Are Franchisees Your Employees?; and Locked In to One Approved Vendor
bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
msoroky@lewitthackman.com
kwallman@lewitthackman.com
tvernon@lewitthackman.com
December 2016
Certified Franchise Executives
Barry Kurtz, Tal Grinblat and David Gurnick completed the experience, education and participation requirements to become Certified Franchise Executives under the auspices of the International Franchise Association (all three are already State Bar of California Certified Specialists). This distinction will be conferred on Barry, Tal and David at a ceremony at the International Franchise Association’s annual convention in January, 2017.
FRANCHISOR 101:
Are Franchisees Your Employees?
Prudent franchisors have been reducing their apparent control over franchisees’ employees to reduce the risk of becoming joint employers of those employees. But could a franchisor’s control over the franchisees themselves be used to prove that franchisees are the franchisor’s employees?
In Matter of Baez, the Unemployment Insurance Appeal Board determined that franchisees of Jan-Pro Cleaning Systems, a janitorial franchisor, were Jan-Pro’s employees. The Board held Jan-Pro liable as an employer to pay unemployment insurance contributions on payments it made to franchisees.
A New York appeals court said the Board may find an employment relationship if “substantial evidence” shows that an alleged employer “exercises control over the results produced or the means used to achieve the results,” and said that control over the means is the more important factor. The court found there was sufficient evidence that Jan-Pro exercised such control over franchisees.
This was because Jan-Pro:
(i) Assigned geographic territories to franchisees;
(ii) Required franchisees to be trained, which Jan-Pro paid for;
(iii) Required franchisees to operate according to Jan-Pro’s procedures and standards, including using only pre-approved equipment and supplies;
(iv) Could claim ownership of concepts or techniques created by franchisees;
(v) Had a contractual non-compete provision against franchisees for 1 year after termination;
(vi) Helped resolve complaints between franchisees and their clients;
(vii) Had the right to discontinue franchisees’ services to any of their clients;
(viii) Provided franchisees with a starter set of business cards bearing Jan-Pro’s logo, and had to approve any franchisee-designed business cards before use; and
(ix) Had the sole right to bill and collect payments from franchisees’ clients.
As a result, the court upheld the Board’s ruling against Jan-Pro.
Experienced franchisors will recognize much of the court’s assembled “evidence of control” as common features of franchise systems. But franchisors may distinguish themselves from Jan-Pro, and hopefully avoid the same fate, by:
A) avoiding, to the extent possible, inserting themselves between franchisees and their customers as Jan-Pro did in points (vi) through (ix) above; and
B) charging franchisees a distinct “initial training fee,” instead of offering training “for free” as Jan-Pro did (point (ii) above).
The latter may be potent counter-evidence against a finding of employment because employees rarely pay their employers for the right to be trained.
See In the Matter of Baez, N.Y. Sup. Ct., App. Div., ¶15,878
FRANCHISEE 101:
Locked In to One Approved Vendor
Franchisors often require franchisees to purchase supplies, materials, or inventory only from suppliers the franchisor approved. But where franchisors see benefits of consolidating by requiring franchisees to participate in volume purchases and ensuring product quality and consistency, franchisees see potential conflicts of interest.
In Window World of Baton Rouge v. Window World, a vinyl window sales and installation franchise, the franchisees agreed to: “sell and install only and exclusively those products, goods, equipment, and parts from vendors approved by [Window World].” The agreements added that Window World would try to get the lowest possible wholesale pricing for franchisees. Window World did not collect royalties from franchisees. Instead it collected from vendors a percentage of the sales price of items sold to franchisees.
In 2007, Window World announced that Associated Materials (AM) would be the only approved supplier of windows. Franchisees sued under antitrust law, claiming Window World and AM had an illegal conspiracy to “lock them in”, forcing them to buy inventory at higher prices than they could get from other suppliers or even than they could get from AM if they weren’t franchisees. The alleged price inflation increased AM’s profits and Window World’s royalty collections.
The North Carolina court concluded the franchisees could pursue their antitrust claim if Window World conspired to manipulate the “market” so that franchisees were forced to pay artificially high prices. But in this case Window World was able to require franchisees to buy windows solely from AM not because of power over the market, but because the license agreements gave the franchisor the right to approve even only one supplier if it wished.
The agreements were clear, so when franchisees signed they had fair warning of the risks of buying a Window World franchise. Franchisees effectively purchased windows in a free market; before signing, they had freedom in the “market” to buy a different franchise in which the franchisor didn’t have the right to designate a sole supplier. The court dismissed the claim.
Before buying a franchise, a potential franchisee should be sure to understand the scope of the franchisor’s right to designate approved vendors. Ask other franchisees in the system if they get competitive prices from vendors. Check the franchise agreement for terms that may limit this freedom in the future. Make sure to understand how the franchisor gets its revenue. It may be illogical to expect to pay rock bottom prices for supplies if what the vendor charges must be enough to also provide revenue to the franchisor.
But don’t automatically reject a franchise just because there is a single source of supply. A franchise brand’s concentration and volume purchasing from a chosen supplier may have offsetting benefits that contribute to the success of the system and its franchisees.
See Window World of Baton Rouge v. Window World, N.C. Super. Ct., ¶15,880