Franchisors face broader liability in employment lawsuits

In exchange for providing their franchisees with a turnkey system for a successful business, franchisors have reaped the financial rewards of the relationship by charging a fee for the use of their name and goodwill without the liability that franchisees assume as employers of the persons who work for them.

While in the past franchisors could expect to shift this liability contractually to their franchisees without the fear of being successfully sued as defendants in employment lawsuits brought against their franchisees, recent California case law, as well as decisions of the National Labor Relations Board (the NLRB) and the Department of Labor (DOL) appear to broaden the scope of franchisor liability in this regard.

Ostensible Agency Doctrine

As a general rule, franchisor liability in California has traditionally turned on the degree of control that a franchisor exercises over its franchisee's employees.

Until recently, a franchisor doing business in California could expect to successfully defend against claims that it was a joint employer of a plaintiff-employee by showing that it did not have authority to hire, fire, set compensation, schedule meal and rest breaks and manage other day-to-day franchisee operations (commonly known as the "right of control" test). In fact, California courts have refused to find that a franchisor was a joint employer of a franchisee's employees even where the franchisor required the franchisee to use its payroll services or retained some degree of supervision and control over a franchisee's employees by requiring them to submit to a background check and to comply with its policies governing customer service.

To the extent the franchisor could show that its actions were required to protect its brand, California courts generally declined to find franchisors liable under a joint employer liability theory. However, the recent decision of a federal district court sitting in California appears to broaden potential liability for franchisors in the employment litigation arena.

In Ochoa v. McDonald's Corp., the court held that while the franchisor, McDonald's Corp., could not be found liable as a joint employer for its franchisee's wage and hour violations on the ground that it exercised control over its franchisee's employees, the court held that McDonald's could potentially be liable as a joint employer under the ostensible agency doctrine.

Ostensible agency is found where the plaintiff can prove the following: (1) the person dealing with the agent does so with reasonable belief in the agent's authority; (2) the belief is "generated by some act or neglect of the principal sought to be charged;" and (3) the relying party is not negligent.

In sum, the court held that there was a triable issue of fact as to whether the franchisee's employees believed that McDonald's Corp. was their employer given the following facts: they wear McDonald's uniforms; they serve McDonald's food in McDonald's packaging; they receive pay stubs and orientation materials marked with McDonald's name and logo; and they applied for jobs through McDonald's website. Under this standard, many franchisors could potentially be found liable as joint employers of their franchisee's employees.

Recent NLRB Decisions

NLRB cases also seem to enlarge the scope of franchisor liability in the employment litigation context. In McDonald's U.S.A., LLC, the NLRB appears to have done away with the traditional "right of control" rule followed by California and many other states (see above), holding that joint employment will be found not only where the franchisor has a direct and immediate right to control a franchisee's employees and operations, but also where the franchisor reserves the right to exert that control, even if never exercised.

This case has gained widespread attention among employers nationally because the gravamen of a franchisor-franchisee relationship is for the franchisor to have mechanisms in place to protect the franchisor's brand, including some which may relate to a franchisee's employment process in order to achieve that goal, that the NLRB now may determine provide a basis to create a joint employer relationship.

Only two weeks after deciding the McDonald's case, the NLRB issued its decision in Browning-Ferris Indus. of California, Inc., which adopts the new definition of "joint employer" enunciated in McDonald's.

The McDonald's NLRB case, as well as the Browning-Ferris case, are currently on appeal. Notably, while the NLRB's general counsel will remain for some time, there may be internal policy shifts and pressure to drop the case, particularly if a fast food executive like Andy Puzder (CKE) is confirmed as secretary of labor.

Although nothing is certain, many labor and employment PR actioners suspect there will be some unraveling of things NLRB has done in recent years, including this and somewhat analogous joint employer standards.

The Department of Labor Adopts a Definition of Joint Employer in the Franchisor Context that is Even Broader than the NLRB's

On January 20, 2016, the Department of Labor's Wage and Hour Division, which is charged with enforcing federal wage and hour laws, issued an Administrative Interpretation (AI) regarding the determination of joint employment under the federal Fair Labor Standards Act (FLSA). This standard is even broader than the NLRA's control test enunciated in Browning-Ferris and makes it easier to find that a franchisor is a joint employer if the "economic realities" of the situation warrant it.

Keep in mind that the AI does not carry the weight of law and courts are free to disregard it. Nevertheless, some courts may find it persuasive.

Steps to Mitigate the Risk of Joint Employer Liability

Given the current legal climate, franchisors may be able to reduce their potential for liability as joint employers of their franchisees' employees by taking the following steps:

* Providing written notice to employees and third parties that no employment relationship exists between the franchisor and the franchisee's employees;

* Prohibiting franchisees from using their trademarks and insignia in all employment-related documents and pay stubs;

* Expressly disclaiming the right to control franchisee employees in all franchise and employment documents;

* Including an indemnification clause in the franchise agreement that would require the franchisee to defend and hold them harmless in connection with any employment-related lawsuits that name the franchisor as a joint employer;

* Refraining from engaging or weighing in on the hiring, training, firing, discipline or compensation decisions relating to the franchisees' employees; and

* Refraining from handling or weighing in on payroll matters, human resources issues, the procuring of workers' compensation or health care insurance or obtaining the requisite tools and equipment for franchisee employees to do their jobs.

Adriana Cara is a partner at Dinsmore & Shohl, LLP in the San Diego firm's employment, labor and benefits department.