In 2018, the Supreme Court of California turned much of the established law regarding worker classification on its head with its decision in Dynamex Operations West Inc. v. Superior Court.1 Dynamex addressed a single, narrow question: whether certain workers were appropriately classified as independent contractors or were instead properly classified as employees for purposes of the state’s wage and hour laws. In the wake of Dynamex, however, some have urged courts to expand the scope of the case beyond the narrow confines of independent contractor/employee classification to instead broadly redefine the law of joint employment and vicarious liability generally. If courts take up this invitation, it may sound the death knell for the franchise model of business operation in California, imposing joint liability on franchisors with little to no control over the day-to-day activities of their franchisees or of those franchisees’ employees.

For legal, practical, and policy reasons, it is hoped that courts will decline to expand Dynamex, keep the case cabined to its facts and the narrow question presented in it, and instead rely on the well-developed body of state law setting forth standards for establishing joint employment status and vicarious liability in the franchise context. Moreover, as the state legislature entertains proposals to purportedly codify the Dynamex decision, it should expressly clarify that the bill is intended to address the standard for determining only whether a worker is an employee or an independent contractor, and not intended to address joint employment status broadly or change the status of franchise relationships.

Background

In Dynamex, the court adopted the so-called “ABC test” for determining whether an individual worker was properly classified as an employee or an independent contractor for purposes of the California’s Industrial Welfare Commission’s wage orders. By any measure, the ABC test is a far broader standard than that applied by California courts previously, and its application results in many more workers being classified as “employees” rather than contractors.

Courts subsequent to Dynamex have aggressively applied the ABC test. Most recently, in 2019, the federal Ninth Circuit Court of Appeals in Vazquez v. Jan-Pro Franchising International, Inc.,2 held that Dynamex and the ABC test provide the appropriate standard for determining whether franchise workers were properly classified as independent contractors or instead were employees of a national master franchisor (as distinct from the regional franchisees with which they contracted) for purposes of state wage and hour law. In doing so, the court dismissed prior California Supreme Court case law recognizing the “special features” of franchising relevant to conducting a vicarious liability analysis. The Ninth Circuit remanded the case to the lower court for an application of the ABC test to the facts presented, but in doing so, stopped just short of expressly concluding that the franchisee workers could be deemed employees of the national franchisor, which could then be held liable for wage and hour violations allegedly committed by its franchisees.

The question now presented to the Ninth Circuit: Are Dynamex and Vazquez “misclassification” cases such that use of the ABC test should be limited to the question of whether a worker is properly classified as an employee or an independent contractor? Or are they broader “employer” cases, meaning that the ABC test is the appropriate standard for determining employer status and joint liability generally under California’s wage orders even in the absence of any claimed misclassification, and irrespective of the business model at issue? The court is squarely presented with that question in the pending case of Salazar v. McDonalds Corp.3

If the Salazar court determines that Dynamex and its progeny are applicable only to the narrower question of whether an individual is an employee or an independent contractor, the impact on franchisors may be lessened—in most franchise models, the question of whether an individual is an employee or independent contractor will rarely be at issue. If, however, the Ninth Circuit concludes that the ABC test is broadly applicable in determining employer wage and hour liability or joint employer status generally—irrespective of any claimed “misclassification” as independent contractors—the franchise model of business operation will be dramatically compromised, as franchisors will find themselves potentially liable for labor law violations by franchisee employees over which they exert little or no control. Simply put, how broadly courts in California choose to read Dynamex is likely to have profound consequences for franchising within the state and its economy writ large.

It is against this backdrop that the California legislature considers A.B. 5, legislation that purports to codify the Dynamex decision. Should the bill be enacted as presently written, it could conceivably expand liability for franchisee employees to franchisors throughout the state, potentially destroying the viability of the franchise model. To date, public discussion of A.B. 5 has focused on the misclassification of employees as independent contractors, and the need to protect workers in the “gig” economy. The potential broader implications of the bill apart from the independent contractor issue have drawn little scrutiny and less discussion. It is possible that the legislature does not intend A.B. 5 to reach beyond issues of independent contractor misclassification to joint employer status more broadly. It that is so, legislators should amend A.B. 5 to make that point expressly clear.

This report begins with a discussion of issues specific to the franchising model of business. It then examines pre-Dynamex case law in California analyzing employer status under state law, including specifically in the franchise context. From there, it analyzes the holdings of Dynamex and its application in Vazquez, and the question left open and now pending before the Ninth Circuit in Salazar. Finally, it analyzes A.B. 5, and the potential devastating impact the bill could have on the franchise model in California.

The Business of Franchising

At the outset, the economic impact of franchising in California should not be understated. Over 75,800 franchises employ almost 729,000 people in the state, generating $28.8 billion in payroll and almost $70 million in output. These jobs and money are at risk if the franchising model is hopelessly compromised or otherwise made unworkable, whether by court-made law or legislative fiat.

By way of brief background, franchising is a method of marketing goods and services that depends upon the existence of the franchisor’s control over a trademark, other intellectual property, or some other commercially desirable interest sufficient to induce franchisees to pay to participate in the franchisor’s system by distributing goods or services under the franchisor’s trademark or name.4 It is typical in franchising that a franchisor will license, among other things, the use of its name, its products or services, and its reputation to its franchisees. It is commonplace—and in fact explicitly required under federal trademark law—for a franchisor to impose quality, consistency, and operational standards on its franchisees. These standards allow franchisors to maintain the uniformity and quality of product and service offerings and, in doing so, to protect their trade names, trademarks and service marks (collectively the “Marks”), the goodwill associated with those Marks, and most importantly, the protection of the consumer.

The Lanham Act, the federal law regulating trademarks, service marks, and unfair competition, mandates that owners of trademarks must “maintain[] sufficient control of the licensee’s use of the mark to assure the nature and quality of goods or services that the licensee distributes under the mark.”5 Moreover, because the Lanham Act provides that a trademark can be deemed “abandoned” when “any course of conduct of the owner . . . causes the mark . . . to lose its significance,”6 franchisors have a strong incentive to control the nature and quality of the good or services sold by their franchisees. As a result, franchisors are compelled to establish and monitor brand standards and provide global oversight with regard to their franchisees.

Given these facts, most franchise agreements will routinely include contractual provisions governing many aspects of business operation, some in great detail, but have little-to-no bearing on a franchisor’s “control” of its franchisees’ employees. Such provisions, commonly found in franchisor/franchisee agreements, include brand standards manuals and guidance; training requirements or suggestions; broad contours for the conduct of business administration, including required hours of operation, trade dress provisions ensuring the visual consistency of brand décor, design, color, and signage; staffing guidance; sample manuals and policies; safety and security standards; and proprietary software for business operation.7 Finally, franchise agreements will often include language expressly characterizing the relationship of both businesses, and setting forth which responsibilities each party assumes or retains.8

The discussion of franchising and the typical features likely to be found in most if not all franchise agreements is not simply an academic point. Rather, it is important to set out that, by definition and legal requirement, franchisors are bound to exert a certain level of control over their franchisees’ operations and procedures (as distinguished from day-to-day control over franchisees’ employees). As California law has increasingly sought to impose liability on one entity by virtue of its “control” over another entity’s employees, this point becomes critical. At times the California Supreme Court has appeared to recognize the distinct features of the modern franchise model, and that a traditional analysis of employer liability—often drawn from precedent hundreds of years old—may be insufficient or inapposite with respect to franchising. Other decisions of that court and of others interpreting California state law have blurred if not elided that distinction. The development of this body of law is explained below.

Defining Employee, Employer, Contractor Status, and Vicarious Liability Pre-Dynamex

While ground-breaking, the Dynamex decision was not written on a clean slate. To the contrary, there was a strong corpus of modern law defining employee and employer, and establishing the standards for imposing liability on an employer for the actions of its servant. Case law developed along two distinct scenarios: (a) cases analyzing whether a given worker was an employee or an independent contractor for statutory or tort purposes; and (b) cases addressing vicarious liability and the concept of “joint employment” in various contexts.

Employee or Independent Contractor: The Borello Test

In 1989, the California Supreme Court issued its seminal decision addressing the test for whether a worker was an employee or independent contractor, Borello & Sons, Inc. v. Department of Industrial Relations.9 At issue in Borello was whether “share farmers” who harvested cucumbers were independent contractors or employees of the grower. Although the case arose in the context of workers’ compensation coverage, the state’s high court recognized that the case had “implications for the employer-employee relationship upon which other state social legislation depends.”10

The court first traced the history of the employee/independent contractor distinction, noting that it arose at common law to limit the vicarious liability of a hiring party for the conduct of one performing service to it. Under the common law, the extent to which a hiring party controlled the details of its servant’s work was the principal measure for determining whether a principal would be vicariously liable for the actions of that servant.

Informed by the “control” test of the common law, the Borello court adopted a multi-factor test for determining whether an individual is an employee or an independent contractor. Under the Borello test, the primary question is whether a hiring entity had a “right to control” how services were performed. The court enumerated a series of “secondary” factors that also informed the analysis, including: (a) the hiring party’s right to discharge at will; (b) whether the worker is engaged in a distinct occupation or business; (c) whether the subject work is usually done under the direction of the hiring party or instead without supervision; (d) the skill required in the particular occupation; (e) who supplies the tools and supplies for performing the work; (f) the length of time for which services are performed; (g) whether work is paid for by time or by the job; (h) whether or not the work is a part of the regular business of the hiring party; and (i) whether the parties believe they are creating an employer-employee or independent contractor relationship.11 The court stressed that no individual factor was dispositive, and could “not be applied mechanically as separate tests; they are intertwined and their weight depends often on particular circumstances.”12

Further, the court explained, the concept of employment was not strictly limited by common law principles, but must be construed with particular reference to the fundamental purpose of any statute at issue. While the common law “control” test was developed to define the contours of an employer’s liability for injuries committed by its employee, the court observed that the fundamental purpose of workers’ compensation law is to determine which injuries to an employee should be insured against by an employer.13 Given that distinction, the court held that the test for independent contractor should be applied with deference to the purpose of the statute, in this instance a remedial scheme designed to provide “comprehensive coverage” of injuries in employment.

Finally, the court recognized that while courts in other jurisdictions had developed different multi-factor tests for contractor status, there were “many points of similarity” between those analyses and the court’s own analysis.14 After a thorough examination of the various factors with reference to the specific facts presented in the case, the court concluded that “by any applicable test” the subject workers were properly classified as employees rather than independent contractors.15 Absent a different specific statutory test or definition, Borello would be applied by courts to determine “employee versus independent contractor” status for decades to follow.

Martinez and the Definition of "Employ"

The leading case setting forth California’s analysis of the definition of “employ” under state wage and hour laws also first arose in the context of agricultural workers seeking to hold a third party liable. There, however, the issue was purely one of joint employment for purposes of vicarious liability—there was no contention that the subject workers were ever classified as independent contractors.

In Martinez v. Combs,16 the California Supreme Court addressed employer vicarious liability outside the context of independent contractor/employee classification. Specifically, the court examined whether three seasonal agricultural workers employed by a farmer could hold liable for alleged wage violations produce merchants through whom the farmer sold his crop. The court first explained that the fact that only an “employer” could be liable under the wage order was “logically inevitable as no generally applicable rule of law imposes on anyone other than an employer a duty to pay wages.”17 The question, then, was whether these produce merchants were “employers” for purposes of the wage orders.

The court first noted that the term “employ” as used in the state wage orders had three alternative definitions: (1) to exercise control over wages, hours, and working conditions; (2) to suffer or permit to work; and (3) to engage such that a common-law employment relationship was formed. The court held that the merchants did not “employ” the agricultural workers under any of those definitions (which have become known as the three prongs of the Martinez test).18

Plaintiffs first argued that the merchants were employers under the “suffer or permit” prong because they knew that the plaintiffs were working, and benefited from that fact. While the court agreed that the merchants benefitted from plaintiffs’ work, it was in the sense that “any purchaser of commodities benefits from the labor of the supplier’s employees.”19 This fact alone was insufficient to impose liability, held the court. Rather, the correct focus of the “suffer or permit” analysis was whether the merchants had the power to prevent the workers from working—finding that they did not, the court declined to impose liability. The court recognized that the merchants hypothetically could have, as a practical matter, forced the farmer to lay off the subject workers or divert their labor to other projects (for example, by refusing to buy strawberries). The court explained, however, that this was true for any substantial purchaser of commodities, and “[s]uch a business relationship, standing alone, does not transform the purchaser into the employer of the supplier’s workforce.”20

Under the “control over wages and working conditions” prong, plaintiffs argued that since defendants “dominated” the farm’s business by virtue of their purchase contracts, they thus exercised indirect control over the workers’ wages and hours. The court recognized that this prong could be broad enough to impose liability if a contractual arrangement was a sham or vehicle for an actual employer to avoid paying wages,21 but given the undisputed fact that the farm alone controlled plaintiffs’ working conditions, the merchants could not be held liable for wages under this prong.22 The court also discussed its prior analysis in Borello, and expressly declined to decide whether that case had any bearing on the case at bar. The court acknowledged that had the farmer been an employee of the merchants, it might be argued that the merchants and the farmer were joint employers—but that was simply not the case. Finally, the court held, the plaintiffs had expressly disclaimed that the merchants had “engaged” them such that a common law employment relationship was formed.23 Accordingly, the court held that the merchants could not be held liable under any test for the payment of wages to the farm’s workers.

Before turning to analysis of how Dynamex conflated the Borello line of cases addressing employee/independent contractor status with the Martinez analysis applied to defining employer under state labor law, it is necessary to address a 2014 decision of the California Supreme Court addressing employer vicarious liability in the specific context of franchising, Patterson v. Dominos Pizza, LLC.24

The “Special Features” of Franchising: Patterson v. Dominos

In 2014, the Supreme Court of California was called upon to determine whether a franchisor was vicariously liable as a joint employer of one of its franchisee’s supervisors who had sexual harassed and assaulted one of the franchisee’s employees. In Patterson, the court asked:

Does a franchisor stand in an employment or agency relationship with the franchisee and its employees for purposes of holding it vicariously liable for workplace injuries allegedly inflicted by one employee of a franchisee while supervising another employee of the franchisee? The answer lies in the inherent nature of the franchise relationship itself.25

At the outset, the court explained, “[a]nalysis of the franchise relationship for vicarious liability purposes must accommodate [] contemporary realities.”26 These realities, as set out by the court, foremost included the fact that a franchisor “imposes comprehensive and meticulous standards for marketing its trademarked brand and operating its franchises in a uniform way.”27 The court acknowledged that to some extent a franchisor “controls” the franchisee’s franchise. That said, it, explained, “It is the franchisee who implements the operational standards on a day-to-day basis, hires and fires store employees, and regulates workplace behavior.”28

The plaintiff argued that the court should apply traditional common law agency principles to hold the franchisor liable, claiming that because the franchisor wielded “detailed control over their franchisees’ general operations” it should be held liable for personal harm sustained in the course of the franchisee’s business. Dominos argued that too literal a reading of traditional agency principles “ignores the realities of modern franchising, which impose a meaningful division of autonomous authority between franchisor and franchisee.”29 Rather, the company argued, the court’s focus should be on whether the franchisor had “day-to-day control over the specific ‘instrumentality’ that caused the alleged harm.”30

The court first engaged in a comprehensive review of prior case law addressing the vicarious liability of a franchisor for its franchisee using common law agency principles. It drew in particular on Cislaw v. Southland Corp., 4 Cal.App.4th 1284 (1992), which held, “it is the right to control the means and manner in which the result is achieved that is significant in determining whether a principal-agency relationship exists.”31 The Cislaw court further noted that a franchisor’s “interest in the reputation of its entire system allows it to exercise certain controls over the enterprise without running the risk of transforming its independent contractor into an agent.”32

The Patterson court concluded that the “means and manner” test could not “stand for the proposition that a comprehensive operating system alone constitutes the ‘control’ needed to support vicarious liability claims” like those raised before it.33 To hold otherwise would “turn business franchising on its head.”34

With those legal principles in mind the court first examined the responsibilities of the franchisor and franchisee under the terms of the franchise contract, noting specifically that the contract vested exclusive control in the franchisee over its employees, and did not establish any right of the franchisor to establish or administer a sexual harassment policy, training program, or reporting system.35 It then examined the actual operation of the business, noting that the franchisee exercised sole control over the application, interview, and hiring process of its employees, and most important, exclusive control over training employees with respect to workplace conduct, sexual harassment, and appropriate responses. Given these facts, the court concluded, there was insufficient evidence that the franchisor controlled the day-to-day operations of the franchise, with respect to hiring, direction, supervision, discipline, and discharge generally, and with respect to the terms and conditions of employment at issue in the case (i.e., harassment training, prevention, and response) specifically, to support a finding of liability. Finally, the court addressed the plaintiff’s argument that immunizing a franchisor from liability in these circumstances contravened the state’s public interest in preventing and protecting employees from harassment. The court rejected that argument, noting that they “lose force” when the franchisor “did not directly control the workforce, and could not have prevented the misconduct and corrected its effects.”36

In short, the Patterson case set a very supportive stage for addressing claims of vicarious liability or joint employer status for franchisors. The case both focused its analysis on the day-to-day control of relevant franchisee operations, but more broadly, recognized the growth and strength of the franchise model, the realities of its operation, and the negative impact a broad or overreaching standard for imposing liability on franchisors for the actions and operations of their franchisees would have on the franchise business model.

Dynamex and the ABC Test

In 2018, the California Supreme Court issued its decision in Dynamex Operations West, Inc. v. Superior Court.37 Here, the court was asked whether the Martinez definitions of “employ” and “employer”—established in the joint employment context—were applicable in addressing whether a worker was misclassified as an independent contractor. As the court phrased it, the “heart of the issue” was the scope of Martinez, and whether that case extended beyond joint employment cases to include contractor/misclassification cases.38

The Dynamex plaintiffs were delivery drivers for a nationwide package delivery company. Prior to 2004, the company had classified its delivery drivers as employees. After that date, the company adopted a new policy and contractual arrangement under which the drivers were considered independent contractors. The drivers sued for misclassification under the state’s wage order.

In deciding whether to certify the case as a class action, rather than apply the Borello standard for determining whether a given worker was an employee or contractor, the lower court instead applied the three-prong definition of employ in the wage order as set forth in the then recently-decided Martinez. On appeal, the Court court of appeal held that neither the wage order itself nor the court’s decision in Martinez were limited to the joint employer context, and that Martinez provided the governing rule for determining whether a worker was an employee or independent contractor under the state’s wage orders. It rejected Dynamex’s contention that Borello provided the appropriate standard for determining employee/contractor status in all instances. With respect to the plaintiff’s non-wage order claims, the court of appeal remanded them for consideration under the Borello test. In essence, the appeals court found that for purposes of wage orders only, Martinez—a wage order case, but in the joint employment context—trumped Borello for wage and hour claims. Dynamex appealed to the Supreme Court of California.

In its decision, the California Supreme Court examined in great detail prior law and its application, including lengthy discussion of both Borello and Martinez. Ultimately, it upheld the lower courts’ determinations, concluding that the “suffer or permit” prong of the wage order’s definition of “employ” was applicable to cases arising under the wage order and must be interpreted broadly to “treat as ‘employees,’ and therefore provide the wage order’s protection to, all workers who would ordinarily be viewed as working in the hiring business.39 For that reason, the court concluded that for purposes of determining whether a worker was an employee or independent contractor under the “suffer or permit” definition contained in the wage order, the appropriate standard was the “ABC test” used for this purpose in other jurisdictions.

Notably, the court at least partially justified its decision to adopt an “exceptionally broad” standard under the wage orders based on:

[T]he fundamental purposes and necessity of the minimum wage and maximum hour legislation in which the standard has traditionally been embodied. Wage and hour statutes and wage orders were adopted in recognition of the fact that individual workers possess less bargaining power than a hiring business and that workers’ fundamental need to earn income for their families’ survival may lead them to accept work for substandard wages or working conditions. The basic objective of wage and hour legislation and wage orders is to ensure that such workers are provided at least the minimal wages and working conditions that are necessary to obtain a subsistence standard of living and protection the workers’ health and welfare.40

The court went on to explain that as a matter of policy, wage orders also protected law-abiding employers from unfair competition by competitors who might utilize substandard employment practices, as well as the public at large (on the theory that if minimum wage standards are not fulfilled, the public will be left responsible for these workers and their families).41

The ABC test is concerning to franchisors, which may now conceivably be held to be the employers of—and liable to—their franchisees’ employees, unless strict and narrow conditions are met. Under the ABC test, a worker is deemed an employee unless the hiring entity proves that: (A) the worker is free from the hirer’s control and direction in performing work (both as a matter of contract and in actual fact); (B) the worker is performing work outside the usual course of the hiring entity’s business; and (C) the worker is engaged in an independently established business, trade, or occupation of the same nature of the work he or she is performing for the hirer.

The “A” prong of the ABC test is in many ways similar to Borello, insofar as it looks to the control exerted by the hiring party over the performance of work and the worker’s terms and conditions of employment. As discussed above, and as recognized in Patterson, in the franchise model, too often legally-imposed requirements with respect to branding and operations—in place to ensure uniformity and consistency, and to protect the interests of both franchisor and franchisee—are argued as evidence of “control” over an employee’s working conditions. Moreover, where proving a lack of control (and thus satisfying prong A) would generally be sufficient to avoid finding a worker to be an employee under Borello, under the ABC test an employer must now additionally satisfying prongs B and C.

Prong B may prove the most problematic for franchise employers. Under prong B, a hiring party must prove that a worker is providing services or performing work outside the normal course of business of the hirer. As an example, the Dynamex court explained that were a retail store to employ a plumber or electrician to repair a leak or install new electrical lines, those services would not be considered part of the retail store’s usual course of business. If, on the other hand, a bakery hired a cake decorator to work on a regular basis on its custom-designed cakes, or a clothing manufacture hired at home seamstresses to make dresses from cloth and patterns provided by the company, which would then be sold by the company, those workers would be performing work within the hiring company’s usual course of business operations.42 Here, the court’s decision seems grounded in social policy as much as any textual analysis. As the Dynamex court observed, “Treating all workers whose services are provided within the usual course of the hiring entity’s business as employees is important to ensure that those workers who need and want the fundamental protections afforded by the wage order do not lose those protections.”43

This standard may be especially difficult, if not impossible, for many franchisors to meet (especially those franchisors that both offer independent franchises and maintain company-owned franchises). By definition, a franchise operation is providing the service of the franchisor’s business. As discussed below, at least one California case has found a distinction between the franchisor’s business and that of the franchisee—but others have not been swayed by that reasoning.

The C prong may likewise present hurdles particular to franchises. To satisfy the C prong, an employer must prove that a worker is engaged in an independently established business or profession, and has taken steps to hold him or herself as an independent business. Where a fast-casual restaurant franchisee engages an independently licensed plumber to fix a pipe in its restaurant, the analysis seems clear. Conversely, if a franchisee attempts to engage an “independent contractor” line cook, it may well face a different outcome.

Finally, insofar as the Dynamex Court grounded its ruling in policy, those policy considerations do not support expanding the use of the ABC test beyond the independent contractor analysis. As noted above, the court found that an exceptionally broad standard under the state’s wage orders was justified by the need to ensure that workers enjoyed a certain measure of protection, and were not subject to substandard working conditions because they were classified as independent contractors rather than employees and thus not protected under the wage orders. Assuming arguendo the validity of these policy concerns, they are absolutely absent outside the context of independent contractor analysis. If the policy purpose of the wage orders is to ensure that a given worker is an “employee” of some business so that he or she has wage protections under the law, those concerns are simply not present where a worker is already an employee of one business, and the question is whether another business is a joint employer. Put more simply, once an employee is receiving a W-2 from one employer, he or she is fully protected under the wage orders—the policy concerns ostensibly justifying the need for a broad reading of the statute to encompass a joint employer simply are not present.

By any measure, the ABC test, when used in the context of classifying a worker as an employee or independent contractor, is a difficult test to satisfy, and results in more workers being classified as employees. When used outside of that specific context as a definition of joint employment generally, it threatens to dramatically and exponentially expand liability to parties who have little or no control or involvement in the day-to-day work of a given worker. Some courts have “checked” the broad expansion of the ABC test, while others have applied it aggressively, and the ultimate question—how does it relate to the relationships between franchisors, franchises, and franchisee employees—remains open.

Dynamex’s Progeny: Curry and Vazquez

Two appellate courts have had occasion to address the bounds and contours of Dynamex, and its application outside of the independent contractor analysis. Their analyses are very different, and which emerges as the dominant method of analysis could have profound consequences for franchising.

Curry v. Equilon Enterprises

Less than a month after Dynamex was decided, the Court of Appeal for the Fourth District of California had occasion to review application of the ABC test in the franchise context in Curry v. Equilon Enterprises, LLC.44 In that case the court determined whether the Supreme Court of California “intended the ‘ABC’ test to apply beyond the independent contractor context.”45

In Curry, the manager of a franchised Shell gas station sought to hold Shell Oil Products liable for various wage and hour violations. The court first analyzed the case using the three-prong Martinez test. Under the “control” prong, the court found that while operation of the franchise was subject to Shell’s operating manual and procedures pursuant to the franchise agreement, it was the franchise owner who set the terms and conditions of plaintiff’s employment, including wages, hours worked, assignments, and the like. It next applied the “common law engage” prong and determined that under a common law test of employment, plaintiff was not an employee insofar as she not supervised by Shell, nor did Shell provide her tools; she was paid on a salary basis; and she was engaged in work different than that of Shell itself. The court analogized to a building owner engaging a property management company to manage the property: “the owner is not engaged in the business of property management. Rather, the owner is in business of owning real estate, while the property management company is in the business of managing properties.”46 Shell, the court found, was not in the business of operating gas stations but rather in the business of owning real estate and fuel; the plaintiff gas station manager was thus in a different business than Shell. Finally, under the “suffer or permit” prong, the court found that Shell did not acquiesce to her being hired; did not have the power to unilaterally discharge her; and did not have the power to prevent the operator from employing her. Accordingly, Shell was not liable under any prong of the Martinez test.

The court then turned to the question of whether the recently decided Dynamex case required the application of the ABC test, rather than the Martinez test. In weighing the question of whether the ABC test’s “suffer or permit” analysis applied in the context of a joint employment case, the court of appeal first noted that in Dynamex, “the Supreme Court was discussing the test from Martinez, and Martinez is a joint employment case. Therefore, arguably, the Supreme Court intended for the ‘ABC’ test to extend beyond the independent contractor context to the joint employment context.”47 That said, the court continued, the California Supreme Court’s policy reasons for adopting the ABC test in Dynamex were:

[U]niquely relevant to the issue of allegedly misclassified independent contractors. In the joint employment context, the alleged employee is already considered an employee of the primary employer; the issue is whether the employee is also an employee of the alleged secondary employer. Therefore, the primary employer is presumably paying taxes and the employee is afforded legal protections due to being an employee of the primary employer. As a result, the policy purpose for presuming the worker to be an employee and requiring the secondary employer to disprove the worker’s status as an employee is unnecessary in that taxes are being paid and the worker has employment protections.

In conclusion, the “ABC” test set forth in Dynamex is directed toward the issue of whether employees were misclassified as independent contractors. Placing the burden on the alleged employer to prove that the worker is not an employee is meant to serve policy goals that are not relevant in the joint employment context. Therefore, it does not appear that the Supreme Court intended for the ABC Test to be applied in joint employment cases.48

While the court came to the conclusion that the ABC test was not meant to apply in the context of a joint employment analysis, “out of an abundance of caution” it nevertheless went on to apply the ABC test to the facts at hand. With respect to prong A of the test (“control and direction”), the court’s analysis of whether Shell controlled the plaintiff’s working conditions for purposes of prong one of the Martinez test was sufficient to show that it did not. As to prong B (“outside the usual course of business”), the court found that Shell was “not in the business of operating fueling stations, but rather of owning real estate and fuel.”49 That, and the fact that the plaintiff was engaged in the distinct occupation of a fuel station manager, satisfied the B prong. Finally, with respect to the C prong, the court explained that insofar as the ABC test is directed toward the misclassification of contractors, applying prong C (“worker is engaged in an independent business”) in the joint employment context leads to an analysis that blends prongs A and B. As Shell did not exercise control over the plaintiff’s working conditions, and the plaintiff’s management of the gas station was distinct from the type of business Shell engaged in, under the C prong she was engaged in the independent business of gas station management. For all of these reasons, the court upheld judgment in Shell’s favor.

Curry offers some hope for franchisors. Foremost, it takes the position that the ABC test should not be applied in the joint employment context, but rather the traditional Martinez test provides the proper analysis. Second, even where the ABC test is applied, Curry made a distinction between the franchisor’s normal course of business—owning gasoline and real estate—and that of the franchisee’s employee (operating a gas station). While an admittedly fact-based distinction, it does leave room for some franchisors to argue that their normal course of business is different from that of a franchise employee. That said, this argument appears to have carried little weight with the Ninth Circuit in Vazquez, discussed below.

Vazquez v. Jan-Pro

Most recently, the federal Court of Appeals for the Ninth Circuit held in Vazquez v. Jan-Pro Franchising International, Inc.50 that the ABC test was appropriate to determine whether a franchisor was liable to employees of its franchisees for wage and hour violations. To date, Vazquez appears to be the broadest application of the ABC test since Dynamex was decided.

In Vazquez, the plaintiffs—janitors who had purchased franchises from a regional franchisor—sued for violations of California wage and hour law. Rather than sue the regional franchisor with which they contracted directly, they instead sued the national franchisor itself (Jan-Pro). In a decision pre-dating Dynamex, the U.S. District Court for the Northern District of California ruled in favor of the defendant master franchisor. Applying the three-prong Martinez test with the “gloss” of Patterson, the court concluded that Jan-Pro did not exert sufficient control over the day-to-day activities of the franchisees, nor did it have the right to, to satisfy either prong one or prong three of the test. Nor did it possess the power to prevent the franchisees from working under the second “suffer or permit” prong. Accordingly, the court found, there was no employment relationship between the franchisees and the national franchisor.

Two years later, post-Dynamex, the Ninth Circuit reversed the lower court, and remanded the case for reconsideration of the employer question under the ABC test. In a lengthy opinion, the court first held that Dynamex applied retroactively, and then explained that for Jan-Pro, on remand, to prove that it was not the employer of its franchisees’ employees for purposes of California wage and hour law, it would need to prove: (a) that the franchisee employees were not directed and controlled by Jan-Pro (both under the contract and in fact); (b) that these employees performed work outside of the usual course of Jan-Pro’s business; and (c) that the franchisee employees were engaged in an independently established trade or occupation.

In sending the case back to the lower court for reconsideration, the Ninth Circuit’s decision made three additional points particularly significant to franchising. First, the court concluded that because Patterson was not a wage and hour case but rather a case about vicarious liability in the tort context, Patterson was wholly inapplicable. The court looked to the remedial purpose of wage and hour laws to conclude: “the franchise context does not alter the Dynamex analysis, and the district court need not look to Patterson in applying the ABC test.”51

Second, the court rejected the substantive argument made in Curry: namely, that the defendant master franchisor was not in the business of providing janitorial services, but rather in the “business of ‘franchising’ rather than cleaning.”52 Noting that various courts and arbitrators were skeptical of this characterization, particularly in the cleaning industry, the Ninth Circuit quoted a lower court in Massachusetts: “Describing franchising as a business in itself … sounds vaguely like a description of a modified Ponzi scheme—a company that does not earn money from the sale of goods and services, but from taking in more money from unwitting franchisees to make payments to previous franchisees.”53 With respect to Curry, which held that Shell Oil was in the business of owning gasoline and real estate rather than of gas station operation, it found that “the dichotomy of ‘gasoline ownership’ versus ‘gas station operation is significantly less troublesome than ‘the business of franchising’ that Jan-Pro purports to be in. Curry is therefore of limited use in the ABC test analysis.”54

Finally, in remanding the case to the lower court for consideration of the employee question under Dynamex, the Ninth Circuit directed the lower court to consider all three prongs of the ABC test, and applying case law from other jurisdictions that apply it. Noting that the court was free to further develop the factual record if necessary, the court made plain its view that “Prong B may be the most susceptible to summary judgment on the record already developed.”55 The court reiterated that under prong B of the ABC test, an individual will be found to be an employee if the hiring entity cannot prove that it was not engaged in the same usual course of business as the subject worker, and directed the lower court to consider whether the work employed by the franchisees was necessary or merely incidental to the work of Jan-Pro, whether their work was continuously for Jan-Pro, and what business Jan-Pro considered itself to be in (a question it had largely already answered). Put more simply, while the appeals court ostensibly remanded the case to the lower court for application of the ABC test, it stopped just short of flatly declaring that because the franchisor was in the same business as its franchisees’ employees—the business of cleaning—it almost surely failed prong B of the disjunctive ABC test, and was properly considered the employer of the franchisees themselves.

Vazquez represents the most significant attack on the franchise model by way of the ABC test: it rejected prior holdings that the realities of franchise relationships needed to be considered in addressing the joint employment question, and so much as stated that where a franchise worker is performing work in the same line of business as the franchisor (which, by definition, will often if not always be the case), the franchisor may be held liable for the wage and hour law violations of its franchisees.

The Scope of Dynamex, Vazquez, and their Progeny: Salazar v. McDonald’s

Presently before the Ninth Circuit Court of Appeals is the question left open by Dynamex (which expressly limited itself to a specific set of facts), and pressed in Vazquez: should the ABC test be used only to determine whether an individual is properly classified as an employee versus an independent contractor, or should it, as Vazquez suggests, be used for the broader purpose of determining whether an entity is an “employer” under state wage and hour laws (or perhaps even more broadly)? And what role, if any, plays Patterson and its recognition of the “special features” of the franchise business model? Each of these questions is presented in Salazar v. McDonalds Corporation.56

In Salazar, the plaintiffs—fast-food workers at eight McDonald’s franchises in California—sued for violations of state wage and hour law. They named as defendants both the franchise owner and the franchisors, McDonalds’s Corporation and McDonald’s USA (“McDonald’s”), and argued that the operational control McDonald’s exerted over its franchises were sufficient to hold the company liable as an “employer” under California’s wage orders. Notably, there was no allegation that these workers were ever classified as independent contractors by McDonald’s or the franchisee.

In the lower court, the parties agreed that Martinez supplied the appropriate analytical framework, but differed as to the role, if any, of Patterson. The court rejected plaintiffs’ contention that Patterson was inapposite: “The decision is instructive because it elucidates the common law definition of employment in the franchisor context, and the common law definition is incorporated as a component of the test articulated in Martinez.57 As the court concluded, to ignore Patterson would result in a “distorted view of operative law.”58

The district court analyzed potential joint employer liability under each prong of the Martinez test. With respect to the first prong of the Martinez test—whether McDonald’s exerted sufficient control over the plaintiff’s wages, hours, or working conditions—the court engaged in a lengthy factual analysis. The court concluded that McDonald’s was not an “employer” under the first prong of Martinez because it did not in fact exercise control over, inter alia, the franchise’s employment or personnel matters; hiring franchise employees; disciplining franchise employees; setting work schedules and assignments; determining when to provide breaks; setting rates of pay; or overseeing franchise employees’ training. As the court characterized it, “McDonald’s operating standards protect brand identity and integrity, but exclude hiring, firing, and other personnel matters.”59 Further, the court continued, McDonald’s contractual right to update operating standards and policies for its franchises was insufficient to find an employment relationship insofar as the franchise agreement “lacks any contractual right authorizing McDonald’s to direct [franchise] employees in their work.60 Citing Patterson, the court noted that its analysis of the franchise relationship must “respect ‘contemporary realities” and that periodic updates to standards and policies were means of “protecting the trademarked brand.”61 The court concluded that “The mere fact that the franchisor has reserved the right to require or suggest uniform workplace standards … is not, standing alone, sufficient to impose ‘employer’ or ‘principal’ liability on the franchisor.”62

The court readily disposed of claims under the other two Martinez prongs. With respect to the “suffer or permit” definition, the court found that McDonald’s, while it could exert significant pressure on the franchise owner through its franchise relationship, “lacked the power to prevent [plaintiffs] from working.”63 With respect to the common-law employment relationship “means and manner” test, the court referred back to its factual analysis under prong one, and the franchisee’s sole power to hire, fire, set wages, and control day-to-day operations to conclude that McDonald’s did not control the subject employees in a manner sufficient to form a common-law employment relationship. Importantly, the court again referred to the Patterson court, which had previously explained that the “means and manner” test could not stand for the proposition that a franchisor’s comprehensive operating system, standing alone, was sufficient to impose vicarious liability.

Finally, in its decision, the Salazar court left open the question of whether McDonald’s could be held liable to franchise employees on a theory of “ostensible agency.” Subsequently, the court held that McDonald’s could not be held liable on an ostensibly agency theory under the text of the subject wage order, which requires that even an “agent” of an employer exercise control over wages, hours, and working conditions.64

Plaintiff’s appeal of the court’s rulings is currently pending before the Ninth Circuit. In their appeal, plaintiffs argue that the lower court erred in deciding as a matter of law that McDonald’s could not be held liable under the Martinez test, and contend that there are sufficient factual disputes that could support a finding of employer status under each of the three prongs of Martinez, as well as on a theory of ostensible liability. Finally, they argue, the district court misapplied Patterson to narrow the scope of liability or otherwise create a franchisor “exception” to the definition of employer under state wage and hour laws. They urge the court to hold that the ABC test should be used to determine whether McDonald’s is an employer of the subject employees under wage and hour law.

As noted above, a—if not the—pivotal question before the court is whether the ABC test is a test of whether an individual is an employee or independent contractor, or whether it is the test of whether an individual is the employee of a given company under state wage and hour law. Plaintiffs urge the court to adopt the reasoning set forth in Dynamex and Vazquez and apply the ABC test, arguing that insofar as these cases addressed liability under California’ wage and hour laws, they provide the relevant standard. They further urge the appeals court to reject any Patterson “gloss” on the case, or modification of the analysis in the franchise context. McDonald’s in turn argues that both Vazquez and Dynamex are limited to the question of whether an individual is a bona fide employee or an independent contractor, and thus inapposite to joint employment. As there has never been a question in Salazar that the subject workers were employees, not independent contractors, McDonald’s argues that these cases have no relevance. They urge the court to look to and apply the analysis adopted in Patterson and Curry.

The question before the Salazar court may have profound consequences for franchisors.65 If the court concludes that the ABC test applies broadly to determine employer status, California franchisors face potential liability for violations of the state’s onerous wage and hour laws claimed by franchise employees over which they have no direct supervision or control. Moreover, as they are likely a deeper pocket than any individual franchise, franchisors are an attractive target for the plaintiff’s bar. Conversely, if the court adopts a narrower reading and confines use of the ABC test only to the determination of whether a given worker is classified as an employee or independent contractor, franchisors may be insulated from such liability (at least where contractor status is not a question). At a minimum, they may structure their franchise relationships to minimize the risk of misclassification.

What will the Ninth Circuit do with Respect to the ABC Test in the Joint Employment Context?

For several reasons, many in the franchise industry hope the Ninth Circuit will reject the expansion of Dynamex beyond the scope of the independent contractor/employee inquiry, recognize the unique nature of franchising in any joint employment analysis, and affirm the district court’s grant of judgment in McDonald’s favor.

As discussed above, the success of the franchising model hinges on the franchisor’s close relationship with the franchised business, and the franchisor’s control over its franchisees’ methods of operation and their quality and operation standards (as distinguished from control over the day-to-day activities of the franchisees’ employees). Indeed, federal trademark law requires the franchisor to exert some level of control over the franchise as a condition of preserving its right to its trademarks. This in turn means that the franchised business offers the consuming public consistency and the same level of quality across all franchises. In fact, if a franchisor fails to maintain sufficient control over its marks, it is considered to have engaged in ‘naked licensing’ and abandoned [its] mark.”66 Put simply, a franchisor’s control over its franchises operations are the heart of the franchise model. If that level of control is deemed to make franchisors the joint employer of—and thus liable to—every one of its franchisees’ employees, the model collapses.

These facts were recognized by the Supreme Court of California only five years ago in Patterson, which recognized that a franchisor’s interest—indeed, legal requirement—to maintain control over its entire franchise system necessarily means it will exert certain controls over any franchisee, and that fact cannot “stand for the proposition that a comprehensive operating system alone constitutes the ‘control’ needed to support vicarious liability claims” like those pressed by the Salazar plaintiffs. Similarly, in rejecting the expansion of Dynamex and the ABC test to a joint employment analysis, the Curry court, through a detailed analysis of the contractual rights between Shell and its franchise, and the direct impact (or lack thereof) on the franchise’s employees, implicitly recognized that franchise arrangements present something different, and expressly acknowledged that the ABC test is ill-suited for a joint employment analysis, particularly in the franchise context.

Finally, as a policy matter, insofar as the Dynamex Court was guided by the purposes of remedial wage and hour laws—to ensure workers are afforded a minimum level of protection from substandard working conditions—those policy considerations, which may bear on the question of independent contractor classification—wholly evaporate in the joint employment context where, by definition, the worker is already an employee protected under the law.

Codifying and Expanding Dynamex: Assembly Bill No. 5

Even if the Salazar Court rules in favor of McDonald’s, the franchise model in California faces a more imminent concern: the codification by the state legislature of the ABC test, which may well undo many protections of a pro-McDonald’s Salazar ruling.

Introduced in December 2018, Assembly Bill No. 5 (A.B. 5) was recently approved by the California state assembly. The bill is now pending in the state senate, with possible hearings in committee and consideration by the full senate likely later this year.

A.B. 5 codifies and expands the California Supreme Court’s holding in Dynamex, and does primarily three things. First, it provides that for purposes of California’s Labor Code, Unemployment Insurance Code, and the wage orders of the Industrial Welfare Commission, unless another definition of “employee” is specifically provided, the state will use the ABC test to determine whether an individual is classified as an employee. As discussed above, under the ABC test, a person providing labor or services for remuneration will be considered an employee unless a hiring entity proves that: (A) the individual is free from its control and direction in connection with the performance of subject work, both under the contract and in fact; (B) the individual performs work that is outside the usual course of the hiring entity's business; and (C) the individual is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Second, the bill exempts from the application of Dynamex persons in certain enumerated occupations, and instead mandates analysis of employee status for these workers under the standard set forth in the Borello decision discussed above. Specific professions include an individual who is licensed by the California Department of Insurance; a physician or surgeon licensed by the State of California performing professional or medical services, a securities broker-dealer or investment adviser or their agents and representatives that are registered with the federal Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the State of California; a direct sales salesperson as defined in the state’s Unemployment Insurance Code; a real estate licensee licensed by the State of California; and individuals providing hairstyling and barbering services who have a booth rental permit and meet certain criteria.

Finally, the bill sets a general exemption for contract for “professional services” where a contracting hiring entity proves that an individual, inter alia, maintains its own business location and has a business license, and may use its own employees in performance of work under the contract; contracts for services with other entities; negotiates their own compensation; sets their own hours; and customarily exercises discretion and independent judgment in the performance of services. “Professional services” are defined as services that either: (a) require a license from the state of California and involve the practice of law, dentistry, architecture, engineering, or accounting; or (b) require possession of an advanced degree in involving specialized instruction in the field of marketing or the administration of human resources. “Professional services” do not include individuals in the field or health care or medicine.

As discussed above, the Dynamex decision was confined to determining whether an individual was an employee or independent contractor in “one specific context.” Specifically, the Dynamex court held that its decision addressed what standard applied “for purposes of California wage orders.67 It is critical to note that, in contrast, A.B. 5 would not merely codify the Dynamex ABC test for purposes of wage orders, but rather throughout the entire Labor, Unemployment, and Workers Compensation Codes.

A key question will be how broadly the legislation is read. On its face, the bill appears to be intended to address the question raised in Dynamex—whether a given individual is properly classified as an employee or an independent contractor, and place the burden of proof on an employer to establish that a worker is not an employee. If the law is applied broadly outside the context of independent contractor classification, in the absence of a different definition of “employer” or a statutory exemption, under A.B. 5, the question of whether an individual is an employee for most if not all purposes will be determined under the broad ABC standard—a standard the Ninth Circuit in Vazquez so much as stated many franchise employees could never meet.

There is one other possibility. To date, discussion of A.B. 5 has almost exclusively focused on its impact on independent contractors, and the need for the legislation to “protect” gig economy workers by classifying them as employees. Little has been said about A.B. 5 in the broader context of joint employment or vicarious liability outside the contractor model. In that light, the bill’s findings are devoted exclusively to the issue of the misclassification of workers, and the impact of misclassification on workers, the state’s economy, and income inequality. It is possible the California legislature simply does not fully understand the potential impact of codifying A.B. 5 on businesses where the misclassification of employees is not an issue. If that is the case, the legislature should consider amending A.B. 5 to make its intent clear, and clarify that the bill is not intended to be used outside of the independent contractor analysis, or to expand liability to franchised business. As set forth above, the failure to do so could have devastating consequences for franchisors, franchisees, their employees, and the California economy.