On September 28, 2021, Fox Rothschild partner Craig Tractenberg with Rochelle Spandorf from Davis Wright Tremaine LLP provided perspectives on drafting licenses and distribution agreements respecting the evergreen issue of creating an accidental franchise in a Strafford Publications webinar. They also discussed best practices for complying with federal and state franchise and business opportunity laws once an inadvertent franchise is established.

The topics addressed were:

  • determining whether a business constitutes a franchise;
  • strategies for drafting licenses and distribution agreements to avoid accidental franchises; and
  • complying with federal and state franchise and business opportunity laws once a franchise is established.

They discussed examples of well known businesses which were deemed to be accidental franchises by courts, and the legal consequences of those legal decisions. Much of the questions and answers from the audience were about structuring to avoid the franchise trap.

Of special interest was the hot topic of agreements in the cannabis space. Rochelle and Craig discussed:

  • the risks of accidental franchising in the cannabis distribution business;
  • retail cannabis/cbd licensing programs (e.g. ONE Cannabis, Miracle Leaf) which operate under a common brand and business concept as service businesses;
  • how some state registration states like California will not permit the offer and sale of cannabis franchises because of federal illegality;
  • other complications including state franchise registration, federal legalization, banking, insurance, federal income tax deductions and financial statement presentation.

As new industry sectors like cannabis move into licensing multiple locations, the reward of franchising–leveraging local knowledge and capital–is obvious. But, sometimes, the danger of the accidental franchise is overlooked inadvertently. Both Rochelle and Craig encourage all businesses expanding with a license model to consider whether they are creating an accidental franchise system.

Recently, I moderated a panel for an International Franchise Association webinar called “From Venture Capital to Private Equity: Franchise Investment Trends and Terms”.  I was fortunate to have fantastic panelists: Satya Ponnuru (General Partner of NewSpring Franchise), Vanessa Yakobson (CEO of Blo Blow Dry Bar), Bernard Markey (Navigator Partners) and Ed Teixeira (Franchise Grade).  I wanted to share some of the takeaways of that panel.

First, to differentiate, the panel covered everything from early stage growth equity investments (venture capital) to later stage private equity buyouts – a lot to fit into one hour!  Both venture capital and private equity have grown exponentially in the last few years – the first half of 2021 approximating the first 2/3 of 2020 in private equity funding according to the Pitchbook Q2 2021 US PE Breakdown report.  And interest in the franchise sector has grown at all stages.

One of the main takeaways was the emphasis all panelists placed on a healthy relationship between the franchisor and the franchisee.  Clearly, a franchise system will not be a strong business unless the financial metrics are solid at the franchisee level – if the franchisees are not making money, the system will ultimately fail.  But also general communication between the franchisor and franchisee and satisfaction with that relationship was an important aspect of strong franchise business.

Second is making sure that the partnership between the founders and others involved in the franchise system and the investors is solid and that goals are aligned between the two.  They will be working together, hopefully for a long time, so it is important to take time to be confident of the relationship.

Third, for a franchise system to make strong efforts to keep your books and records in order.  If you don’t have someone on your team that is in charge of legal, compliance and/or the financial end of the business, that needs to be added.  Everything from the basics of making sure receipts and franchise agreements are properly signed to gathering solid data on your franchisee businesses should be undertaken from the beginning.

And all seemed to agree that, except in rare circumstances, a solid Item 19 Financial Performance Representation is important.  A lack of an Item 19 was viewed as a warning sign.

Of course, pointers relating to the due diligence process and the negotiation of the transaction were covered, but it is important to keep these high-level tips in mind as well.

Third-party food delivery services via app (e.g., DoorDash, GrubHub, Uber Eats, Postmates, etc.) have become–especially in these pandemic times–a vital part of the restaurant industry ecosystem. And we know that franchise systems regularly utilize and partner with these app-based services. Now, New York City has enacted groundbreaking new laws to regulate these services. Some portions of the laws, such as bathroom access privileges, place new requirements on restaurants.

Carolyn D. Richmond, Glenn S. Grindlinger, and Timothy A. Gumaer of Fox Rothschild’s New York Labor and Employment Group took a deeper dive into what these new laws mean:

New York City Council has passed a package of six bills that together regulate nearly every aspect of the relationships between third-party food delivery services and their delivery workers within New York City. The bills, passed on September 23, 2021, (and explained in more depth below) are expected to be signed into law by Mayor Bill de Blasio within the next few days.

Restaurants will be directly impacted by a provision in one of the bills that says all third-party food delivery services must modify contracts with restaurants to ensure that bathroom facilities are made available to delivery workers unless exceptions apply.

Prohibition on Fees for Payment of Wages

Bill 2296-2021 prohibits third-party food delivery services from charging delivery workers a fee in order to obtain their wages and tips in a specific payment method, such as direct deposit or check. Additionally, the bill requires third-party food delivery services to pay its delivery workers on a weekly basis.

Disclosure of Gratuity Polices

Bill 1846-2020 prohibits third-party food delivery services from soliciting a tip from a customer unless it also discloses (i) the proportion or fixed amount of each tip that will be distributed to the food delivery worker, (ii) the manner in which the tip is provided to the worker (whether immediately or not), and (iii) the method in which the tip will be provided (in cash or another method).

The law also requires that, for each transaction, a food delivery worker shall be notified:

  • how much the customer paid as a gratuity
  • whether the customer paid an additional gratuity after delivery
  • if the customer decided to remove the gratuity, and
  • the reason for the removal if such a reason is provided.

Upon any change or payment of gratuity, the third-party delivery service shall notify the food delivery worker and credit such gratuity to the individual’s account. The third-party delivery service shall also disclose to the courier the aggregate amount of compensation and the aggregate amount of gratuities earned by the courier no later than the day after they are earned.

Third-party food delivery services must maintain for at least three years records demonstrating compliance with the above requirements as a condition of maintaining a license to operate in New York City.

Minimum Payments Per Trip

Bill 2294-2021 establishes the mechanism by which the City will determine the minimum amount earned by a food delivery worker per trip, exclusive of gratuities.

Under this bill, the Department of Consumer and Worker Protection (the Department) is tasked with analyzing the working conditions for food delivery workers, including:

  • the pay they receive and the methods by which pay is determined
  • total income typically earned
  • expenses of such workers
  • equipment required to perform their work
  • the hours of such workers
  • average mileage per delivery trip
  • mode of travel
  • safety conditions

The bill gives the Department the power to request or issue subpoenas for production of data, documents and other information from a third-party food delivery service relating to food delivery workers. Such information may include the times that workers are available to work for the third-party service, how trips are offered or assigned to workers, the compensation workers receive from the service, any gratuities workers receive, agreements or policies covering workers, contact information of workers, information relating to the setting of fees paid by food service establishments and consumers, and any other information deemed relevant by the Department.

Based on its analysis, the Department shall, no later than January 1, 2023, establish a method for determining the minimum payments for a food delivery worker. How much a food delivery worker will earn per trip will be based upon such calculation. Third-party food delivery services are forbidden from taking a tip credit toward wages it must pay food delivery workers.

Beginning February 1, 2024 (and no later than February 1 of each year thereafter), the Department shall announce any update to the minimum payment calculation. The update, if any, would then take effect on April 1 of the same year.

Geographic Limits on Delivery

Bill 2289-2021 addresses general provisions relating to the working conditions for workers and requires that third-party food delivery services permit workers to set limits on distance and routes for deliveries.

Third-party food delivery services must inform the delivery worker, prior to the trip, the address where the food, beverage or other goods must be picked up, the estimated time and distance per trip, whether the customer provided a gratuity, and the compensation for the trip (excluding gratuity).

Delivery workers must also be provided the opportunity to (i) set the maximum distance per trip they will travel, and (ii) reject routes that include bridges or tunnels, both of which can be changed at any time by the worker and at their sole discretion. Third-party food delivery services are forbidden from retaliating against a worker for their chosen parameters in the form of, amongst other things, denial of work opportunities, reduction in hours or pay or a reduction in the worker’s public or internal “approval” rating.

Each third-party food delivery service must also provide its workers with a notice of rights under the law. Such notice of rights will be created and published by the Department.

For each violation, a third-party food delivery service will be subject to a $500 fine for the first violation and, for subsequent violations that occur within two years of any previous violation, up to $750 for the second violation and up to $1,000 for each succeeding violation. Food delivery workers will also be entitled to seek compensatory damages in actions against third-party food delivery service for any violations under the law.

Insulated Food Bags to Be Provided to Delivery Workers

Bill 2288-2021 requires third-party food delivery services to provide, at their own expense, insulated food bags to food delivery workers that have worked at least six deliveries for the service. Previously, a third-party food delivery service could require its workers to provide insulated food bags at their own expense.

The bill gives the Department the power to deny, suspend, or revoke a third-party delivery service’s license to operate in New York City if the service is found to have violated these provisions two or more times within a two-year period.

Bathroom Access for Delivery Workers

Bill 2298-2021 states that a third-party food delivery service must include in its contracts with restaurants a provision that requires the restaurant to make available its bathroom facilities to third-party food delivery workers so long as the delivery worker seeks access to the facilities while picking up an order for delivery. However, the bill notes that a restaurant is not required to do so if (i) accessing the toilet facility would require a worker to walk through the establishment’s kitchen, food preparation area, storage area or utensil washing area or (ii) accessing the facility “would create an obvious health and safety risk to the food delivery worker or to the establishment.”

While the bill does not define the term “health and safety risk,” the Department is charged with developing rules and enforcing the bathroom measures.

Fox’s franchise team will continue to monitor these new laws, watching to see if they become a trend in other cities and even states across the country.

The Covid-19 pandemic has changed a lot of things, including employment verification. Does your franchise system understand the special provisions the federal government instituted in the I-9 Employment Eligibility Verification process as a result of the pandemic? If not, you could quickly find yourself on the wrong side of the law.

Join Fox Immigration Partners Catherine V. Wadhwani and Mark D. Harley on Tuesday, October 5, 2021, at 12 noon ET/9 am PT for a one-hour webinar that will provide an overview of current Form I-9 requirements, appropriate steps for return-to-work and potential liability for non-compliance.

Register for the webinar HERE.

While the Protect the Right to Organize (PRO) Act was passed by the House of Representatives, it has not been made part of the Biden administration’s infrastructure efforts thus far and does not appear have sufficient support to overcome a certain filibuster in the Senate. Therefore, passage of the Act in its present form is unlikely, especially because the reconciliation process being used for the so-called Biden Budget Blueprint would not seem to apply to the PRO Act.

Thus, at the same time a strong anti-PRO Act lobby appears to be gaining momentum, the administration is reportedly contemplating adopting parts of the PRO Act by executive order, although the scope of such an order would be constitutionally limited.

Whether or not the PRO Act becomes law, David Weil may be inclined to either revert to the Obama era “economic realities” joint employment standard or could propose an even stricter ABC joint employment test. Dr. Weil’s book, Fissured Employment, provided a thoughtful foundation for the economic realities standard, but whether he would support a stricter ABC test is anyone’s guess.

The NLRB is constrained by existing legislation and cannot independently adopt all the changes featured in the PRO Act, nor could an executive order command legislative changes. For example, only the PRO Act would by law embed the indirect control standard into the NLRA. That said, the Board could revise its definition of employee, as it did during the Obama era, in the course of its quasi-judicial activities. The NLRB traditionally has three members from the President’s party and two from the opposition. With staggered terms, the Board’s composition can be slow to change. However, with Biden’s recent nominations to the Board, control of the NLRB could soon change to Democratic.

Whether and how much of the PRO Act can or will be implemented legislatively, by executive order, or by agency regulation is unpredictable. The answers will determine the landscape to which the franchise industry must adapt, and certainly there will be judicial challenges to the outcome. But in the interim, the industry must prepare to survive the maelstrom.

The California version of the ABC test is arguably the most hostile to franchising. Nonetheless, the risk is not confined to California.

This is because the ABC employee classification test, with variations, has been adopted in a majority of states including, in addition to California: Alaska, Arkansas, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Kansas, Louisiana, Maine, Massachusetts, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.

Despite this wave of ABC test adoption, absent federal action, such as the PRO Act or DOL adoption of an ABC joint employment test, some states are likely to retain a direct control-based employment standard. But the direction is clear: away from a direct contract standard toward the troublesome ABC test.

As if its aggressive ABC test wasn’t enough, the California legislature very recently but narrowly defeated the so-called FAST Recovery Act, designated AB 257. That Act would have established unelected councils with power to establish industry-wide standards on wages, hours and working conditions in the fast food industry. In addition, it would have established joint liability for fast food franchisors and franchisees, substituting the newly-established councils’ employment policies for those of the owner-franchisee. In an ironically positive vein, the FAST act would make it very difficult to support a theory that the franchisor or the franchisee controlled or directed the employees of fast food franchises.

The FAST Act failed by a mere three votes. It is likely to appear again.

The second troublesome threat is the joint employment standard. The Obama Adminstration DOL caused angst in the franchise industry in January 2016, when it adopted a joint employment standard that focused on “whether the employee is dependent on the potential joint employer who, via an arrangement with the intermediary employer, is benefitting from the work.” Administrator’s Interpretation No. 2016-1, U.S. Department of Labor, January 16, 2016 (the “Interpretation”) Section II B.

The Interpretation explained that “the vertical joint employment analysis must be an economic realities test and cannot focus only on control.” The Department summarized a seven factor analysis:

  • Does the putative joint employer direct, control or supervise the work performed “beyond a reasonable degree of contract performance oversight?”
  • Does the putative joint employer control employment conditions, directly or indirectly, even if such control is not exclusive?
  • Is the putative joint employer’s relationship with the employer a long-term relationship?
  • Is the nature of the employee’s work repetitive, rote, relatively unskilled and/or does it require little or no training?
  • Is the employee’s work integral to the putative joint employer’s business?
  • Is the employee’s work performed on premises owned or controlled by the putative joint employer?
  • Does the putative joint employer perform administrative functions related to employment, e.g. “handling payroll, providing workers’ compensation insurance, providing necessary facilities and safety equipment, housing, or transportation, or providing tools and materials for the work.”

The DOL’s action followed a ruling by the NLRB in Browning Ferris Industries of California, Inc., in which the Board held that a third party with indirect control could be held jointly responsible, with the direct employer, for actions taken by employees.  This was the case regardless of whether the putative joint employer had ever actually exercised such control.

The franchise industry wrestled with the “economic realities” standard through the remainder of the Obama Administration, urging the DOL and the NLRB to acknowledge the existence of bona fide franchise/franchisor relationships. The agencies ultimately did so, by focusing not only on a franchisor’s contractual right to control aspects of franchised operations, but on the franchisor’s use of that power. In 2018 the NLRB concluded in Hy-Brand Industrial Contractors, Ltd & Brandt Construction Co., that the potential joint employer must have actually exercised joint control over the employee. 366 NLRB No. 94 (2018). The Board reiterated that position in Browning-Ferris Industries of California, Inc., declaring that a joint employer must possess and exercise direct and immediate control over at least one essential term or condition of employment. 369 NLRB No. 139 (2020).

The Trump Administration DOL withdrew the Obama Administration economic realities standard and engaged in a rule-making process that reverted to a control test of joint employment. However, in May 2021, mere days before the Trump rule was to become effective, it was withdrawn by the new Biden Administration. A new rulemaking is anticipated (and feared).

Next Up: Potential State Legislation

The PRO Act would do serious, and perhaps mortal, damage to the franchise industry. It would make sweeping changes to the National Labor Relations Act (NLRA), the Labor Management Relations Act (LMRA), and the Labor Management and Disclosure Act (LMDA). Most pertinent to franchising, the PRO Act would adopt the California ABC standard for determining employment status for purposes of the NLRA.

Initiated in Dynamex Operations West, Inc. v. Superior Court, (4 Cal. 5th 9013 (2018)), the ABC standard was later a feature of Assembly Bill 5 (AB-5), enacted and codified as Section 2750.3 of the California Labor Code. Under that test, a worker is presumed to be an employee unless the hiring entity can demonstrate all of the following:

  1. The worker is free from control and direction of the hiring entity in the performance of the work, both under the contract and fact; and
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Few, if any, franchisors would be able to meet all three of requirements. Thus, a franchisor would likely be deemed the employer of its franchisees and the franchisee’s employees under the ABC test, negating the essential basis of the franchise relationship. Significantly, the value of franchisees’ independent businesses could evaporate.

Exacerbating the PRO Act’s risks, misclassification of an employee’s status would be an unfair labor practice under the NLRA, with a potential penalty of up to $50,000 for each misclassified employee. Penalties could be monumental. Other union-friendly provisions of the PRO Act include the elimination of Right to Work laws in twenty-eight states and the imposition of personal liability on corporate officers and directors for labor law violations in certain circumstances.

Coming Soon: the Joint Employment Standard

Omens of the Apocalypse for the franchise industry are everywhere:

  • The pending Protect the Right to Organize (PRO) Act;
  • The return of David Weill, author of Fissured Employment and chief architect of the Obama era joint employment standard, to the Department of Labor as Wage and Hour Administrator;
  • Withdrawal of the control-based joint employment standard by the DOL, and potential replacement with an ABC test;
  • The shift of control at the NLRB, from majority Republican to majority Democratic control as early as August of this year;
  • State ABC laws, some of which are hostile to franchising;
  • An 87 page condemnation of the franchise industry by Senator Catherine Cortez Masto, urging adoption of a federal franchise statute and more robust regulation by the FTC;
  • The California FAST Act, which failed by just three votes, but will surely reappear in the next legislative session.

The franchise industry is facing challenges that strike at the heart of a vibrant, progressive business model that has allowed trademark owner franchisors and trademark licensee franchisees entrepreneurial opportunities to build wealth. The success of franchising is well-documented: nearly 800,000 franchised businesses employ 7.5 million workers; people of color, women, and veterans comprise more than 30% of franchisees; and franchised businesses generate revenues of approximately $670 billion.

My colleagues have periodically accused me of overreacting to these threats to the franchise industry, and perhaps when I began wondering whether the sky could fall, this was true. But not now. This is a perfect storm for the franchise industry. My prior blogs chronicled the accumulating challenges. I was not alone, of course. But never has the industry been in such peril. How bad could it be? The collective impact of these potential new actions go the heart of the franchisor/franchisee relationship that is the foundation of the entire industry. The ability of individuals to establish independent businesses by exploiting the good will, business acumen and know-how of brand owners (franchisors) could be destroyed.

In a series of blogs over the next couple of days, I will cover these threats in turn. First Up? The PRO Act.

Starting on July 1, 2021. the NCAA permitted student-athletes throughout the country to profit from their name, image, and likeness (“NIL”). This decision marks a major shift from the NCAA’s longstanding amateurism model.  Twenty-eight states have also enacted their own NIL laws, and sixteen of those—including Alabama, Florida, Georgia, Mississippi, New Mexico, Texas, Kentucky, Ohio, Oregon, Pennsylvania and Illinois—have signed NIL legislation to take effect in 2021 alone.

Neither the NCAA nor the federal government have addressed NIL laws, which has made for a fragmented model that varies from state to state.  For example, Georgia’s NIL law allows for team pooling arrangements whereby student athletes who receive compensation for the use of their name, image, or likeness agree to contribute a portion of the compensation they receive to a fund for the benefit of other student-athletes.  Mississippi’s NIL law even authorizes student-athletes to hire agents to negotiate marketing opportunities.

Some student-athletes have already started taking advantage of this seismic shift in college sports.  University of Wisconsin quarterback Graham Mertz recently tweeted a video of his new trademark, and University of Iowa basketball player Jordan Bohannon has a deal with a local fireworks company Boomin Iowa Fireworks. And, when you get to college football royalty like Alabama? Well, Alabama QB Bryce Young has already obtained about $1 million in endorsement deals, according to his coach Nick Saban.

Meanwhile, boosters want a piece of the action as well. Dan Lambert, the owner of prominent MMA training facilities and a huge University of Miami football fan, has offered to pay every athlete on the ‘Canes roster $500 per month this year to promote his chain of gyms on social media. Lambert has also reportedly founded a company that will raise money from local Miami-area businesses to pay athletes who endorse them.

It will be interesting to see how NIL laws change the college landscape.  Recruiting is one of many areas where NIL laws may have an effect.  For example, a highly touted prospect with endorsements deals on the horizon might be swayed from School A to School B if School B is in a state with a less restrictive NIL law.  It will also be interesting to see how colleges and universities respond to their student-athletes’ outside endorsements.  What if a student-athlete signs a contract that conflicts with the school’s pre-existing sponsors or university codes of conduct? For example, BYU has already adopted a rule that bans athletes from endorsing a product that violates its honor code which, in the case of BYU, means not just alcohol but coffee is off limits.

Still interesting in having your franchise system or franchisees get a piece of the action, so-to-speak? Compliance with myriad NCAA and state rules respecting NIL should be carefully considered, as certain moves retain the risk of disqualifying athletes and teams–something no booster who bleeds blue (or red, or green or . . . well, you get the idea) wants to cause.  That said, navigating NIL rules laws may present some obstacles, but has the potential to be a high-reward endeavor.  And it might very well add a unique layer of intrigue and drama to college sports this season.

(Parts of this post previously appeared on the Fox Rothschild Above the Fold blog.)