In a decision delivered on August 27 2010, the Dusseldorf Higher Labour Court commented extensively on the question of the demarcation between the status of an employee and that of a franchisee (Decision 10 Sa 90/10). This question is often relevant to franchise systems in which the franchisee is typically a natural person rather than a corporate body.
However difficult this demarcation in individual cases might be, it is of great practical significance. The status of an individual as either an employee or a franchisee determines which court has jurisdiction over disputes and, above all, whether labour law and social insurance law apply. In the commercial respect, too, the demarcation can be significant for the franchisor, considering the social insurance law contributions which must be paid by the employer for its employees.
The court ruled that an employment relationship between the franchisee and the franchisor is not usually established if the franchisee cannot fulfil his or her contractual obligations alone, but rather is dependent on assistance from the franchisor, and whether he or she is at the same time contractually entitled to provide his or her performance through third parties. This applies even if the franchisee is, in the actual performance of his or her work, subject to strict regulations which have been set out by the franchisor.
Self-employment and employment are distinguished from each other by the degree of the individual's personal dependence. Individuals who are mainly free to structure their work and to determine their working hours are considered to be self-employed in accordance with Section 84 of the Commercial Code. It has been established in the courts that individuals who are bound to follow instructions on the performance of work which are determined by another party and are personally dependent are considered to be employees.(1)
Accordingly, individuals who are not free to structure their own work and determine their own working hours, but are subject to wide-ranging instructions, are not independent. This especially applies to the content, performance, duration and place of performance of the contractual services. Personal dependence can arise from the legal structure of the contract or its practical performance. When deciding whether an employment relationship exists within a franchise system, all circumstances of the individual case must be taken into account, including the selection of the contract type.(2)
The defendant was a wholesale company which sold baked goods, snacks and other goods at a number of bakery shops. On the basis of franchise agreements, the company provided its franchisees with fully equipped, ready-to-use shops. The plaintiff concluded franchise agreements for a number of such shops with the defendant.
Aside from the payment of rent and other fees, the franchise agreements imposed many binding regulations on the plaintiff, leaving him with only limited commercial discretion. As well as determination of the stock, a comprehensive purchase obligation was imposed. This purchase obligation covered not only the baked goods themselves, but also other raw materials, consumer and packaging materials and consumer articles such as tableware. The plaintiff was entitled to offer other goods for sale only with the written consent of the defendant. Further restrictions on the plaintiff existed in relation to book-keeping, cash management and payments, and the defendant was also expected to follow a handbook specifying the content and conduct of the business.
The legal claim related essentially to the question of whether, through the franchise agreements concluded between the parties, an employment relationship had been established. The plaintiff argued that he was obliged under the contracts to work in personal dependence and was bound to the instructions of a third party for reward. The Krefeld Labour Court dismissed the claim. The plaintiff appealed to the Dusseldorf Higher Labour Court.
The Dusseldorf Higher Labour Court decided that the contract between the parties was not legally to be classified as an employment contract. While it does not automatically follow from the nature of a franchise agreement that the franchisee cannot be an employee, the necessary degree of personal dependence for this was not achieved in the case at hand.
Contractual provisions are not instructions under labour law
The standard franchise agreement used unarguably contained many regulations which were binding on the plaintiff and left him with limited commercial discretion. In particular, the core of the commercial business directed to profit – namely, the independent sale of goods – could be determined by the plaintiff only within narrow limits.
However, the plaintiff ignored the fact that the defendant, through the contractual regulations, did not issue labour law instructions, but rather established commercial conditions for the plaintiff's work, as is normal in a franchise system. The strict integration of the franchisee was commercially motivated.(3)
This makes it clear that the many regulations set out by the franchisor need not necessarily constitute instructions, but may be considered system-relevant characteristics of a legal relationship which are beneficial to both parties. The parties may decide in favour of this legal relationship on the basis of private autonomy just as well as in favour of employment. Aside from the employment relationship, room for legitimate interests in the establishment of a franchise must remain.
The right to have performance provided by third parties is decisive
In the case at hand, no binding instructions regarding the employment relationship could be read into the franchise agreements. The plaintiff was not obliged personally to perform the contractual obligations, but was entitled and compelled to involve employees. This fact decisively supported the view that the plaintiff was independent, and could be taken into account in the overall assessment where performance by third parties was the rule and not a rare exception.
The plaintiff was, over and above the formal entitlement, dependent on the involvement of others. It was his task to instruct, supervise and motivate the personnel. The plaintiff was therefore the employer of these assistants. The defendant did not reserve the right to make decisions on the continuation of employment contracts concluded by the plaintiff.(4)
If, therefore, the actual practice does not indicate an employment relationship, the parties must remain bound by the type of contract selected by them, insofar as the performance of the contractually agreed work could be considered either as employment or as self-employment.
Due to the fundamental significance of the classification, consent to appeal to the Federal Labour Court on a point of law was granted. This appeal was filed with the Federal Labour Court under File 10 AZR 619/10. As such, this issue has yet to be settled. Nevertheless, the case law thus far provides helpful indications of the demarcation between employee and franchisee, which has often proven difficult in the past.
The Dusseldorf Higher Labour Court confirmed in its judgment that the risk of a franchisee appearing to be self-employed exists in particular with the restriction of working time autonomy and the specification of a place of work. If the franchisee, on the contrary, is entitled to depend, and in fact is dependent, on third parties for the performance of his or her contractual obligations, then in principle, adequate autonomy and therefore independence of the franchisee can be assumed. He or she is then free to perform other work instead of personally performing the contractual duties.
The autonomy necessary for independence is not restricted by strict contractual regulations of the franchise. In line with the Higher Regional Court of Dusseldorf's decision of September 7 2009,(5) the Dusseldorf Higher Labour Court took into account that the strict integration of the franchisee is typical of franchising systems, and that therefore the strict integration of the franchisee does not render the franchise agreement immoral or imply that an employment relationship exists. The judgement therefore establishes clarity and is to be welcomed as being in the interests of the franchise industry.
However, practical questions remain as to how these criteria are to be implemented into actual contracts so that the risk of the franchisee appearing to be self-employed is avoided from the outset.
For further information on this topic please contact Karsten Metzlaff or Karl Rauser at Noerr LLP by telephone (+49 30 20 94 20 00), fax (+49 30 20 94 20 94) or email ([email protected] or [email protected]).
(1) See, for example, BAG NJW 2004, 461.
(2) See BAG NJW 2010, 2455 on the employment status of an insurance agent.
(3) With reference to Decision I-16 U 62/08, OLG Dusseldorf, September 7 2009. For further details of that case please see "Strict integration of franchisee does not render agreement immoral".
(4) Contrary to Decision 2-Sa 206/05, LAG Bremen, February 21 2007.
(5) Decision I-16 U 62/08.