Franchise 101: AB 5’s Preemptive Strike; and Shelf the Self-Help

December 22, 2020
Fighting AB 5 text on metallic figures

Franchisor 101: AB 5’s Preemptive Strike

Franchisors faced unprecedented challenges in 2020. Enactment of California’s Assembly Bill 5 on January 1, 2020 was just the tip of an iceberg. As the COVID-19 pandemic upended franchise systems across all industries, franchisors grappled with legal, operational and business consequences of AB 5’s “ABC Test.”  Are franchisees now employees? Do all types of franchises meet the ABC Test or just some of them?  Will franchised businesses be exempt? These questions loomed large one of the most challenging years ever as the franchise industry sought reprieve from AB 5.

Several more bills sought to exempt franchise companies. None gained traction. The last lobbying opportunity was an assembly bill by the same AB 5 author. It passed with exemptions for 18 industries, but franchising was not one of them.

The International Franchise Association (IFA) took action after the latest derailed effort. In November, IFA, independent Supercuts and Dunkin’ franchise associations and the Asian American Hotel Owners Association, sued in federal court to challenge AB 5’s application to franchise relationships. The suit seeks a court declaration that franchisors and franchisees alike are exempt from AB 5’s sweeping ABC Test.

The crux of IFA’s suit is that franchising is stuck between a rock and hard place. Federal law, such as the FTC Franchise Rule and Lanham Act, require franchisors to exercise control over franchisees to protect their trademarks and other legal rights. The Lanham Act is a federal law that gives trademark owners protections, legal rights and remedies, but only if the trademark owner maintains control over quality of goods and services sold under the mark. But now, this mandated exercise of control risks triggering an employer/employee relationship under the ABC Test.

Similarly, IFA claims federal franchise law is inconsistent with the ABC Test. The FTC Franchise Rule regulates sales of franchises, including disclosures franchisors must make to prospective franchisees. The Rule defines employment and franchise relationships as mutually exclusive of one another. If franchisors cannot comply with their obligations under federal law, without being subject to AB 5 and its ABC Test, IFA’s argument is federal law preempts the inconsistent state law, therefore AB 5 cannot apply to the franchise relationship.

Supporting IFA is a recent federal court decision in Massachusetts. 7-Eleven prevailed against franchisees claiming they were misclassified as independent contractors under the state’s equivalent of the ABC standard, due to control by 7-Eleven over the business relationship. The court found the FTC Franchise Rule and Massachusetts’ ABC test conflicted and could not be reconciled. Similar to the IFA lawsuit, the court noted that any ruling that franchisees under federal law were also employees under state law would eviscerate the franchise model by penalizing franchise companies for misclassification based on nothing more than complying with one law over another.

Franchisors and franchisees will want to monitor IFA’s lawsuit and communicate with their franchise counsel. If IFA’s suit is successful, the ABC Test will not apply to determine if franchisees are properly classified under state law. However, franchisors and franchisees should be mindful of proposed federal law, such as the Protecting the Right to Organize (“PRO”) Act, that seeks to codify a federal ABC standard. Passage of the PRO Act could moot IFA’s argument.

Read: IFA et al. v. State of California, No. 3:20-cv-02243-BAS-DEB (filed Nov. 17, 2020)

Bad Play text superimposed over close up image of six numbered lottery balls

Franchisee 101: Shelf the Self-Help

Lola Salamah and Amro Elsayed signed a franchise agreement with M.M. Fowler, Inc., the franchisor of Family Fare gas stations, to operate a gas station franchise in North Carolina.

A few years into the franchise relationship, an employee stole nearly $23,000 of lottery tickets from their store. On the advice of Donald Pilcher, their business consultant and day-to-day contact with the franchisor, the couple bought back the tickets over time, by marking them as sold and placing their own funds in the store’s cash register. The franchisor was not told directly about the theft, because the franchise agreement mandated a faster timeline for the couple to repay the stolen amount.

Three years later, after having trouble repaying the rest of the lottery ticket debt, the couple asked Family Fare to split the difference. Family Fare responded with a termination notice based on “significant lottery shortages” at the store. The same day, Pilcher entered the store, took the key to the store’s safe, seized control of the cash register and had the locks changed.

The couple sued Family Fare, M.M. Fowler Inc., Pilcher and the company president, claiming defendants misclassified them as franchisees rather than employees, wrongly terminated their franchise in violation of civil rights laws because they are Arab Americans, and violated state unfair trade practices law based on the franchisor’s wrongful self-help eviction of the couple from their store.

The federal court in North Carolina ruled in the franchisor’s favor on the employment and civil rights claims and found that the termination was proper. However, on one issue the court sided with the couple, finding sufficient fact issues for the jury to decide if there was a wrongful eviction by force and by repossession of goods in the store. A jury would have to decide if harm from the eviction, in the form of the husband’s severe anxiety attack, an emergency room visit and medical bills, was caused by the termination and self-help actions.

Franchisors will often point to franchise agreement provisions that let the franchisor enter the premises in a termination. These provisions, however, do not give a franchisor a right to violate unfair business practice laws when using self-help. Going too far may give rise to damages claims by a franchisee.

Read: Elsayed v. Family Fare LLC, No. No. 1:18-cv-1045 (M.D.N.C. Aug. 10, 2020)

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