Last year, the franchising industry witnessed developments that significantly affected the core of its business model. These developments stem in large part from both federal and state governments taking a more active role in regulating the interests of labor and franchisees. Whether the governments’ approaches were proper is up for debate. However, what is not debatable is that franchisors must account for these developments to comply with franchise law and mitigate risk to their franchise system. Since the 2016 franchise annual renewal period is rapidly approaching for most franchise systems, now is the time for franchisors to assess and implement the requisite changes in their franchise program. This alert discusses three of the most significant developments franchisors will need to address during the 2016 franchise renewal period.

New Joint Employment Test
The National Labor Relations Board (“NLRB”) made two rulings on the “joint employment” [1] test that could potentially have far-reaching financial and legal implications on the franchise business model. On August 14, 2015, in McDonald’s USA, LLC, a joint employer, et al., [2] the NLRB denied McDonald’s request to challenge or strike NLRB General Counsel Richard Griffin’s expansive new definition of “joint employer.” Using this definition, the General Counsel alleged that McDonald’s is a joint employer with its franchisees, due to McDonald’s right to control certain employment and personnel matters of its franchisees. [3] Just two weeks after the McDonald’s ruling, the NLRB, in Browning-Ferris Indus. of California, Inc., [4]adopted the General Counsel’s new joint employment definition, abandoning the longstanding rule that required the exercise of control, and instead finding that the right to control, even if not exercised, is enough. The Board ruled on a 3-2 vote that Browning-Ferris Industries of California Inc. (“BFI”) was a joint employer with Leadpoint Business Services (“LBS”). [5] This decision was based on the NLRB finding BFI possessed both direct and indirect control, and the right to control the essential terms of the employee relationship of the employees provided by LBS. (For additional insights on Browning-Ferris Indus. of California, Inc. please see our “NLRB Broadens Joint Employment Standard” alert).

Given that the cornerstone of the franchise relationship is to have built-in controls to protect the franchise system (some of which will inevitably encroach upon the employment matters of franchisees), these recent rulings have caused substantial uncertainty and consternation for franchisors deciding how to structure their franchise programs to avoid joint-employer liability. To help temper these concerns, the NLRB’s General Counsel has made public statements noting that joint-employer status is a very fact‑specific inquiry, and controls necessary to protect the quality of the product or brand will not be enough to trigger joint-employer status. Additionally, the NLRB provided guidance in Freshii Advice Memo dated April 28, 2015 (“Memo”), to help franchisors seeking to avoid being deemed a joint employer under the new test.

In the Memo, the NLRB advised on whether Freshii Development, LLC (“Freshii”) [6] was a joint employer with Nutritionality, Inc., one of its franchisees (“Nutritionality”). The NLRB concluded in the Memo that Freshii was not a joint employer with Nutritionality under the new joint employer test, since Freshii did not “significantly influence the working conditions of Nutitionality’s employees.” The NLRB also noted in the Memo that there was no evidence that Freshii and Nutritionality shared control of, or codetermined, the essential terms of the employees’ contracts (e.g. hiring, firing, discipline, supervision, or setting wages).

Although the General Counsel’s public statements and Memo are nonbinding, they do provide some helpful guidance on structuring and updating franchise program documents to mitigate a franchisor’s risk of attaining joint-employer status. Some general pointers for franchisors to follow to reduce joint-employer risk include:

• Mandating that the franchisee includes signage in the franchise unit that clearly indicates to the franchisee’s employees that the unit is owned and operated by the franchisee.

• Including express language in the franchise agreement and other related franchise program documents that the franchisee is solely responsible for its employee and personnel matters.

• Allowing franchisees to, in fact, make employment decisions, including what policies to implement, how to set employee schedules, developing compensation and benefits plans, how to discipline employees, and employees’ hiring and firing.

• Avoiding franchisor day-to-day supervision of any kind and, in the event the franchise agreement requires or contemplates inspections, ensure that franchisor-level inspectors provide instruction only to high levels of franchisee management, and not front-line employees.

• Including in the franchise agreement and other franchise program documents only those controls that are required to protect goodwill and standards of the franchise system. [7]

Proposed Overtime Exemptions
Current law guarantees overtime pay for employees working in excess of 40 hours per week if they earn less than a certain threshold. Employees earning more than the threshold may be exempt from the rules. On June 30, 2015, the Department of Labor (“DOL”) proposed overtime rules that will substantially increase the minimum salary level needed to classify an employee as potentially exempt from the overtime pay requirement. [8] Under the proposed rules the minimum salary for a worker to be overtime exempt will rise from $23,660 to $50,440, and the highly compensated employee exemption will increase from $100,000 per year to $122,148. In addition, to prevent the exemption levels from becoming outdated, the DOL is proposing a mechanism that automatically updates the salary and compensation thresholds on an annual basis.

The Solicitor of Labor, Patricia Smith, mentioned at a recent American Bar Association event that it is unlikely the final rules on this matter will be issued until late 2016. Of course, the issuance of the final rules may change depending on the results of the upcoming presidential election, but there appears to be support in both parties for raising the exemption thresholds by some amount.

Notwithstanding the politics relating to this matter, if these prospective rules are adopted, there will be significant ramifications on labor costs and liability risk for employee misclassifications for both franchisees and franchisors (including franchisors that own and operate corporate units as well as franchisors that may fall within the scope of the new joint-employer test). [9]

In addition to evaluating the impact of these proposed rules on franchisors’ annual budgeting process, franchisors should also begin to assess how to best:

• Calibrate their workforces to comply with these proposed regulations (e.g. identifying positons that may no longer qualify as exempt, reclassifying employees, etc.).
• Make disclosures in the franchise disclosure document (e.g., Items 1, 7, and 19) to avoid claims relating to a material omission of fact.
• Inform franchisees and their franchisee advisory councils on how these rules may impact their operations.

New (and Proposed) Relationship Laws
California amended its franchise relationship law on October 11, 2015, to provide additional franchisee protections with respect to franchise terminations, renewals, transfers, and buyback obligations. This amended law took effect on January 1, 2016, and in connection with the amended law, franchisors with California franchisees will need to update, among other things, their:

• California Addenda to the franchise disclosure document and franchise agreement to reflect the changes in law.

• Franchise renewal and transfer policies to account for the new standards.

It is worth noting that, in recent years, there has been a groundswell of debate surrounding franchise relationship laws, and this debate has rekindled a push for some states to strengthen existing or pass new franchise relationship laws. [10] For example, the states of New Hampshire, Maine, Massachusetts, and Pennsylvania have introduced bills to create franchise relationship laws in their respective states. Now, the federal government has gotten into the “act” with Rep. Keith Ellison introducing the two bills: the Fair Franchise Act of 2015 (“FFA”) [11] and the Small Business Administration Franchise Loan Transparency Act of 2015 (“SBAFLTA”) [12]. The FFA and SBAFLTA are both currently being considered in committee.

Similar to state franchise relationship laws, the FFA seeks to provide franchisees with greater protections on standard relationship law matters like franchise renewals, terminations, and assignments. Under the SBAFLTA, franchisors (except those in the lodging industry) will be required to include additional disclosures in their franchise disclosure document regarding first-year operations of franchisees in the franchise system. The SBAFLTA also requires the franchisor to disclose to the franchisee any financial information pertaining to the performance of any franchise location that the franchisor provides to a potential lender on behalf of the franchisee-borrower. Although neither the FFA nor SBAFLTA is expected to pass, these proposed laws do underscore the fact that franchise relationship laws have become a political issue that will continue to gain momentum as we move through 2016. Accordingly, these initiatives could have major effects on franchisee intake processes and contractual requirements.

We will continue to monitor and keep you abreast on these and other franchise matters in 2016.

Notes:
[1] Being deemed a “joint employer” by the NLRB under the National Labor Relations Act (“NLRA”) might subject a franchisor to collective bargaining requirements, as well as liability for violations of labor laws by its franchisees. It is worth noting that the NLRB’s joint employment test does not apply to all employment statutes, and certain employment statutes have their own test for joint employment. In fact, the Wage and Hour Division of the Department of Labor (“DOL”) recently issued Administrator’s Interpretation No. 2016.-1 (“Interpretation”), providing guidance on when a joint employment relationship exists under the Fair Labor Standards Act (“FLSA”) and Migrant and Seasonal Agricultural Worker Protection Act (“MSA”). In the Interpretation, the DOL asserts that the joint-employment test under the FLSA and MSA is more expansive than the NLRB’s test, and focuses on the economic realities of the employment relationship. (See http://src.bna.com/b7j). As a consequence, the standard for determining that franchisors have liability for the wage and hour violations of franchisees may be even more likely to result in exposure for the franchisor.

[2] 362 NLRB No. 168 (2015)

[3] Under the General Counsel’s formulation of the test, a joint-employment relationship is found not only when an entity’s control over the employment matters of another is direct and immediate, but also where such entity indirectly controls or reserves the right to control certain terms and conditions of the employment relationship of another party’s employees.

[4] 362 NLRB No. 186 (2015)

[5] LBS was an employment agency that supplied BFI with its employees.

[6] Freshii is a franchisor of fast-casual restaurants.

[7] This analysis will be a familiar exercise to franchise attorneys who advise on structuring trademark licensing and distribution arrangements to avoid franchise law liability.

[8] The DOL has stated that these rules would extend overtime protections to nearly five million white-collar workers within the first year of implementation.

[9] Although the NLRB’s definition of “joint employer” only applies to the NLRA, recent developments from government agencies and courts alike signal broadening standards for finding employee status.

[10] In general, franchise relationship laws govern the ongoing contractual relationship between the franchisor and franchisee after the execution of the franchise agreement. Nearly one-third of the states have enacted some form of a franchise relationship law.

[11] H.R. 3196

[12] H.R. 3559