This week, I attended the International Franchise Association's annual Legal Symposium. One of the hot topics discussed during the Legal Symposium is the recent Massachusetts federal court decision in Awuah v. Coverall North America, Inc. Depending on who you talk to, this decision is either an anomaly or a major threat to franchising as a business model. Personally, I found the case to be worrisome but hoped that the case was just an outlier that would not be followed by other courts. Now, after having listened to some of the speakers at the Legal Symposium, I am not so sure.
For those of you that have not heard of Awuah, the case involved a suit by franchisees against their franchisor, a janitorial cleaning service (Coverall North America). The franchisees claimed in the lawsuit that Coverall had misclassified them as independent contractors under the Massachusetts Independent Contractor Act (the "Act"), and that they were in reality employees. Under the Act, a party claiming independent contractor status must show all of the following:
- The contractor is free from control and direction in connection with the performance of a service;
- The contractor performs a service that is outside the usual course of the employer’s business; and
- The contractor is customarily engaged in an independently established trade or profession.
In reviewing the relationship between Coverall and its franchisees, the federal court in Massachusetts focused on the second prong of the test. In finding that Coverall did not produce sufficient evidence to show that the contractors (its franchisees) were performing a service outside of Coverall's usual course of business, the court found that franchising is not a "business" in itself. Instead, the court reasoned that franchising is a means to distribute goods or services to final end users in a cost effective manner, and that the goods or services being distibuted to those end users determine the character of the franchisor's business. In the case of Coverall, the court found that Coverall and its franchisees were in the same business — that of selling janitorial cleaning services to the ultimate end users. In this way, the court likened the franchise relationship to a "modified Ponzi scheme."
The Awuah decision puts at risk many of the fundamental assumptions governing the franchise relationship. Of particular concern is that the court rejected Coverall’s argument that “franchising,” i.e. the development of a system using a trademark, licensing a system, and training franchisees how to operate a business according to the system, is a business that is separate and distinct from the business of franchisees. Although the statute at issue applies only to contracts touching Massachusetts, many states have similar tests to distinguish an independent contractor relationship from the employer-employee relationship.
The fundamental questions now being asked are: (1) how likely is it that the reasoning in Awuah will be upheld in Massachusetts; and (2) will that reasoning be adopted by other state courts? The speakers at the Legal Symposium were not encouraging in their views and outlook on the issue. Apparently, relatively recent decisions of other state courts have used similar reasoning to reach the same result, albeit with no statements that could be converted to attention-grabbing soundbites. The long-term effects of the decision remain to be seen, but it's safe to say that the cause for concern is genuine. Franchisors should pay close attention to this issue and watch for new court decisions and legislation as the law in this area continues to develop.
UPDATE: I have uploaded an additional post on this topic, Are Your Franchisees Really Your Employees? Giving Further Consideration to Awuah v. Coverall.