“This is a struggle that's going to play out for a long time, and will resonate throughout the franchise industry and many others.” Philip Zeidman, partner at DLA Piper
This article will give you an overview of the long-running legal battle that has a number of franchising leaders saying the franchise model is being attacked, and could lead to some major changes within the industry.
The Origin
Between 2012 and 2014, a significant number of McDonald’s workers made complaints to the National Labor Relations Board (NLRB) – the primary federal labor law enforcement agency. The complaints covered a range of items about working conditions in restaurants that the workers felt were sub-standard.
However, instead of suing the individual McDonald’s locations, the suit took aim at McDonald’s corporate claiming that it was ultimately responsible for conditions at individual locations. This belief runs counter to the prevalent thought process within franchising. It’s widely advertised that franchises allow franchisees to be in business “for themselves, but not by themselves,” meaning they get support but are the ones who bear the responsibility for success or failure of their location(s).
The Initial Ruling
In August 2015, the NLRB passed a ruling that expanded its joint-employer standard, potentially putting franchise headquarters on the hook for working conditions at an individual’s franchise location.
While the ruling on the case, which was combined with a similar case involving Browning-Ferris Industries, didn’t explicitly mention franchising, it implicated franchises through its stance on indirect control of workers.
The ruling found that a company can be considered a joint-employer if it exercises any control over working conditions or if it reserves the authority to do so – with the latter stipulation being the most applicable to franchise corporate offices. Previously, the standard for joint-employer was “direct and immediate” control.
Defending the Franchising Model
“One of the biggest misconceptions is that someone in your community who owns a franchise is not a small, local business owner, when in reality, that’s exactly what they are.” Matt Haller, senior vice president of the International Franchise Association (IFA)
The fear for franchise industry leadership is that the ruling will take away the feeling of autonomy franchisees have, despite being part of a network. Per Birkhoff Research Group, here’s a summary of the potential consequences of the NLRB ruling:
- Franchisors being considered employers if they have any control over the terms and conditions of workers' employment.
- As employers, franchisors will be responsible for all employees and subcontractors, even if they played no part in hiring them.
- Employees of large franchise organizations will be able to unionize and fight for their interests (such as a higher minimum wage).
- Franchisees will lose a great deal of control over hiring, wages, hours, and working conditions.
- The franchise business model may lose ground, which may lead to lost jobs, along with increased prices for consumers.
In response to the ruling, franchisees and franchise industry officials who disagree with the decision, most notably the International Franchise Association (IFA), are speaking up in their opposition of this and other related legal rulings. In an editorial, new IFA President & CEO, Robert Cresanti (who was then IFA’s executive vice president of government relations & public policy) said:
“It has long been accepted that franchisees are the sole employers of their workers
With its belief as such, it isn’t surprising that the IFA has backed potential legislation like the Protecting Local Business Opportunity Act, which it says “will provide franchise businesses much needed certainty in the face of an unrelenting barrage of regulatory action.”
More Push Back
Nearly a dozen states have passed or are considering actions to clarify the franchisor-franchisee relationship and maintain the independence of local franchises, including the following examples.
Last summer, a number of franchise groups reached a compromise on California Assembly Bill 525, which updated and modified language used in matters of the termination, compensation, transfer and renewal of franchises. Under the compromise, AB 525 preserves the overall framework of state franchise law so that franchisors retain the ability to enforce uniform quality standards and protect brand integrity for consumers.
Wisconsin Senate Bill 422 was signed the first week of March 2016 by Governor Scott Walker, and applies to state enforcement agencies. The bill excludes a franchisor as the employer of a franchisee, or of an employee of a franchisee for purposes of certain laws relating to employment.
In Utah, House Bill 116 came about to clarify that neither a franchisee nor a franchisee's employee shall be deemed to be an employee of the franchisor for any purpose.
The co-defendant in the case, Browning-Ferris, is also challenging the ruling. The California-based waste management company filed its most recent brief to the U.S. Court of Appeals for the D.C. Circuit in early June. The brief alleges that the new joint-employer standard is not practical for companies as it is too broad and vague.
Is There Any Effect on Franchises Coming Into the U.S.?
Though not as great in number as franchises that expand from the U.S. to another country, a number of franchises do enter the U.S. from other countries. Will these regulations and proposed regulations effect them? According to industry experts, the effect of the potential changes will be even less clear for international franchises that want to enter the U.S. – particularly in the area of awareness.
As franchise industry expert Paul Segreto tells Franchise Direct, “It's not so much that new and proposed regulations would effect international franchises from entering the U.S. market as much as it would be them even being aware of the regulations.”
He continues, “Often, and I'm working with one [franchise] right now, they enter the market, get location(s) opened and aren't even aware of the regulations, opening as they have in their home country or other countries. This is especially the case if their strategy is to be the U.S. franchisor and open unit by unit as opposed to awarding the U.S. franchise rights to a single entity.
“As hard as it is for U.S. franchisors to minimize control so as to be considered a joint employer, it is going to be even more difficult, if not almost impossible for international franchisors entering the U.S. to minimize control. It's just not their cultures to do so as many come from regions where hierarchy is respected and expected.”
Other Agencies Taking a Look
It’s worth noting that the NLRB isn’t the only governing body putting franchising under the microscope. The nuts and bolts of the franchising model have been examined by other federal entities such as the U.S. Occupational Safety and Health Administration (OSHA) and the Small Business Administration (SBA).
Shortly after the NLRB ruling, OSHA initiated a document request reminiscent of the one the NLRB made in its investigation, and has indicated it wants to follow the NLRB’s lead in expanding the scope of joint employment.
In its draft guidance document, which is essentially a preview of the way a government agency is leaning on an issue, OSHA states “As a general matter, two entities will be determined to be joint employers when they share or codetermine those matters governing the essential terms and conditions of employment and the putative joint employer meaningfully affects the matters relating to the employment relationship such as hiring, firing, discipline, supervision and direction.”
The OSHA draft guidance document also contains out a long list of questions and criteria it wants clarification on to determine the degree of control a corporate franchisor exerts over the operations of its individual franchises. After gaining the information sought, the administration will move forward with a final decision on whether the proposal of expanding its scope of joint employment will be adopted in whole, in part, or not at all. A timetable for a final OSHA decision on possible changes to regulation could not be found.
A New SBA Addendum
In addition, the SBA sought clarification on the franchisor-franchisee relationship in early 2015. In late 2016, the SBA released an addendum for its franchise program, which went into effect at the beginning of 2017.
According to federal guidelines, SBA-backed loans are only available to independent small businesses. Previously, in cases where prospective franchisees of a system would unable to obtain a SBA-backed loan because “affiliation” was deduced from a review of the franchise’s franchise agreement, the SBA (along with FRANdata) worked in conjunction with those franchisors on an individual basis to craft franchise-specific addenda to modify the control terms within the agreement.
Now, there is one blanket SBA addendum for all franchises. The addendum serves as an add-on to the franchise agreement, which remains in effect until the loan is paid in full or the SBA no longer has interest in the loan. The IFA has raised objections to the new method, wanting to keep reviews done on an individual basis.
The outcome for many of these inquiries and cases will be significantly dependent upon the direction the new administration takes, especially the incoming Labor Secretary. And, initially, with the nomination of Hardee’s and Carl’s Jr. CEO Andy Puzder, the interests of franchisors appeared like they would be very well represented. However, the nomination hit a snag in February when several senators urged the White House to withdraw Puzder’s nomination for a number of factors. Puzder went on to withdraw himself from consideration on February 15.
Editor Note: This post was originally posted on July 14, 2016, and is updated as more information is released.