On September 18, 2019, the Governor of California signed into law Assembly Bill 5 (AB 5), which could impact your franchise system's operations in California. The law does not take effect until January 1, 2020 and may be subject to a referendum ballot initiative. While AB 5 was aimed primarily at so-called gig economy businesses, it could have severe, and possibly unintended, consequences on franchised businesses.

AB 5 in brief

AB 5 codifies the ABC test − the standard adopted by the California Supreme Court in its seminal 2018 decision in the case entitled Dynamex Operations West, Inc. v. Superior Court of Los Angeles − for determining whether workers in California should be classified as employees or independent contractors. The Dynamex court held that a hiring entity has the burden of establishing that a "worker" is an independent contractor for purposes of the wage orders adopted by California's Industrial Welfare Commission. To meet this burden, the hiring entity must prove each of the following three prongs:

  • the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact
  • the worker performs work that is outside of the usual course of the hiring entity's business and
  • the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Relationship of AB 5 to franchising

Whether California intended AB 5 to apply to franchise businesses is unclear because the law was hastily enacted and poorly crafted. If AB 5 is deemed to apply, this could result in a franchisee in California (and conceivably in turn its employees) being deemed employees of the franchisor.

There are of course certain controls inherent in a franchise relationship, but under AB 5, franchisors will be required to prove that these controls, whether under the parties’ contract or in fact, do not impact the worker. If the franchisee is claiming to be the “worker,” and the interests of franchising are not taken into account, it could be difficult, if not impossible, for a franchisor to satisfy this prong.

In addition, under the second prong of the ABC test, franchisors will have to prove (again a potentially difficult task) that they are not in the same course of business as the "worker." Lastly, it is not clear whether a franchisor can establish that its franchisees are customarily engaged in an independently established trade, occupation or business that is of the "same nature as the work performed."

There are other concerns with AB 5: (1) while the Dynamex case was limited to wage orders, AB 5 covers the entire California labor code, thereby expanding the types of claims for which a franchisor could be responsible under the ABC test; and (2) the retroactive effect (if any) of AB 5 is unclear. The Legislative Counsel's Digest to AB 5 states that AB 5 "should apply retroactively to existing claims and actions to the maximum extent provided by law." (Note that this language is not in the text of AB 5 itself.) What exactly this means and how it will be interpreted remain to be seen.

Ongoing efforts to amend or clarify AB 5

The International Franchise Association (IFA) and other lobbying groups are aggressively seeking more clarity about the application of AB 5 as well as a specific exemption from the law for franchise businesses.

In a September 13, 2019 letter sent by Assemblywoman Lorena Gonzalez, the sponsor of AB 5, to the California Assembly (after the bill was passed but before it was signed into law by Governor Gavin Newsom), Ms. Gonzalez admitted that the bill failed "to capture the intent of the author due to drafting error" in certain instances; she therefore has directed her staff to clarify the law's applicability. In addition, opponents of AB 5 are pursuing a ballot initiative which could at least delay implementation of AB 5 until November, 2020, thus providing additional time for clarifying amendments and expanding the list of exemptions.