In 2014, franchising heralded the California Supreme Court's decision in Patterson v. Domino's Pizza, Inc., 60 Cal. 4th 474 (2014), which undertook an extraordinarily thorough review of the history of franchising, the unique manner in which franchised businesses operate, and the necessity of recognizing those unique features in deciding whether a franchisor has exercised too much control over its franchisees' operations. Since its issuance, Patterson has been adopted by courts throughout the country, and its reasoning has been employed in various contexts. Courts have relied on Patterson to address not only vicarious liability claims, but also joint employment claims and, more recently, misclassification claims brought by franchisees.

On May 2, 2019, the Ninth Circuit issued a decision that brings into question the continued vitality of that decision. In Vazquez v. Jan-Pro Franchising Int'l, 2019 WL 1945001 (9th Cir. May 2, 2018), the Ninth Circuit reviewed a district court's decision that a franchisor was entitled to summary judgment on claims that it had misclassified its master franchisee's franchisees. This sort of review typically hinges on whether there were material facts in dispute. However, in Vazquez the question was somewhat different because, long after the district court's grant of summary judgment, but before the Ninth Circuit ruled on the appeal, the California Supreme Court issued a decision – entitled Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (Cal. 2018) – that changed entirely the test for determining whether someone is an independent contractor.

In lieu of the multi-factor test that had been in place for over 30 years, Dynamex adopted, through judicial fiat, what is commonly known as the "ABC test." That test presumes that everyone is an employee unless the "hiring entity" can prove each of the following three elements: (a) that the person is free from control and direction, both under his contract and in fact; (b) that the person performs work outside the usual course of the hiring entity's business; and (c) that the person is engaged in an independently established business.

The Vazquez decision

In light of this intervening change in the law, the first question Vazquez addressed was whether the new test applied retroactively to the franchise relationships in question. Even though those relationships terminated years before Dynamex was issued, the court in Vazquez decided that the ABC test applied retroactively.

More importantly, the court concluded that the fact that franchise businesses were involved "does not alter the Dynamex analysis," and that "the district court need not look to Patterson in applying the ABC test." In the Vazquez court’s view, Patterson's extensive discussion of franchising was nothing more than "dicta," and the standard that Patterson adopted – which the Vazquez court asserted was limited to "vicarious liability tort cases" – had no relevance in wage and hour cases, which it implied served greater social interests.

The Vazquez reasoning is flawed

The Vazquez court’s reasoning is as unsatisfying as its holding. While it acknowledged that franchise relationships "necessarily include a degree of control over the franchisee by the franchisor in its legitimate effort to protect its brand," the court decided that those necessary controls had no role in cases that assert misclassification claims under the ABC test. That conclusion is particularly concerning for franchising because the first part of the ABC test (Prong A) requires that a party be "free from control and direction" to be deemed an independent contractor.

The Vazquez court's analysis of Prong B of the test is equally problematic. The court stated that this test would not be satisfied – resulting in a finding of employment – if (i) the franchisor's business ultimately depends on the franchisees’ performance of services, or (ii) the franchisor holds itself out (i.e., markets itself) as being in the same business (making hamburgers, producing tax returns, etc.) as its franchisees. It is unclear how franchisors are supposed to advertise on behalf of their franchisees (which they are generally contractually obligated to do) if they do not market their franchise systems as providing the services or products that their franchisees provide. It is equally unclear whether there is any franchise business that does not depend on its franchisees' performance of services or sale of products.

The risk to franchising if Vazquez is not reversed or modified

Jan Pro will be filing a petition for rehearing in Vazquez that will be supported by several amici, including the International Franchise Association. Unless the panel or the full court reconsiders its view, the impact on franchising could be enormous. Under Dynamex, every person who performs services for another entity is deemed to be an employee. The burden is on the "hiring entity" to prove that the person is not an employee, which can only be done by satisfying all three prongs of the independent contractor test. Those franchisors who cannot satisfy that test will be exposed to significant damage claims that could have a lasting impact on the viability of their franchise systems as a whole.

In that regard, it is important to keep in mind that the risk created by this is not limited to minimum wage and overtime claims. The plaintiffs pressing these claims are alleging that the expenses that franchisees incur operating their businesses – such as payroll, rent, and the costs of equipment maintenance – should all be the responsibility of the franchisor because, under California law, employees cannot be responsible for any expenses associated with operating their "employer's" business. If franchisors are forced to bear those expenses, it is difficult to see how franchising makes economic sense.