For several years now, franchisors have been rightfully concerned with the risks associated with joint employment claims and the proliferation of cases asserting such claims. This concern, however, has overshadowed the risks presented by another employment-based claim: that franchisees are actually employees and have been misclassified as independent contractors. While many had thought that misclassification claims were only a concern of commercial cleaning franchisors, a recent lawsuit indicates that is not the case.
The allegations of the complaint
In Haitayan, et al. v. 7-Eleven, Inc., four franchisees of 7-Eleven filed a putative class action in the United States District Court for the Central District of California claiming that, because of the controls 7-Eleven exercises, they had been misclassified as independent contractors and were entitled to damages under both the Fair Labor Standards Act (FLSA) and the California Labor Code. The plaintiffs' complaint asserted that these damages consisted of the overtime compensation they did not receive and the expenses the franchisees incurred in operating their stores, such as their payroll costs and the monies they spent maintaining equipment and cleaning and purchasing uniforms. The lawsuit purported to have been brought on behalf of all of the over 1,500 7-Eleven franchise locations operating in California.
Under both the California Labor Code and the FLSA, whether someone is an employee or independent contractor depends primarily on the level of control the putative employer exercises over the alleged worker's performance. The Haitayan plaintiffs asserted that 7-Eleven exercised excessive control by retaining a security interest in inventory and limiting withdrawals from the party's shared bank account, requiring that prospective franchisees undergo training (without pay) before they could become a franchisee, establishing the hours during which stores must operate, controlling the location and layout of stores and the types of and sources for products sold within the stores, requiring that store employees wear branded apparel, mandating that franchisees comply with 7-Eleven's operating standards, reserving the right to inspect stores to enforce compliance with those standards, and processing payroll for the franchisees' employees.
The court's ruling
On March 14, 2018, the District Court granted 7-Eleven's motion for judgment on the pleadings and dismissed the plaintiffs' lawsuit with prejudice. Haitayan, et al. v. 7-Eleven, Inc., Case No. CV 17-7454-JFW, 2018 WL 1626248 (C.D. Cal. Mar. 14, 2018). While it stated that "no binding decision ha[d] addressed which standard courts should apply in determining whether a franchisor is an employer of a franchisee," the court's analysis shows that it appreciated the unique nature of the franchised business model and the need to recognize the features of that model in assessing the viability of the franchisees' claims.
Quoting extensively from Patterson v. Domino's Pizza, LLC, 60 Cal. 4th 474 (2014), the court observed that franchisees acquire a business plan that the franchisor "has created for all of its stores," and that the plan "requires the franchisee to follow a system of standards and procedures." Haitayan, 2018 WL 1626248, at *2 (quoting Patterson, 60 Cal. 4th at 489). The court also noted that the goal in franchising, "which benefits both parties to the contract, is to build and keep customer trust by ensuring consistency and uniformity in the quality of goods and services, the dress of franchise employees, and the design of the store themselves." Id. (quoting Patterson, 60 Cal. 4th at 490).
Reviewing plaintiffs' allegations in light of these principles, the court held that "all of [7-Eleven's] requirements are merely goods, presentation, and service standards designed to ensure operational uniformity among 7-Eleven branded stores." Haitayan, 2018 WL 1626248, at *4. Finding that 7-Eleven's alleged controls did "not exceed what is necessary to protect 7-Eleven's trademark, trade name, and good will," the court granted 7-Eleven's motion for judgment on the pleadings and dismissed plaintiffs' complaint with prejudice.
The significance of this decision
There a several takeaways from the Haitayan decision. First, as the somewhat more familiar joint employment case law has made evident, there is an inherent tension between the tests that govern joint employment and misclassification claims – which are largely based on concepts of control that find their genesis in respondeat superior principles – and franchising, which is premised in part on a franchisor's exercise of control over its franchisees' operations. Unless and until legislation is enacted that implements the principles that Haitayan and Patterson applied, counsel defending these claims should take steps to try to ensure that the court or arbitrator understands that any analysis of the level of control exercised by a franchisor must take into account the fact that, both as a matter of statute and practice, franchisors are required to exercise certain controls over their franchisees' operations. Creating a uniform system, and taking steps to ensure consistency and uniformity in franchisees' application of that system, is the essence of the franchise business model. Those actions cannot be enough, standing alone, to transform a franchisor into either an employer or a joint employer.
Second, the California courts remain strong defenders of the franchised business model. In addition to Haitayan, at least five different federal courts have applied the principles set forth in Patterson in concluding that an employment relationship did not exist between a franchisor and its franchisees or its franchisees' employees. See Roman v. Jan-Pro Franchising Int'l, Inc., No. C 16-05961 WHA, 2017 WL 2265447 (N.D. Cal. May 24, 2017); Salazar v. McDonald's Corp., No. 14-02096, 2016 WL 4394165 (N.D. Cal. Aug. 16, 2016); Vann v. Massage Envy Franchising LLC, No. 13-CV-2221-BEN (WVG), 2015 WL 74139 (S.D. Cal. Jan. 5, 2015); Ochoa v. McDonald's Corp., 133 F. Supp. 3d 1228 (N.D. Cal. 2015); Ambrose v. Avis Rent A Car Sys., Inc., No. 2:11-cv-09992-CAS (AGRx), 2014 WL 6976114 (C.D. Cal. Dec. 8, 2014). While some of these rulings are on appeal, California's body of law on these issues is currently one of the most settled in the country.
Finally, while many commentators have spoken about the importance of reviewing franchise agreements and operations manuals to minimize joint employment risks, that advice is equally important concerning claims for misclassification. The primary factor that courts consider in determining whether an individual is an employee for purposes of the FLSA is the degree of the alleged employer's right to control the manner in which the alleged employee performs his or her work. As Haitayan shows, courts are increasingly cognizant of the fact that franchisors must exercise certain controls to protect their trademarks, system and goodwill. The more that the link between a franchisor's controls and the need to protect its marks, system and goodwill becomes attenuated, the more likely it is that those controls will be deemed indicia of an employment or joint employment relationship.