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McDonald's "joint employer" ruling in the US – a threat to the unique franchisor/franchisee relationship?

31/07/2014

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United Kingdom

The National Labor Relations Board (NLRB) in the United States ruled on Tuesday that McDonald’s could be held jointly liable for labour and wage violations by its franchise operators.

The National Labor Relations Board (NLRB) in the United States ruled on Tuesday that McDonald’s could be held jointly liable for labour and wage violations by its franchise operators — a decision that, if upheld, could set a worrying precedent for many franchise brands in the restaurant and other service industries.

The ruling comes after the NLRB investigated 181 complaints that fast-food workers brought in the last 20 months, accusing McDonald’s and its franchisees of illegally firing, threatening or otherwise penalizing workers.

The NLRB found merit in 43 of the 181 claims, and said it would include McDonald’s as a joint employer, a classification that could hold the company responsible for actions taken at thousands of its restaurants - approximately 90 percent of McDonald's restaurants in the United States are franchise operations. The complaints included the assertion that McDonald’s was a joint employer on the grounds that it orders its franchisees to strictly follow its rules on employment practices and that McDonald’s often owns the real estate interest in franchisee owned restaurants. McDonald's intend to contest the ruling.

The ruling runs contrary to a recent case in the US involving the Subway brand (Doctors' Associates, Inc v Uninsured Employers' Fund) which found that the franchisor was not liable for its franchisee's employees' compensation payments (which the franchisee had failed to make). The International Franchise Association (IFA) considers that the misclassification of franchisees as employees is a real threat to the franchise business model and has been lobbying state legislatures to amend state laws to properly account for what the IFA refers to as "the unique relationship at the heart of franchising"

The UK Position

There has been no direct clarification in the UK regarding the extent to which a franchisor can be vicariously liable for the acts or omission of its franchisees, including being considered to be the employer of the franchisee and/or the franchisee's employees.  In broad terms, only an employer can be held liable for the acts or omissions of its employees and such a liability will not exist in an equivalent independent contracting relationship.

The courts in the UK have considered the nature of the relationship between franchisor and franchisee when addressing the enforceability of restrictive covenants. The common approach (following cases such as Office Overload v Gunn and Dyno-Rod v Reeve) is that the franchisor / franchisee relationship is more akin to that between a vendor and purchaser than an employer / employee and, for that reason, the courts have enforced restrictive covenants in franchise cases which would be far too onerous to be enforceable against an employee. However, this issue does depend on the facts of the individual case as was reinforced by the first instance decision in Fleet Mobile Tyres v Stone and Another in which the Judge said that there were certain aspects in which the parties' relationship was not so completely kept at arm's length as it would be in the case of vendor and purchaser.

Therefore the answer will depend on the nature of the relationship between the parties. The fundamental principle of franchising has always been that the parties to a franchise agreement are separate and distinct business entities. But this principle is complicated by the fact that:

(a) franchisees derive their corporate identity and working practices from intellectual property rights licensed to them by the franchisor;

(b) the relationship will often be governed by strict contractual terms and the requirements imposed on the franchisee by a detailed operating manual. These mechanisms give the franchisor a high level of control over the franchisee's business.

Although franchise agreements typically specify that the franchisee is to be regarded as an independent contractor, the court will look through that and examine the true nature of the relationship between the parties and the business realities. The court will particularly consider the level of control a franchisor has over a franchisee's business in determining whether the franchisee is, in reality, an employee.

Conclusion

The NLRB ruling would appear to be out of step with the generally accepted legal and academic understanding of franchising. Equally, rulings or judgments in the United States have no direct impact on the UK, although such judgments can be persuasive. Until further guidance is provided by the UK courts, franchisors can be at risk of claims from franchisees' employees or third parties.

 In order to minimise this risk, franchisors should:

(a) ensure that the franchise agreement and operating manual are drafted in such a way which consistently characterises the parties' relationship as that of independent franchisor and franchisee; and

(b) not exercise undue control over the day-to-day running of the franchisee's business. This could occur cumulatively, with control being extended over too many aspects of the business, or too intrusively, so that the legal independence of the franchisee is overwhelmed by him being regarded as at the "beck and call" of the franchisor.  Every situation will be different, as both the legal structures, as well as the means by which the franchisor interferes in the franchisee's business, vary radically from one business to the next.

It is easy to assume that because nothing has happened "it ain't broke, so don't fix it".  The reality is that some businesses may have allowed "control-creep" to build up over the years, and in different ways, and it is likely that in some networks there may be a serious "legal accident" waiting to happen.

What is clear is that situations where the franchisee is a sole trader or, if using a limited company, where the individual is in reality doing all the work, can be contrasted with larger, more 'corporate' franchisees where the risks are likely to be much reduced.

For further information please contact your usual franchise team member or Gordon Drakes (Senior Associate).

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