Article of Interest

Franchisors as Joint Employers
By: Vijay Pattispu

The Texas Legislature has recently enacted laws attempting to immunize franchisors from liability under various employment laws. Such immunity is not complete, however, and still depends on how much control a franchisor exerts on franchisees or employees. Federal law developments, moreover, have been trending in the opposite direction, finding more franchisors standing in the shoes of employers under various federal employment laws.

Texas Senate Bill 652, which went into effect on September 1, 2015, expressly provides that franchisors shall not be considered employers of their franchisees or their franchisee’s employees for purposes of certain employment laws.

The statute uses the definition of “franchisor” provided in federal regulation: “any person who grants a franchise and participates in the franchise relationship,” including sub-franchisors. 16 C.F.R. §436.1(k). A “franchise,” in turn, is

          any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

          (1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;

          (2) The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee's method of operation; and

          (3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

16 C.F.R. §436.1(h).

A franchisor thus defined is now generally excluded by statute from being considered an employer under the following chapters of the Texas Labor Code:

 - Chapter 21 (Employment Discrimination)
 - Chapter 61 (Payment of Wages)
 - Chapter 62 (Minimum Wage)
 - Chapter 91 (Professional Employer Organizations)
 - Chapter 201 (Unemployment Compensation Act)
 - Chapter 401 (Workers’ Compensation Act)
 - Chapter 411 (Workers’ Health and Safety)

But if a franchisor “has been found by a court of competent jurisdiction in this state to have exercised a type or degree of control over the franchisee or the franchisee’s employees not customarily exercised by a franchisor for the purpose of protecting the franchisor’s trademarks and brand,” then that franchisor does not get excluded from coverage and may therefore have exposure as an employer under the above listed laws.

Thus, on one hand, franchisors must to some extent control their franchisees in order to protect their legal status as franchisors under federal law. On the other hand, franchisors must not exert too much control, lest they become employers under Texas law.

So how much control is “just right,” that Goldilocks level of control whereby a franchisor can stay a franchisor, and yet avoid becoming an employer?

The answers might be straightforward for product-based franchising, i.e., networks in which franchisees sell a company’s proprietary product line and hold themselves out with some sort of identity with that company supplying the product. For product-based franchisors, the approach to follow may be to exert control on the products, while leaving employment decisions to the franchisees.

The answers are less clear for so-called “business format” franchising, where the intellectual property franchised out consists of things like the business plan, systems, procedures, and standards—those things that altogether form the brand of the business. This type of franchise is common in industries like fast food, lawn care, tax preparation, car repair, hospitality, etc. The value-add from uniform systems is the integrity of the brand and the associated preservation of the trademark or service mark.

But these systems can often include specifications on employees’ hours, rates of pay, leave accrual, seniority systems, and layoff and recall procedures, among a host of other matters that ordinarily require compliance with a host of employment-related laws concerning wages, discrimination, safety, etc.

Does this level of specification of the terms and conditions of employment go beyond protecting the trademark? Or is it nothing but mere protection of the trademark, which is on the business format? This new issue does not appear to have been resolved in Texas. The answer will determine whether the franchisor will benefit from the new statutory exclusion from employment law liability, or whether, on the other hand, the franchisor stands in the shoes of an employer, and must thus arrange its business with attention to matters of unemployment insurance, workers’ compensation, and other issues.

Finally, practitioners should be aware that these state law developments are occurring against a backdrop of federal law developments going the other way—toward more franchisors being found liable as employers. The National Labor Relations Board, for example, has filed suit against McDonald’s in cities across the United States, and the Department of Labor recently issued guidance material indicating that under the Fair Labor Standards Act, many entities that appear to be merely franchisors are in fact employers, since the applicable definition is to “suffer or permit” work done.

These new developments at the state and federal levels are somewhat new, and there are at least as many questions as answers in this area. Whatever the ultimate trajectories and interactions of these developments, the takeaways for practitioners are clear. In advising businesses that implement or are considering implementing a franchise business model, the throttle on how much control the franchisor has on the activities of the franchisees and their employees should be done with at least some attention to state and federal employment laws. It is not enough simply to delineate differences as a matter of contract, which could be defeated by statute. In advising franchisees and employees, practitioners should be aware of the possibility of the franchisor sharing in or assuming responsibility for its own decisions leading to the dispute under state or federal employment laws.

Views and opinions expressed in eNews are those of their authors and not necessarily those of the Texas Young Lawyers Association or the State Bar of Texas.