In November 2017, four convenience store franchisees brought suit in federal court against 7-Eleven, Inc., alleging that they and all other franchisees were employees of 7-Eleven. The case was filed in the United States District Court for the Central District of California, entitled Haitayan, et al. v. 7-Eleven, Inc., case no. CV 17-7454-JFW (JPRx).

In alleging that they were 7-Eleven’s employees, the franchisees brought claims for violation of the federal Fair Labor Standards Act (“FLSA”) and the California Labor Code, alleging overtime and expense reimbursement violations. The trial court granted judgment in 7-Eleven’s favor, concluding that 7-Eleven was not the four franchisees’ employer under California law or federal law.

The court noted that the franchisees’ “basic legal theory underlying [their] claims [wa]s that 7-Eleven’s restrictive policies and practices created an employment relationship between the parties.” The court concluded that because the franchisees could not establish an employment relationship, each of their claims failed.

For example, while 7-Eleven required the franchisees to keep their stores open 24 hours per day, 364 days per year, the court was persuaded by the fact that the franchisees themselves were not “actually required to work at the stores a particular number of hours or on particular days” – they could hire employees to meet these requirements. And while the franchisees argued that 7-Eleven controls the payment of all wages and instructs franchisee on pay practices, performance appraisals, and disciplinary actions, including worker terminations, that did not persuade the court because “the fact that a franchisor pays a franchisees’ employees’ wages does not create an employment relationship,” and the franchisees admitted that they have unfettered discretion to hire and fire employees and set wages.

Because the franchise agreements explicitly provided that franchisees “control the manner and means of the operation” of their stores and “exercise complete control over and all responsibility for all labor relations and the conduct of [franchisees’] agents and employees, including the day-to-day operations” of franchisees’ stores and employees, the court concluded that such minimal control was insufficient to make franchisees common law employees of 7-Eleven.

The federal court’s decision is a welcome one for franchisors that have sound franchise agreements and practices in place. It is certainly possible that the court would have reached a different conclusion had 7-Eleven’s franchise agreement or practices provided for 7-Eleven to have a greater right to exercise control over franchisees.  In light of this decision, franchisors should review their agreements and practices to ensure they do not have a right to control the wages, hours, or working conditions of franchisees.

Claims that employees have been misclassified as independent contractors remain a focus for private plaintiffs and government agencies. Contracts that exert control over the business of another company may be a particularly fertile source of misclassification claims by plaintiffs seeking unpaid wages.

Two recent suits arising from franchise agreements with Jani-King, described by the Third Circuit as “the world’s largest commercial cleaning franchisor,” demonstrate the potential liability that can arise under these circumstances.

Wage Hour Division Sues Based on Misclassification of Franchisees

Last week, the Department of Labor filed suit claiming that franchisees of Jani-King of Oklahoma Inc. are actually employees under the Fair Labor Standards Act.

The DOL alleges that the franchisees typically have no employees of their own, but rather are individual who are required to pay Jani-King a franchise fee, royalties, and other payments to receive cleaning assignments.

The suit contends that Jani-King, among other things, sets customer cleaning rates; negotiates with customers over the cleaning contracts under which franchisees work; reassigns cleaning contracts from one franchise to another; handles “all aspects of how and whether cleaners are paid for the work they perform;” and collects payments from customers.

Notably, the only claim in the DOL’s Complaint is for an injunction requiring Jani-King to begin keeping records of the wages and hours its alleged employees. The fact that the DOL has chosen to pursue injunctive relief in the absence of any other remedy suggests a strong interest in the principles at issue in the case.

Third Circuit Affirms Class Certification Based on Franchise Agreement & Manuals

The DOL suit was preceded by a September 21, 2016, decision by the Third Circuit Court of Appeals.  That decision upheld a district court’s order certifying a Rule 23 class action of approximately 300 Philadelphia-area franchisees who claim to be Jani-King employees.

In determining whether an employee has been misclassified as an independent contractor under Pennsylvania law, the Third Circuit stated that “the paramount factor is the right to control the manner in which the work is accomplished.”

The District Court’s opinion had pointed to specific provisions in the Jani-King franchise agreement, policy manual and training manual through which Jani-King (among other things) mandated how often a franchisee communicated with customers and dictated how franchisees addressed customer complaints, maintained their records and solicited business.

The District Court stated that “[t]hose documents also demonstrated that Jani-King controlled the franchisees’ work assignments, has the right to inspect the franchisees work, and has the ability to change the policies and procedures as it sees fit.”

Because the Jani-King franchise agreement, policies manual, and training manual were common to the class, they supported the conclusion that common issues would predominate in misclassification cases by franchisees. Therefore, the Third Circuit affirmed the District Court’s class certification order.  The plaintiffs will therefore be able to pursue class claims against Jani-King under the Pennsylvania Wage Payment and Collection Law.

The sometimes-rigid nature of franchise relationships can not only be evidence of the level of control characteristic of an employment relationship, but can also provide a basis for arguing that claims should joined in a Rule 23 class action. Companies, therefore, should consider whether the controls imposed by franchise agreements (or any other contracts) are justified by their potential to create unwanted employment relationships.

New York Attorney General Contends Domino’s is a Joint Employer with Franchisees

After spending the last few years litigating with Domino’s franchisees over wage hour violations, the New York Attorney General has filed suit contending that franchisor Domino’s Pizza Inc. is a joint employer with three franchisees, and therefore is liable for the “systematic underpayment” of franchise employees.

The New York Attorney General also claims that, regardless of whether it’s a joint employer, Domino’s is liable for misrepresentations and nondisclosures that led to the underpayment of employees at the three franchises and violated the New York Franchise Sales Act.

Background

Through settlements in March 2014 and April 2015, twelve Domino’s franchise owners paid a total of approximately $1.4 million to settle the Attorney General’s claims for violations of New York’s minimum wage and overtime laws.

After the second settlement, New York Attorney General Eric Schneiderman accused Domino’s Pizza, Inc. of “turn[ing] a blind eye to illegal working conditions.”  Mr. Schneiderman stated:  “My message for Domino’s CEO Patrick Doyle is this: To protect the Domino’s brand, protect the basic rights of the people who wear the Domino’s uniform, who make and deliver your pizzas.”

Domino’s was thus left to choose its poison:  It could involve itself directly in addressing the alleged “illegal working conditions” at the risk of making itself a joint employer; or it could maintain a hands-off approach in an effort to avoid joint employer status, while further violations might increase its potential liability.

Nevertheless, Domino’s attempted to balance these concerns.  In a March 18, 2016 letter to the New York Attorney General’s Labor Bureau Chief, Domino’s offered to fund legal compliance training for franchisees, require franchisee’s to accept a code of conduct and pay for a monitor to inspect franchisee stores for compliance.  Domino’s further stated that it would “work with its franchisees in an effort to create a pool of funds to pay restitution to any underpaid franchisee employees.”

Allegations of Joint Employment

The Attorney General apparently found Domino’s proposal to be insufficient.  Therefore, in May 2016, the Attorney General filed a Verified Petition in New York Supreme Court alleging that Domino’s was a joint employer with its franchisees because it had:

  • required Franchisees to purchase hardware and software for Domino’s PULSE management system;
  • maintained payroll and employment records for franchisees;
  • exerted control over franchisee hiring, firing and disciplining of employees;
  • controlled aspects of employee compensation at franchisee stores;
  • dictated staffing and scheduling requirements for franchisee stores;
  • imposed an antiunion policy on franchisees; and
  • required a franchisee purchasing existing stores to keep the prior staff largely intact and in the same positions at the same rates of pay.

Domino’s status as a joint employer in this case will be evaluated under New York law.  However, it is notable that in Patterson v. Domino’s, the California Supreme Court examined Domino’s practices in 2014 and found it was not a joint employer under California law.  The California Supreme Court based its decision on uncontradicted evidence that the franchisee (i) made day-to-day decisions involving the hiring, supervision, and disciplining of his employees, and (ii) ejected the franchisor’s suggestion that an alleged sexual harasser should be fired, and neither expected nor sustained any sanction for rejecting that suggestion.

Alleged Misrepresentations

In addition to joint employment, the Verified Petition alleges:

Domino’s itself caused many of the wage violations because Domino’s encouraged franchisees to use a “Payroll Report” function in the software system Domino’s required franchisees to install and use in their stores (known as “PULSE”), even though Domino’s knew since at least 2007 — yet failed to disclose to franchisees — that PULSE’s “Payroll Report” systematically under-calculated the gross wages owed to workers.

The Verified Petition further alleges that, while failing to tell franchisees about the problems with PULSE, Domino’s charged franchisees $15,000 to $25,000 for the PULSE hardware and software.

Therefore, the New York Attorney General contends that Domino’s is liable for fraud and violations of the New York Franchise Sales Act (which requires a franchisor to provide a prospective franchisee with detailed information regarding “all written or oral arrangements,” including those for the sale of goods or services, in which the franchisor has an interest).

Wage Hour Violations

Underlying these theories for imposing liability on Domino’s are the allegations that its franchisees failed to pay the proper overtime rates to tipped employees.

For example, the Verified Petition alleges that PULSE fails to properly calculate overtime pay for tipped employees under New York law.  12 NYCRR § 146-1.4 states that when “an employer is taking a credit toward the basic minimum hourly rate…, the overtime rate shall be the employee’s regular rate of pay before subtracting any tip credit, multiplied by 1½, minus the tip credit.”  The regulation goes on to state:

It is a violation of the overtime requirement for an employer to subtract the tip credit first and then multiply the reduced rate by one and one half.

The New York minimum wage was $8.75 per hour in 2015, and the maximum tip credit was $3.10 per hour.  Thus, the overtime rate of any tipped employee should have been at least ($8.75 per hour x 1.5 for overtime) minus ($3.10 per hour tip credit), or $10.03 per overtime hour.

However, according to the Verified Petition, the software used by the Domino’s franchisees subtracted the tip credit first, and then multiplied the reduced rate by 1.5.  The Petition states:  “PULSE calculates the employee’s overtime rate at $8.48 per hour ($5.65 times 1.5), which is $1.55 per hour less than the then-current 2015 legal overtime rate for tipped delivery employees.”

Accordingly, the Verified Petition contends that “PULSE systematically undercalculates the gross overtime wages owed to franchise delivery workers who were paid tipped rates.”

The New York Attorney general further contends that Domino’s is liable because the franchisees (i) did not aggregate the hours worked by employees who worked at more than one location; (ii) claimed tip credits for employees on days when they works at a non-tipped position for more than 20% of the employee’s shift or for two hours or more during the shift; (iii) did not calculate or pay the required “spread of hours” pay when a daily shift is longer than 10 hours; and (iv) required drivers to pay their own expenses for delivery vehicles in violation of New York Labor Law §193.

Conclusion

Undoubtedly, the franchise business model will continue to give rise to claims of joint employment.  To the extent possible, franchisors should attempt to eliminate any appearance that they control the employment with a franchisee, particularly in regard to hiring, firing and the payment of wages.  Where involvement by the franchisor is unavoidable, a franchisor must make every effort to comply with the law and communicate any potential concerns to franchisees.