It is no secret: Cash-strapped federal and state governments have been stepping up enforcement and increasing penalties against businesses that misclassify employees as independent contractors and exposing these businesses to additional employment-related liabilities for wage and overtime pay, health, welfare and retirement benefits, and income and employment tax contributions and withholding. We have been watching and reporting on the rapidly changing legal and legislative landscape concerning worker misclassification, and advising businesses to review and refine their practices with respect to independent contractors.

Now it appears that franchisors need to be warned to do just the same with their franchisees. In a recent decision out of Massachusetts (see Awuah v. Coverall North America, Inc.), a federal district court judge held that the franchisees of Coverall’s janitorial franchise business were actually Coverall employees, not independent business operators, under the Massachusetts Independent Contractor Statute (the “MICS”). Suggesting that franchising could function like a “modified Ponzi scheme,” the court concluded that, because Coverall developed the systems used by the franchisees, trained them, gave them uniforms and badges, contracted with and billed all customers, and received a percentage of revenue on each cleaning service, Coverall and its franchisees were in the same commercial cleaning business and thus, under the MICS, were in an employment -- rather than an independent business -- relationship.

Is the MICS a legislative anomaly? Is there reason to fear that application of worker misclassification rules in the franchise arena (whether right or wrong) may spread beyond Massachusetts?

The MICS is not a complete anomaly. It sets out what is commonly known as the “ABC” test, which is named in reference to its three elements that are supposed to be simpler and easier to apply than alternative common law classification tests. The ABC test is generally viewed as the most difficult test to pass if you are trying to establish independent contractor status. It has been adopted in some form or another in approximately 25 states and is currently included in pending legislation in other states. Its use from jurisdiction to jurisdiction may vary; it is most often applied in the unemployment benefits context and is sometimes limited to particular industries. In contrast, the MICS generally applies without regard to industry or the employment-related issue at stake. Nevertheless, given the prevalence of the ABC test, and the intensive governmental focus on worker misclassification, it is conceivable that challenges to the independent status of franchisees could spread, including to jurisdictions beyond Massachusetts.

In the wake of Coverall, franchisors should be reviewing and refining their franchise relationships and arrangements and be alert to legislative and legal developments in relevant jurisdictions. Keep in mind, while agreements and structural aspects of independent business relationships (franchise or otherwise) are considered in the analysis, they are not determinative. When applying the applicable tests, government agencies and courts may pay lip service to form and then focus on how the relationship functions practically. Case-by-case is the standard, and any particular case will turn on application of its own set of facts.