The year that was in franchising - a look back at legal issues simmering in the US and which might come our way in 2015 | Fieldfisher
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The year that was in franchising - a look back at legal issues simmering in the US and which might come our way in 2015

The United States of America is the home of franchising. For cultural as well as geographical reasons, the franchising sector in the US is significantly larger and arguably more sophisticated than any The United States of America is the home of franchising. For cultural as well as geographical reasons, the franchising sector in the US is significantly larger and arguably more sophisticated than any other foreign market. Traditionally, we often look "across the pond" to see what trends are emerging, both in terms of consumer preferences but also in relation to legal developments, which may find their way to these shores.

From a legal point of view, 2014 was a very interesting year in the US for the franchising sector, but perhaps for the wrong reasons. Three issues which have been simmering for years came to ahead:

1. Improving Franchisee "Equity"

The Californian "Fair Franchising Act" sought to address a perceived fundamental unfairness in franchisee relationships, which leaves the franchisee with very little "equity", other than the value of their equipment when their franchise rights expire. The Act was borne out a dispute between McDonald's and a long-serving franchisee, who, after 30 years of operation, was informed that its lease would not be renewed and so would lose its franchise rights. Contractually, all the franchisee was entitled to was the value of its business equipment and it was bound by typical post termination restrictions. The franchising sector in the US has a strong and vociferous franchisee lobby which supported the Act, but it was opposed by the International Franchise Association (IFA). Ultimately,  Governor Jerry Brown vetoed the Act, but other states, such as Iowa and Rhode Island have passed similar versions and many more have sought to pass similar measures but failed.

This matter highlights a common misconception about franchising - that franchisees have an ownership stake in the brand that they represent and the customer base that they help build. A franchise agreement is a time limited licence, during which the franchisee can access and follow a tried and tested business format and build a business under a well known brand. However, when the licence comes to an ends, the franchisee has no residual rights over the goodwill it has generated for the brand and is required to "hand back the keys", in the same way as a tenant would to a landlord. Post termination restrictions are there to protect a franchisor's legitimate interests, including their know how and the ability to recruit a new franchisee to operate in that location. It is crucial that franchisees go into these relationships with their eyes wide open and only make an investment if the return is there for them during the term of the franchise agreement.

This is not to say that all franchise agreements are perfectly conceived. Each business is different and there is a fine line between enabling a franchisor to effectively police and operate its network and ensuring that franchisees have a sufficient security of tenure.

The UK is a long way from seeing the introduction of similar legislation on these issues, but there have been a number of cases over the last few years in which claimants have sought to have the principle of "good faith" implied into "relational agreements", such as franchise agreements. In 2014, Carewatch Care Services Limited v Focus Caring Services Limited and Others was the first franchising case to deal with this issue head on. The judge rejected all of the arguments that a number of implied terms should be read into the contract and also upheld that a franchisor's "step in" right to take over and operate the business on termination or expiry of a franchise agreement was valid. However, it is likely that these issues will come up again and, with a different set of facts, the outcome could be different.

Please click here for more information on good faith in franchise agreements.

2. Minimum wage

The state of Seattle passed a minimum wage act that requires companies with more than 500 employees to raise their hourly wages to $15  over the next three years. However, the law treats franchisees as a single entity, so the requirement applies to all franchisee-owned businesses that are part of a larger network.

The IFA is appealing against this new legislation, but the matter highlights a wider issue of the sometimes unintended adverse impact of poorly conceived or drafted legislation. Certain jurisdictions, such as South Africa, have very cumbersome consumer protection laws, in which the definition of a
"consumer" catches franchisees, meaning that franchisors, including international franchisors, have to comply with those laws in order to have enforceable franchise agreements.

A new Consumer Rights Bill is doing the rounds in the UK parliament and it remains to be seen whether the final bill will avoid having any unforeseen and adverse consequences for the franchising sector in the UK.

3. Joint Employer Liability

The National Labor Relations Board (NLRB) ruled 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 came after the NLRB investigated 181 complaints by fast-food workers, 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.

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.

To sum up........

Franchising is a dynamic commercial relationship. When used in an ethical fashion it should create a genuine "win win" for both franchisor and franchisee. However, these recent developments suggest that there is a risk that franchising could become a victim of its own success, both in the US and elsewhere. As the sector grows, so does the likelihood that special interest groups will grow in confidence and influence on both sides and potentially distort the debate, basing their aims on misconceptions of what franchising is and how it should work. Government might be tempted to legislate, perhaps unnecessarily or ineffectively.  In these uncertain times, it is therefore important that those who support and understand franchising make their voices heard.