Charles Dicken’s A Tale  of Two Cities famously opens with “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness … .”

This opening could be applied to the results of the last political election, the public health of our nation, or even the strains of work and family under the current challenges. The words also fit the dichotomy exhibited in the restaurant and franchise commercial environment today.

We miss our restaurants and they miss us. Before COVID-19, off-premises dining was a cutting edge concept being investigated as a supplemental income stream. Now curbside and delivery, as well as architectural changes, are a necessity and a matter of survival. Let’s see how this is playing out now, and will in the future.

First, dine in restaurants had to learn about new architecture. Plexiglas counter windows, masks and expedited ordering required additional investment in infrastructure. In the meanwhile, cooks and servers had to fight the virus and dwindling customers. Labor lawyers were called as often as physicians to address the difficult issues of compliance with public health initiatives as applied to labor issues. Restaurants had to go to curbside pick-up and reinvest in delivery options, often sacrificing margins and profitability to survive.

The Winter of Despair

Even before Covid, many restaurants were financially challenged. Older chains were under pressure from changing demographics, increased competition and rising costs for years. Even those restaurants which began reconfiguration in 2019 found their progress stymied by the impact of COVID-19, resulting in accelerated closure of both franchised and company operated locations. The coronavirus broke the back of iconic chains such as Chuck E Cheese, Sizzler, Toojay’s Deli, Il Mulino, Le Pain Quotidian, California Pizza Kitchen, Cosi, and Friendly’s Restaurants. The companies were forced to file Chapter 11, close underperforming locations, reject overpriced leases and sell to strategic buyers with the wherewithal to continue the best practices of the brand. Experts predict somewhere between 40-60 % of restaurants nationally will close permanently. For these restaurants, this is the season of despair.

Many of these franchised chains have huge franchisees which also had to reorganize in Chapter 11. The largest franchisee of Golden Coral, 1069 Restaurant Group LLC almost took the chain down by itself. NPC International Inc., the nation’s largest franchisee of Pizza Hut and Wendy’s restaurants, filed bankruptcy and wants to sell its entire company to the Flynn Restaurant Group LLC.

The Season of Hope

The bankruptcy of NPC International also shows that the death of restaurants has been somewhat overstated. With reduced competition, bidding wars and increased merger and acquisition activity of restaurant chains have developed.

As of December 1, 2020, Wendy’s has opposed NPC’s the sale to Flynn, the largest restaurant franchisee in the U.S.  Wendy’s instead has made its own offer with a consortium of regional franchisees. Wendy’s is in talks with NPC to drop its opposition in return for an agreement by Flynn to invest tens of millions of dollars in NPC’s Wendy’s restaurants. San Francisco-based Flynn owns more than 1,200 restaurants, including Applebee’s (452), Arby’s (639), Taco Bell (282) and Panera Bread (136) brands across 33 states. Some of those brands compete with Wendy’s. as defined in some of the Wendy’s franchise agreements, but not in others.

Dunkin’ Brands, operator of both Dunkin’ Donuts and Baskin-Robbins, has agreed to be acquired by Inspire Brands for $11 billion. Inspire Brands is backed by private equity firm Roark Capital. Inspire Brands is also the owner of Arby’s.  Zaxby’s, the 900 unit chicken restaurant chain founded by two partners 30 years ago, is selling a significant stake to Goldman Sachs to allow it to go national. Merger and acquisition is alive and well.

Overheard at the Restaurant Finance and Development Conference in November 2020 was the report that franchise and restaurant investment capital is plentiful, but not at traditional banks. Some banks are open to it, but most of the bankers interested are in those non-traditional banks, who have little competition, and charge accordingly. Private equity and private placement money is available as well at reasonable costs.

Some chains are going public. Burger Fi, an approximately 125 unit Florida based “better burger” franchise chain went public in December 2020, via use of a special purpose acquisition company (a “SPAC”). A SPAC is sometimes referred to as a blank check company, because the investors’ money is collected first and then an acquisition is targeted. In this case, the acquiring SPAC is Opes Acquisition Corp. The acquisition has allowed Burger Fi to have additional cash to saturate markets outside of its core market in Florida and be nationally competitive with a high quality meat burger.

Companies positioned for increased delivery, drive thru efficiencies and home delivery have prospered. Pizza restaurants have reported steady 20% increases, and some brands have even quadrupled their sales. Yum Brands, a publicly held owner of various brands reports same store sales increases for its US operations, including KFC up 9%, Pizza Hut up 6% and Taco Bell up 3%.

As we move forward in 2021, more restaurant shakeouts and consolidation will occur. Independent chefs will move into the former space of aged out restaurants, and continue the cycle of rejuvenation. All the more reason to visit your favorite eateries now, and to look forward to the innovations which will adopt to changing customer needs and values.

Buried deep in the roughly 5,500 pages of the most recent COVID relief legislation are two unexpected gifts for trademark owners. One of those gifts, the Trademark Modernization Act:

(a) Essentially overrules eBay v. MercExchange and creates a rebuttable presumption of irreparable harm on a finding of trademark infringement, including in instances of cybersquatting; and,

(b) Allows petitions to expunge or reexamine registered marks that are not or have never been used in commerce in connection with the goods and services listed in the registration. This process is available for marks less than 10 years old, but during the first 3 years of enactment, the process can be used with older marks.

Trademarks and service marks are hugely valuable assets in many businesses, especially franchises; and every mark owner is obligated by law to protect its marks. Too often, however, the legal path to protection is studded with speed bumps. Even if an infringement action succeeds, courts are too often reluctant to issue permanent injunctive relief, and meeting the eBay v. MercExchange standard for that relief is daunting. After spending thousands of dollars, a trademark owner may end up with only partial relief – not enough bang for the bucks!

Happily for trademark owners, the Trademark Modernization Act changes the injunction calculus. Injunctive relief will be a presumptive remedy for infringement; the defendant must rebut the presumption. This provides a real opportunity for owners to achieve meaningful and permanent relief.

The second gift in the Modernization Act would have been helpful to me  years ago. I was an associate, helping a franchise client with a new concept. The client wanted to find the owner of a registered, uncontestable, but long-unused mark, to clear the way for the client’s chosen mark. I learned two things from the episode: (a) it’s difficult to challenge a long-standing but unused mark, and (b) if you don’t want to be found, the hills in northern Greenville (South Carolina) county are a good hiding place. (The latter situation has changed in the last 40 years.) Had the Modernization Act been law at the time, I might not have burned shoe leather trying to locate the owner. We could have filed a petition to expunge or reexamine the registration, rather than initiate a more burdensome cancellation proceeding.

While less important than reversing the injunctive relief standard for marks, this second change may be the basis for sweeping unused marks from registration, at least for classes in which the mark is not or has never been used.

And we all thought that that the bill was just 5,000 pages of COVID relief!

The one-two punch of state and federal employment standards activity poses an existential threat to franchising; many commentators, including this one, have acknowledged that fact. But why? Did the California legislature or the Obama Department of Labor intend to deliver a knock-out punch to a very popular business structure that creates tens of thousands of independent franchisee business owners, who in turn employ hundreds of thousands of workers?

I recently had an interesting conversation on this topic with Erik Sherman, who contributed “Trump Labor Department Pushes Quick-Boiling Independent Contractor Rule that the White House has Left of Simmer” to a recent issue of Forbes. The current “mess” that I referred to in the Forbes article seems to be the product of union anger with the gig economy and ineptitude on the part of the Trump Department of Labor.

Briefly, the Obama DOL issued new standards for determining joint employment, often referred to as the “economic reality” test. In the franchise context, the standard was applied to determine the relationship between the franchisor and the franchisees’ employees: specifically, whether the franchisor is the joint employer of the franchisees’ employees. Startling to the franchise industry, the test focused not on issues of control but a bevy of other factors of which control was only one. It was likely that many, if not most, franchisors would be deemed joint employers of their franchisees’ employees. After initially moving to enforce the new standard, the DOL paused, apparently to consider the effects of those actions on the franchise industry.

As I’ve explained in a prior post, the Trump administration issued new joint employment standards, reverting to the former control-based tests. That effort was judicially rejected as procedurally and substantively defective. The DOL intends to publish a new control-based joint employment standard on January 6th, theoretically effective 60 days later. But a Biden DOL can delay effectiveness to allow time for a reversal, thus dooming the Trump DOL’s eleventh hour action. Bottom line: The currently effective DOL joint employment standard remains the Obama economic reality test.

At cross-purposes with the Trump DOL action, the California legislature enacted the infamous AB-5 legislation which adopted three factor test for employment that virtually assures that most franchisors would be deemed the employers of both their franchisees and their franchisees’ employees. Many states have enacted similar legislation.

As the Forbes article argues, Uber and Lyft were the primary target of California’s AB-5 legislation, which was actively and aggressively promoted by unions, and the DOL’s economic reality standards eyed the same targets. Uber and Lyft heavily financed a successful California ballot initiative, Proposition 22, to nullify the effects of AB-5 on app-based businesses. The initiative was worded narrowly, to benefit only its investors; Uber and Lyft thus dodged the AB-5 bullet. Meanwhile, time will run out on the Trump’s attempts to short circuit the usual regulatory process and reissue the control-based joint employer standards.

The franchise industry, collateral damage in the fight against Uber and Lyft, has suffered a severe injury. We start 2021 with federal regulations and, in many states, laws that could render the franchise business model untenable.

Congress passed a wide-ranging COVID-19 relief package on December 22, 2020, that provides over $900 billion in aid to individuals and businesses. President Trump has now signed the relief bill, called the Bipartisan-Bicameral Omnibus COVID Relief Deal, into law. The law addresses four areas of importance to franchising: the Families First Coronavirus Response Act (FFCRA), the Paycheck Protection Program (PPP), the Economic Injury Disaster Loan (EIDL) program and SBA Emergency Grants for shuttered live venue operators or promoters.

Families First Coronavirus Response Act Partially Extended

Congress declined to extend the mandatory leave requirements of the FFCRA in the relief package but did allow companies to continue to receive payroll tax credits if they voluntarily provide paid leave to their employees for reasons that are covered by the law. The FFCRA requires employers to provide up to 12 weeks of paid leave to employees who are unable to work for a variety of reasons related to COVID-19.

The FFCRA is scheduled to expire on December 31, 2020. If employers voluntarily decide to provide leave to employees that would have been available under the FFCRA through March 31, 2021, employers may still receive a payroll tax credit for any such paid leave provided to employees.

PPP Loan Changes

The relief package also makes significant changes to PPP loans available to small businesses. The bill (1) expands the ways in which businesses may use PPP loan funds; (2) provides for a second wave of PPP loans in certain circumstances; and (3) allows borrowers to request an increase to their initial PPP loan amounts.

Expanded Use of PPP Funds

There new ways in which borrowers can use PPP funds. Under the initial program, PPP loans could only be used for the following purposes: (1) payroll costs; (2) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave as well as insurance premiums; (3) employee salaries, commissions or similar compensation; (4) payments of interest on any mortgage obligations (which did not include any prepayment or payment of principal on a mortgage obligation); (5) rent (including rent under a lease agreement); (6) utilities; and (7) interest on any other debt obligations that were incurred before the covered period.

In addition to the above-noted uses for PPP funds, the new law also allows PPP loan recipients to use the funds for the following reasons:

  • Covered operations expenditures: a payment for any business software or cloud computing service that facilitates business operations, product service or delivery, the processing, payment or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses;
  • Covered property damage costs: a cost related to property damage and vandalism or looting due to public disturbances that occurred during 2020 if such costs were not covered by insurance or other compensation;
  • Covered supplier costs: an expenditure made by an entity to a supplier of goods for the supply of goods that (1) are essential to the operations of the entity at the time the expenditure is made; and (2) is made pursuant to a contract, order, or purchase order (i) in effect at any time before the covered period with respect to the applicable covered loan; or (ii) with respect to perishable goods, in effect before or at any time during the covered period with respect to the applicable covered loan.
  • Covered worker protection expenditures: an operating or capital expenditure to facilitate the adaptation of the business activities of an entity to comply with requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, or the Occupational Safety and Health Administration, or any equivalent requirements established or guidance issued by a State or local government, during the period beginning on March 1, 2020 and ending on the date when the national emergency declared because of COVID-19 expires (related to the maintenance of standards for sanitation, social distancing or any other worker or customer safety requirement related to COVID-19). Covered worker protection expenditures may include (1) a drive-through window facility; (2) an indoor, outdoor, or combined air or air pressure ventilation or filtration system; (3) a physical barrier such as a sneeze guard; (4) an expansion of additional indoor, outdoor or combined business space; (5) an onsite or offsite health screening capability; or (6) other assets relating to compliance with the government requirements or guidance established for COVID-19 as determined by the Small Business Administration (SBA). Also included are expenditures for PPE masks, gloves and respirators.

These new categories apply to PPP loans made before, on or after the enactment of the latest bill, unless the borrower has already had their PPP loan forgiven. Furthermore, the law has expanded the period during which PPP funds maybe used until March 31, 2021.

PPP Second Draw Loans

Borrowers may now also be eligible to receive a second PPP loan, called a Second Draw Loan. To be eligible to receive a Second Draw Loan, a business must:

  • Employ not more than 300 employees;
  • Have used or will use the full amount of their first PPP loan; and
  • Demonstrate at least a 25 percent reduction in gross receipts in the first, second or third quarter of 2020 relative to the same 2019 quarter. Applications submitted on or after January 1, 2021, are eligible to utilize the gross receipts from the fourth quarter of 2020.

Borrowers may obtain a Second Draw Loan of up to a maximum of the lesser of $2 million or 2.5 times the borrower’s average monthly payroll costs. Businesses classified as Accommodation and Food Services under code 72 of the North American Industry Classification System (which includes restaurants, bars, and hotels) may receive a loan up to the lesser of 3.5 times their average monthly payroll costs or $2 million. Businesses with multiple locations that were eligible to receive a PPP loan under the initial PPP requirements must have 300 or fewer employees per physical location to receive a Second Draw Loan.

Requesting a PPP Loan Increase

The latest relief package requires that the SBA issue guidance to lenders within 17 days of enactment of the law that would allow borrowers who returned all or part of their PPP loan to reapply for the maximum amount applicable so long as they have not yet received forgiveness. Borrowers also would be allowed to work with their lenders to modify the value of their loan if their initial loan calculations would have increased due to changes in the PPP’s final rules.

Economic Injury Disaster Loans (EIDLs)

The new relief law further enhances and clarifies the EIDL program. First, additional funding was added for EIDL advances to be made to businesses located in low-income communities and on an emergency basis. Unfortunately, the law at the same time extends the time for the SBA Administrator to approve applications for Emergency EIDL grants and disburse funds from 3 to 21 days. That is balanced somewhat by the fact that the covered period has been extended until December 31, 2021. Perhaps most importantly, the law repeals the provision of the CARES Act requiring PPP borrowers to deduct the amount of an EIDL advance from their PPP forgiveness amount.

Grants for Shuttered Venue Operators

The law authorizes $15 billion for the SBA to make grants to live venue operators or promoters, theatrical producers, live performing arts organization operators, museum operators and motion picture theater operators who demonstrate a 25 percent reduction in revenue.  The SBA may make an initial grant of up to $10 million and a supplemental grant of up to 50 percent of any initial grant. Grants must be used to certain specified expenses such as payroll costs, rent, utilities and PPE. Finally, the law authorizes SBA increased oversight of recipients.

We will of course continue to monitor developments as the new relief law is put into practice.

Thank you to my colleague Alexander Bogdan, who helped compile this summary of the Bipartisan-Bicameral Omnibus COVID Relief Deal.

Franchisor obtains $2,064,735.75 arbitration award against failed area developer.

In an arbitration decision handed down by the American Arbitration Association, Rita’s Franchise Company, LLC obtained an award against a Washington state area developer for $2,064,735.75, consisting of damages of $738,892.27 to date of hearing, counsel fees of $1,012,565.92, and reimbursement of costs. The award also declared that Rita’s properly terminated the 2015 Area Development Agreement, the 2015 Franchise Agreement and the 2016 Express Agreement in the Washington territory.

The damage award is significant not only because of the quantum, but also because the claimant, Rita’s Franchise Company, LLC was not the franchisor from whom the Respondents purchased the franchise. The original franchisor was Rita’s Water Ice Franchise Corporation (“Old Rita’s), from whom the Claimant purchased the franchise assets in 2016. The Respondents claimed that its defenses against the Old Rita’s could be asserted against the Claimant, citing theories of de facto merger, sham transaction or other theories which could lead to successor liability.

The arbitrator heard expert testimony on the issues, examined the facts, and concluded that the claims and defenses against Old Rita’s could not be asserted against the Claimant. The award did not address the merits of the claims against Old Rita’s, which was not a party to this arbitration. The arbitrator considered the successor liability issue to be a seminal issue in deciding the award.

At 4 p.m. today, Pennsylvania Governor Tom Wolf (who himself has tested positive for COVID) and Secretary of Health Rachel Levine issued new, “limited-time”, targeted COVID mitigation orders. The orders hit the franchise industry hard. About the only silver-lining is that, unlike the indefinite restrictions imposed last spring, these new restrictions have a specific time period:  from 12:01 a.m. on Saturday, December 12, 2020, until 8:00 a.m. on Monday, January 4, 2021.

The following are the changes resulting from the new orders:

  • All in-person dining in the retail food services industry–including bars, restaurants, breweries, wineries, distilleries, social clubs, and private catered events–is prohibited.
    • Outdoor dining, take-out food service and take-out alcohol sales, however, may continue.
  • All in-person businesses are limited to 50% of maximum legal occupancy, unless limited to a smaller number by other order.
  • All indoor gyms and fitness facilities are prohibited from operating.
    • Outdoor operations may continue, subject to masking and social distancing rules.
  • All indoor entertainment venues must close, including all theaters, concert venues, museums, movie theaters, arcades, casinos, bowling alleys, private clubs and similar facilities.
  • Indoor gatherings are limited to 10 persons.
    • Houses of Worship during religious services are exempt.
  • Outdoor gatherings are limited to 50 persons.
  • All sports and extracurricular activities at the high school level and below, including club sports, are suspended.
    • The high school and youth sports suspension includes practice.
  • Professional and collegiate sports may continue.
    • However, no spectators may attend.

Given the rising case counts in Pennsylvania, I appreciate these orders. That said, it doesn’t make them any more palatable. Stay safe out there!

Over the last 8 years or so, the ever-changing landscape of employment laws has arguably posed an existential threat to franchising. The franchise business model may not make sense if franchisors are legally defined as the employers of their franchisees or joint employers of their franchisees’ employees. But what is an “employee” and who is a “joint employer?”

Question 1: Joint employment – Will a Biden DOL defend the Trump regulation, will it enforce the economic realities standard, and/or will it demarcate a safe harbor for franchising?

During the Obama administration, the Department of Labor adopted a joint employment standard advocated by the DOL’s Wage and Hour administrator, Dr. David Weill. The new “economic realities” standard diverged from the long-standing control test by incorporating additional factors, including such things as the ultimate source of the business and who controls the business model. The NLRB adopted the new standard and began enforcement actions against large franchisors, insisting that the franchisor was the joint employer of its franchisee’s employees. Panic ensued.

Enter the Trump administration. Although the economic realities standard remained the official test of joint employment, enforcement actions directed at franchisors had ebbed during the Obama administration. That lull continued through the first three years of the Trump administration. Finally, in late 2019, the DOL rushed a rule making process and reverted to the control standard joint employment test, even adding a specific exclusion for franchise relationships. Franchisors exhaled.

But wait! Several state Attorneys General challenged the new regulation in New York et al v. Scalia, and the court invalidated the regulation on procedural and substantive grounds. The administration has appealed that ruling, but no decision will be forthcoming until after the changing of the guard at the DOL. In the meantime, the Trump DOL is rushing through another rulemaking process, but whether there is time to do so (and whether that process would withstand another challenge) is an open question.

I admit my crystal ball is no clearer than anyone else’s, and much depends on Biden’s appointments to DOL posts, but here’s my prediction: the Biden administration will (a) abandon its appeal of the Scalia ruling (that’s a no brainer in my book); (b) not defend the result of the Trump DOL rulemaking process if/when it is challenged; (c) revert to the economic realities standard for assessing joint employment; but (d) create a narrow safe harbor for franchisors. My prediction of a safe harbor may be overly optimistic, but it’s based on the mild retreat in enforcement against franchisors in the later stages of the Obama administration.

Question 2:     Misclassification: Will the ABC standard be codified in federal law, will more states adopt the ABC standard, and will courts widely determine that federal laws preempt state employment laws?

Just as the Trump administration was engaging in welcome rulemaking on the joint employment standard, California courts were taking an opposite direction in misclassification cases. Courts opined that, under California state law, an entity was the employer of a worker unless the relationship could satisfy all three tests of worker independence. The so-called ABC test included considerations of (A) the worker’s freedom from control or direction or putative employer; (B) whether the worker performs work outside of the putative employer’s business; and (C) whether the worker is customarily engaged in an independent business of the same nature as the work performed. The franchise industry could not satisfy any of these prongs, and certainly not all of them. Panic returned.

Panic increased as the ABC test was codified in legislation in California (the infamous AB-5 legislation), the California trial court suggested that the opinion announcing the ABC standard should be applied retroactively, other states adopted similar ABC tests, and bills proposing federal codification of the ABC test were introduced in Congress.

A dim light of relief appeared in a ruling by a federal district court in Massachusetts. The court acknowledged that the ABC standard could not be harmonized with federal laws applicable to franchising, specifically the FTC Franchise Disclosure Rule and the Lanham Act – both of which rely on a degree of control over the franchisee/trademark licensee. Federal law preempted state law, the court concluded; thus, the Massachusetts employee classification law did not apply to franchise relationships. A few other courts have adopted this rationale and similarly exempted franchises from state ABC laws. Preemption may rescue franchise systems from state ABC standards, but if the standard is codified in federal law, it’s an entirely different matter.

Panic has not ebbed.

My humble prediction, with much trepidation, is that (a) the ABC standard will not be the subject of successful federal legislation; (b) more states will adopt the ABC classification regime, some (not California) with exemptions or variations that are more franchise friendly; (c) while additional courts will agree that federal franchise laws preempt contrary state laws, the principle will not expand as expeditiously or widely as needed to calm the franchise industry; and (d) many franchisors will be faced with difficult, if not impossible, decisions in ABC states.

On balance, the challenging times may end with a COVID vaccine, but not for franchising.

Hot on the heels of disappointing AB-5 news from California, a federal district court in Manhattan delivered a stinging rebuke to the Department of Labor (“DOL”), invalidating the control-based joint employment rule issued by the Department only 6 months ago.

The DOL Rule adopted a control-based test of joint employment for purposes of federal employment law, in particular the Federal Labor Standards Act (“FLSA”). The Rule was strongly cross-current to states legislative actions adopting versions of the ABC joint employment test, e.g., California’s AB-5 legislation, and encouraged franchisors and franchisees to believe that the franchise business model might escape the worst impacts of these state actions. In Biblical terms, joy has turned to weeping.

Almost immediately after the DOL Rule issued, a coalition of Attorneys General from 18 states challenged the Rule’s validity. On September 8th, a federal Judge largely agreed with the AGs in a 62 page opinion in New York v. Scalia, on the issue of vertical employment. Of course, it is the vertical test that’s critical in the franchise industry. The DOL got that test wrong on all fronts, the Court opined. Not only was the process of adoption deficient, but the substance ignored the language of the FLSA by impermissibly narrowing the Act’s joint employment standard.

The DOL has not raised the white flag in response to the Court’s ruling; instead it has signaled defiance: “We stand by the Rule and are weighing all options.” An appeal is apparently not an option, another attempt at rulemaking by the DOL will take time that this Administration may not have, and traversing the Court’s objections would be a tall order given the Judge’s detailed and closely reasoned exegesis of the FLSA, its purposes, history and implementation over its 50+ year history. It particularly rankled the Judge, it seems, that the Rule effectively exempted the franchise model from the joint employment definition.

Where does this leave the franchise industry and the many thousands of people whose employment depends on the success of the model? On the hot seat. While the current DOL is highly unlikely to press for enforcement of the FLSA using the prior joint employment test, a future Administration may do so. States that have adopted an ABC joint employment test, on the other hand, may become emboldened to push state enforcement efforts.

A glimmer of optimism might be found in 7-Eleven’s very recent (September 10th) escape from a misclassification suit in Massachusetts, Patel v. 7-Eleven. Relying on Massachusetts’ Independent Contractor Law (“ICL”), codifying the ABC joint employment test, a group of 7-Eleven franchisees alleged they had been misclassified as independent contractors rather than employees. The crux of the case was the impossibility of harmonizing the legal requirements imposed on franchisors under federal law with the presumption of employment in the Massachusetts ICL law. As the Court reasoned, it was impossible for any franchise to satisfy the first prong of the ABC test, requiring a demonstration that the independent contractor is free from the principal’s control, given that the FTC franchise rule only applies to relationships in which the franchisor exerts a significant degree of control over, or provides significant assistance to the franchisee in its method of operation. Those same characteristics would prevent 7-Eleven and other franchisors from meeting the first prong of the ICL. Every franchise relationship would by definition constitute an employment relationship under the ICL. The ICL thus irretrievably conflicted with federal law. Happily for 7-Eleven, the Court held that federal law must pre-empt application of the Massachusetts ICL.

The 7-Eleven case offers a glimmer of hope to franchisors facing state law enactments of the ABC joint employment test. But the Court’s decision in 7-Eleven would lead to exactly the result feared by the Scalia Court – franchises would be could never be joint employers under an ABC test.

Joint employment standards truly are in chaos, and the future is even less predictable than before. As the saying goes, “watch this space,” but with trepidation.

As if COVID, wildfires, and heat weren’t enough, California franchisors and franchisees suffered another gut punch when the legislature rejected a proposed franchise exemption to AB-5.

When AB-5 was enacted in 2019, to the horror of the franchise industry, it appeared to create a presumption that the franchise business model created an employment relationship between franchisor and franchisee and franchisee’s employees. The Bill’s sponsors in the Assembly disclaimed any intent to interfere with positive business relationships that allow small businesses, including franchised outlets, to continue and pledged to address the issue in future amendments to the law. The apologetic statement, promising amendments, temporarily calmed the waters.

Then COVID attacked, and the industry focused on survival in the wake of quarantine orders and massive unemployment. Now, just as the world adjusts to a new reality, word emerges from the California legislature that there will be no franchise exemption to AB-5. An early draft of AB-5 amendments included a franchise exemption, but the provision died as amending legislation wended its way to enactment. Amplifying the AB-5 adversity is the risk that the Dynamex case, which presaged AB-5, will be applied retroactively, exposing those considered employers under the test codified in AB-5 to years of prior year employment tax exposure.

Commentators blame/credit unions for the exemption’s demise, but the source hardly matters. What does matter is that franchisors and franchisees will need to again reassess their approach to franchising in California’s AB-5 environment. The lure of access to the fifth largest economy in the world enhances the risks inherent in making the wrong decision.

In a 2019 alert, “New California Law Imperils Franchise Model,” my colleague Elle Gerhards and I noted a few possible actions by franchisors and franchisees in the wake of AB-5, none of them palatable. Franchisors and franchisees need to reconsider frankly discouraging choices: (a) bow to pressure and change to an employment model; (b) cling to the franchise model, but redefine obligations and change the financial model; (c) withdraw from California. There is a raft of nearly-impossible steps that would be required to implement significant changes to the franchise business model, not the least of which are the contractual underpinnings of the franchise relationship.

Now, with no apparent hope that a franchise business model and AB-5 can co-exist, will franchisors begin the agony of decision-making? What is the future of the thousands of California franchisees and their tens of thousands of employees in the process? Millions are unemployed in the wake of COVID; is now the time to add thousands more to the ranks?