adequate. But instead of suing just the individual McDonald’s, the suit took aim at McDonald’s corporate too.


In response, the fast food chain’s corporate office claimed it was not liable for the management conditions of workers in franchised outlets. However, the claim was rejected in a preliminary ruling.


Gavel on a TableThe August 2015 final ruling on the case, which was combined with a similar case involving Browning-Ferris Industries, expanded the NLRB’s joint-employer standard. The board said the ruling was necessary in order to protect workers in today’s time, and that the standard from over 25 years ago no longer keeps pace with the diversity of current workforce arrangements.


Formerly, a company was considered a joint-employer only if it exercised direct control over worker conditions. With the new ruling, a company is now considered a joint-employer even if it indirectly exercises control over working conditions, or if it reserves authority to do so.


The indirect control over working conditions and reservation of authority is where franchises come in. Though franchising is not explicitly mentioned, the NLRB ruling essentially expands legal liability for franchisors. In theory, it makes franchisors and franchisees joint employers, equally responsible for employment conditions at individual franchises. More details are expected to emerge later this year through a number of hearings around the country.


The fear from many in the industry is that the NLRB decision will lead to franchisors becoming more involved in the day-to-day running of their franchisees’ businesses in order to avoid potential troubles. There is concern that the “for yourself” in the franchising mantra of “in business for yourself, but not by yourself” will no longer be true with the franchisee role becoming more of a manager than a business owner.


How the Definition of Roles for Franchisors and Franchisees Potentially Effects Funding

The way the franchisor and franchisee roles are defined is important not only from an operational standpoint, but a financial one as well. And because of this, the NLRB isn’t the only entity evaluating how the franchisor and franchisee roles intersect. The Small Business Association (SBA) is evaluating the franchisor-franchisee relationship as well.


The SBA, via its loan programs, is responsible for a significant amount of funding to the U.S. franchise industry. The following data covers 2014:

  • The SBA guaranteed the financing of almost 30,000 new franchise units
  • An estimated 43% of first-time franchisees used SBA loans
  • An estimated 23% of existing franchisees used SBA loans to acquire additional units
  • The SBA lent an estimated $6 billion to new and prospective franchisees


Hands Exchanging MoneyIn December 2014, the SBA published a notice to the Federal Register asking about the “affiliation” of franchisors and franchisees. More specifically, the SBA was seeking clarification to determine whether individual franchise units are offshoots of the franchisor or independent small businesses that share a common business setup.


Why is this distinction so important? If it is determined franchisors bear “excessive control” over franchisees, the SBA would be forced to shut off funding to franchisees. Due to a congressional mandate, the SBA can only lend to small businesses.


In the notice, the SBA asked 13 questions to gain perspective. The questions ranged from the SBA process to asking if the franchise agreement and franchise appeal processes should be simplified. In addition, the SBA identified instances of “common affiliation issues found in franchise agreements,” as well as three categories of contention: Pricing, Right of First Refusal (ROFR) on a Partial Assignment or Change of Ownership, and Option to Purchase/Lease Real Estate Owned by the Franchisee.


The comment period closed in early 2015 with 117 people/organizations filing a submission. Chief among them, the International Franchise Association (IFA). The IFA gave an overview of its comments in the July 2015 edition of Franchising World magazine:

"The comments included a discussion of the proper treatment of receipts deposited into a franchisor-controlled account and when franchisor billing of customers is necessary, the appropriate restrictions a franchisor may place on a franchisee’s transfer of the business interest, a franchisor’s ability to set a price on the sale of assets upon termination, expiration, or non-renewal of the contract, and reasonable restrictions on the franchisor’s step-in rights.

IFA’s comments further recommended modifications to the loan application process to simplify and streamline it. These suggestions include conducting franchise affiliation reviews based on a set of published standards that are fixed for at least two years at a time and allowing franchisors to sign a non-material change statement each successive year after an SBA review in lieu of another costly and time-consuming SBA review. IFA also urged greater distribution of any proposed changes to the affiliation standard by the SBA to the franchising community, such as through the IFA and the American Bar Association Forum on Franchising."


As of now, there have been no major changes to the availability of funding to franchisees from the SBA. But it remains to be seen what will happen dependent upon potential fallout from the NLRB ruling.


Other Agencies Looking Into the Relationship

The Occupational Safety and Health Administration (OSHA) is curious about the franchisor-franchisee relationship too. According to the IFA, OSHA investigators are executing document requests similar to the ones the NLRB performed during its McDonald’s investigation.


State Capital BuildingIn response to the inquiries, franchising industry officials have been on the offensive to minimize any potential damaging effects. As discussed above, the IFA sent in detailed comments answering the SBA notice. In regards to the OSHA requests, the IFA wrote a letter to OSHA Administrator David Michaels questioning the purpose of the requests.


Additionally, in the last year, political lobbying has been constant with the IFA and concerned franchisees turning to Congress for support. “We are respectfully urging members of Congress to rein in regulators who are creating great uncertainty for franchise businesses about the viability of a business model that creates opportunities for millions of Americans,” Elizabeth Taylor, vice president of government relations, public policy and counsel at IFA said in an interview with the Washington Bureau Chief of The Business Journals.


And franchisees are making their voices hear as well. In mid-August, just before the NLRB ruling was announced, several franchise owners met with House Representative Steny Hoyer to discuss the possible impact on their businesses. Hoyer relayed to those assembled that Congress would take a good look at the board decision once it’s released. He also reminded those in attendance that “The NLRB cannot do anything that Congress cannot overturn.”

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