Vazquez is a warning for franchises and other businesses that use independent contractors to practically analyze their business models using the ABC test and consider whether amendments to contracts or changes to their business models are needed so that contractors and workers are not deemed to be employees.

In Vazquez v. Jan-Pro Franchising International, Inc., a decade-old proposed class action against a franchisor, the Ninth Circuit ruled on May 2, 2019, that the recent California Supreme Court case Dynamex Ops. W. Inc. v. Superior Court of Los Angeles, 416 P.3d 1 (Cal. 2018) applies retroactively.

Dynamex: (1) embraces the standard presuming that all workers are employees rather than contractors and (2) places on any entity classifying an individual as an independent contractor the burden of establishing that such classification is proper under the newly adopted “ABC test.” The test requires the hiring entity to establish three elements to disprove employment status: (A) that the worker is free from the control of the hiring entity in connection with work performance—both under the performance contract and in fact; (B) that the worker performs work outside the hiring entity’s usual business; and (C) that the worker is customarily engaged in an independent business of the same nature as the work performed.

In Vazquez, the Ninth Circuit analyzed Jan-Pro’s two-tiered business model when analyzing whether franchisees are employees, rather than independent contractors, of the franchisor.

For the first-tier of the business model, Jan-Pro contracts with “master owners” to whom it sells exclusive rights to the use of the “Jan-Pro” logo, which is trademarked. As of 2017, there were 91 different master owners. Jan-Pro retains the right to inspect any premises serviced by a master owner or any of the master owner’s franchisees to ensure that Jan-Pro standards are being maintained. Jan-Pro also has contractual requirements regarding how the businesses are to be conducted. The franchise agreement requires the master owners to pay Jan-Pro: (1) 10 percent of the franchisee fee paid to them by unit franchisees; and (2) 4 percent of the revenues that they collect from unit franchisees’ customers for their cleaning services.

For the second-tier of the business model, the master owner then sells business plans to unit franchisees, without needing approval from Jan-Pro. However, Jan-Pro requires that the master owner state in their contracts with the unit franchisees that Jan-Pro is a third-party beneficiary of those contracts. The master owner has its own business structure and is responsible for their own marketing, accounting and general operations. The master owner does not typically perform any cleaning services. The master owner provides the unit franchisees with an initial book of business, startup equipment, training programs, customer assistance relations and billing/invoices services. The agreement states that a unit franchisee is an independent contractor solely in business for itself and thus may hire its own employees, set wages and decide whether to pursue certain business opportunities. Thus, Jan-Pro’s business model is two-tiered with: (1) Jan-Pro acting as franchisor, and the master owner acting as franchisee; and (2) the master owner acting as franchisor to the unit franchisee.

This California federal class action is a decade old because, in part, related class action claims were addressed in Massachusetts and California federal district and appellate courts and in Georgia state trial and appellate courts. The Ninth Circuit addressed whether to retroactively apply the independent contractor ABC test, which was recently adopted in California in the 2018 Dynamex ruling. The Ninth Circuit relied on California’s general tradition of judicial pronouncements having retroactive effect. The Ninth Circuit rejected Jan-Pro’s assertions regarding fairness, stability and reliance on a ruling that had not existed when business decisions were made years earlier. The court focused on the practical realities of the relationships such as, for example: (1) Jan-Pro reserved the power to make site visits and inspect books and records, but rarely did so; and (2) master owners hold themselves out as “Jan-Pro International” on websites. The Ninth Circuit remanded to the District Court to consider the merits of the case in light of Dynamex.

Vazquez is a warning for franchises and other businesses that use independent contractors to practically analyze their business models using the ABC test and consider whether amendments to contracts or changes to their business models are needed so that contractors and workers are not deemed to be employees. Companies should also consider their document retention policy to defend against lawsuits in which the ABC test is retroactively applied to their business activities that occurred years ago. Further, companies should consider their insurance coverage and whether to obtain claims-made policies.