Franchise 101: New Joint Employer Rule Nixed for Now; and Trashing the Competition

Franchisor 101: New Joint Employer Rule Nixed

In another twist to the joint employer saga, a United States District Court in New York voided the Department of Labor’s (“DOL”) new rule for joint employment. Eighteen (18) states and the District of Columbia brought a lawsuit challenging the rule. The court found that DOL’s new rule conflicts with definitions in the Fair Labor Standards Act (“FLSA”) and is both arbitrary and capricious.

DOL’s new joint employment rule uses a four-part test to determine if an employer is a joint employer of another company’s employees. If met, an employer would be jointly and severally liable to another company’s employees for damages for violating the FLSA.

The test consists of whether the alleged joint employer (1) hires or fires the employee; (2) supervises and controls the employee’s work schedule or conditions of employment to a substantial degree; (3) determines the employee’s rate of pay and method of payment; and (4) maintains the employee’s employment records.

The court rejected the new rule as contrary to law because it conflicted with the FLSA. The rule used the FLSA’s definition of “employer” as the sole basis for joint employer liability, while ignoring interrelated definitions in the FLSA for “employer,” “employee,” and “employ.” There was also inconsistency in the rule’s creation of separate tests to determine whether an entity is an “employer” and whether the entity is a “joint employer.”

The court also found the rule was arbitrary and capricious. This was due to (1) inability of DOL to explain why it departed from prior interpretations of joint employment; (2) conflict between the FLSA and the Migrant and Seasonal Agricultural Workers Protection Act (“MSPA”) despite the MSPA regulations which state that the joint employment test should be the same under both the MSPA and FLSA; and (3) failure to adequately consider the new rule’s cost to workers, such as wage theft by employers or an employer’s insolvency.

The International Franchise Association intervened in the case to support DOL. This lets IFA appeal the decision, if they choose to do so. For now, this ruling invalidates the DOL rule and creates uncertainty for employers. Franchisors should get advice of counsel as to how this opinion impacts their franchised business, within the context of implementing best practices during the COVID-19 pandemic. While the joint employer saga is likely to continue and generate more guidance in the future, franchisors should ensure, at a minimum, that franchisees determine essential terms of employment, including hiring, firing, discipline, wages, and when and where work will be performed.

Franchisee 101: Trashing the Competition

In a misappropriation of trade secrets action, a franchisor sued a prospective franchisee, claiming breach of a non-disclosure agreement (“NDA“)by operating a competing business. The prospective franchisee signed the NDA before attending the franchisor’s discovery day. The court disagreed, finding all information the prospective franchisee learned and used in the competing business was public knowledge, not subject to an NDA.

Todd Perri, a prospective franchisee of Smash Franchise Partners, franchisor of mobile trash compacting businesses, researched the franchisor’s business model. Perri used information the franchisor posted online, spoke to franchise brokers about the franchise, and participated in calls about the business. These included an introductory call and a call relating to the economics of business and start-up expenses required to begin operations.

After both calls, Perri was required to sign an NDA before he could attend franchisor’s discovery day. Perri signed the NDA and continued to learn about the franchisor’s system from franchisor executives and franchisees. Perri did not sign a franchise agreement. Instead, he began a competing mobile trash compacting business.

The franchisor sued Perri for misappropriating trade secrets and sought a preliminary injunction to bar Perri from using and disclosing the franchisor’s confidential and proprietary information. The franchisor claimed Perri began operating a competing business, despite having signed the NDA. The court denied injunctive relief.

The franchisor claimed the confidential information Perri received included information posted online and information received from franchisees. The court found such information is publicly available and not protected by the NDA. This was because it excluded (1) information that was publicly available at the time of disclosure and (2) information that was provided by a third-party. The court determined that the information received by Perri was not specific enough to reveal critical information about the franchisor’s business.

Prospective franchisees who research a franchise system and receive information from a franchisor, who then decide to open a similar competing business, should consult with counsel to ensure that operating the business will not breach an existing agreement with the franchisor, such as a non-disclosure agreement.

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