As I continue to consider material for new blog posts, I have watched with interest the topics in which people seem most interested. Over the past several months, the blog post that has consistently received the most attention is Awuah v. Coverall: Is The Franchising Model Really At Risk? This is no real surprise, as the Awuah decision has garnered much attention as an area of concern for franchisors. As I recently gave a presentation to the Nevada Franchise Business Network on this topic, I thought I could supplement that post with some of the material I covered in my presentation. This blog post is a summary of the material I covered.
In franchising, the prevailing and accepted view of franchise relationships is that franchisees are independent contractors of their franchisors – not employees. The primary concern franchisors have with Awuah is that the court in that case determined, after considering the nature of the parties’ relationship, that the franchisor (Coverall) was actually an employer of the franchisee (Awuah) for the purposes of a state employment statute.
Traditionally, individuals who perform services in exchange for compensation have been classified into one of two categories: employees or independent contractors. Generally, an “employee” is a person who works for another (the employer) under an express or implied contract, under which the employer has the right to control the details of the employee’s work performance. An “independent contractor,” is entrusted by a second party to undertake a specific project, but is left free to do the assigned work and to choose the method for accomplishing the task.
One of the three pillars of franchising is “right to control” – or, as stated in the FTC Franchise Rule, whether the franchisor “exercises significant control over, or provides significant assistance in” the franchisee’s overall method of operation. Consequently, some courts have difficulty distinguishing between a franchisor’s “control” over a franchisee and an employee, who is directed in how to perform the details of her work.
In Awuah, the plaintiffs, who performed cleaning services as franchisees for Coverall North America, filed a lawsuit in Massachusetts Federal Court claiming that Coverall misclassified them as independent contractors is a franchisor of health-based janitorial cleaning services. Describing themselves as immigrants with little to no fluency in English, the plaintiffs contended they were misled into paying franchise fees to win cleaning jobs.
Analyzing the plaintiffs’ claims, the Court applied Massachusetts’ Independent Contractor Act (the “Act”). Under the Act, an individual performing a service is considered an employee unless:
the individual is free from control and direction in connection with the performance of a service;
the individual performs a service that is outside the usual course of the employer’s business; and
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.
The burden is on the party claiming independent contractor status (in this case, Coverall) to prove that it is not an employer.
Considering the facts, the Court focused on the second prong only – looking at whether the service performed by the franchisee was “outside the usual course of business” of Coverall. Citing numerous cases, Coverall argued that it was in the business of franchising, and not commercial cleaning business. The Court disagreed. Holding that the plaintiffs were employees of Coverall, Court noted that “franchising is not in itself a business, rather a company is in the business of selling goods or services and uses the franchise model as a means of distributing the goods or services to the final end user without acquiring significant distribution costs.”
In particular, the Court focused on Coverall’s business model, and found persuasive the facts that: (1) Coverall developed the System used by its franchisees; (2) Coverall trains its franchisees and provides them with uniforms and identification badges; (3) Coverall itself contracted with all customers, with limited exceptions; (4) Coverall was the party responsible for billing all customers for the cleaning services performed; and (5) Coverall receives a percentage of the revenue earned on every cleaning service.
Although items (3) and (4) (contracts directly with customers; direct billing) distinguish Coverall from most franchise systems, those points alone may not be enough to avoid analysis similar to Awuah. The problem is that the Court in Awuah did not base its decision on those two factors alone, and it is impossible to tell from the wording of the decision what relative weight was given to each of the five key facts found persuasive by the Court. Moreover, there have been decisions (albeit in different contexts) during the past several years reaching essentially the same conclusion relating to a franchise system, but relying on other aspects of “control” to find the relationship to be either employer / employee or principal / agent.
The reality is that, for most franchise companies, there is no realistic way for a franchisor to completely ensure that its franchisee is not deemed to be an employee. That being said, there are some steps that a franchisor may take to provide it with additional ammunition (or defenses) should the issue ever arise. Some items that a franchisor may want to consider to create a better argument that its contracts do not create employment relationships:
Franchising operations and company-owned stores should be held in separate legal entities
Franchisees should be required to form a legal entity to hold the franchise
Allow franchisees to negotiate and manage customer contracts
All billing should be done by franchisees
Consider eliminating covenants not to compete (trademark / trade secret protection would still apply).
Each of these items should be carefully considered and discussed with an attorney before they are implemented. While none of these practices will guarantee that a court will not, like the one in Awuah, find a franchisor to actually be an employer of its franchisee, they may offer additional layers of protection to resist such arguments.