Because franchisors typically write the franchise agreement, it should come as no surprise that the rights in the agreement balance in favor of the franchisor. Understandably, it is inherent in the nature of any franchise relationship that there is some risk to the franchisor’s business operations that could result from an occurrence at a franchisee’s restaurant. For example, a franchisee’s failure to follow safe food service standards could negatively impact the goodwill of the franchisor’s brand. And, franchisors have long been considered a “deep pocket” in premises liability claims for accidents that occurred at a franchisee’s restaurant. Franchise agreements have evolved to address those risks.
The Franchisee Assumes The Risk, And Expense, For Both Parties
The law recognizes that parties have a fundamental right to freely enter into contracts, including agreements that assign liability from one party to another. Under these indemnity agreements, one party may shift all of the risk of loss relating to an event – which can include the obligation to pay monetary judgments and attorneys’ fees, costs, and expenses – to the other party.
Modern franchise agreements typically include broad indemnity provisions relating to employee risks in favor of the franchisor. Thus, for example, if a restaurant employee names both the franchisor and franchisee as defendants in a workplace harassment lawsuit, an indemnity provision may require the franchisee to pay for the franchisor’s costs to defending itself and for any other losses it may incur because of the lawsuit. Such an indemnity provision will likely be enforced, even in situations where the franchisor’s operating standards may have some relevance to the case, or in situations in which the franchisor’s employees may have had some involvement in the pertinent facts.
In many cases, the franchisor will present a franchise agreement that includes an indemnity that:
- Extends to the franchisor, its affiliates, subsidiaries and their officers, directors, employees, agents, successors and assigns;
- Requires the franchisee to defend the franchisor;
- Gives the franchisor the option to control the defense and select separate counsel (which, as discussed below, supports the separateness of the two entities);
- Includes claims brought in state and federal courts, arbitration proceedings, investigations, administrative proceedings, tax matters, government inquiries, and other similar proceedings;
- Covers damages of any nature, including damages, punitive damages, fines, penalties, costs, expenses, and attorneys’ fees; and
- Provides indemnity even if the franchisor’s conduct may have contributed to the damages alleged.
When the franchisor insists on such an indemnity, a franchisee should be sure to review and understand exactly the risks that it is assuming. It should also keep this allocation of risk in mind when issues arise in the restaurant that could implicate the franchisor. Failure to do so can be costly.
The Franchisor May Require The Franchisee To Obtain Special Insurance
Increasingly, franchise agreements are including a requirement that a franchisee maintain Employment Practices Liability Insurance (“EPLI”). EPLI provides protection against claims made by employees, former employees, or potential employees. Fortunately, while not every type of employment-related claim can be insured, EPLI is readily available and can cover the vast majority of claims, including claims under state and federal discrimination statutes like Title VII and the Americans with Disabilities Act. Additionally, many franchise agreement not only require the franchisee to maintain EPLI coverage for itself but also that its coverage should extend to hold the franchisor harmless for claims made against the franchisor.
Because EPLI can be expensive, a potential franchisee should be sure to understand exactly what the franchisor is requiring, in addition to obtaining an estimate of the cost of the premiums before signing the contract. After the contract is signed, the franchisee will have a duty to maintain the required coverages at all times.
Acknowledge That No Joint Employer Relationship Exists
The essence of a franchise arrangement is the concept that uniform operating standards build a reliable network of restaurants that can offer a consistent product and experience. For this to be effective, the franchisee must follow the franchisor’s requirements. Failure to maintain sufficient separateness between the franchisor and the franchisee, however, may result in increased exposure for both parties.
As a general matter, many employment laws recognize that a single employee may be employed, simultaneously, by two or more legal entities that may be jointly liable for violations. Most commonly, joint employer relationships are found in subcontracting or employee leasing arrangements. Increasingly, plaintiffs and the administrative agencies that enforce employment laws are looking to hold both franchisor and franchisee accountable under employment laws as an employer.
Although not dispositive of whether a joint employment relationship exists, an acknowledgment in the franchise agreement can be an important tool. First, it clearly sets forth the understanding between the franchisor and franchisee as to who is the proper employer. Secondly, the parties can cite that acknowledgment and understanding when responding to inquiries by administrative agencies like the Equal Employment Opportunity Commission (“EEOC”) or answering claims. This benefits the franchisor, in that it may eliminate the franchisor’s involvement. By the same token, in light of the typical indemnity provision, it also benefits the franchisee, which would otherwise be potentially responsible for continuing litigation costs to defend two parties (both itself and the franchisor).
Other Provisions Minimize The Risk Of Being A “Joint Employer”
Although it serves an important purpose, a simple acknowledgment that the franchisor is not a joint employer will not likely stave off the EEOC or an employee’s attorney from naming both franchisor and franchisee as employers. The franchisor’s involvement not only inherently adds complexity to the litigation but also additional exposure to the franchisee, which is likely on the hook for litigation costs. Thus, is imperative that the franchise agreement, as a whole, be structured in a way to minimize the risk of the franchisor being found to be an employer. This can often be accomplished without compromising the franchisor’s requirement that operational standards be followed.
The tests that a court may employ to determine whether someone is an “employer” varies based on the law giving rise to the claim and can even vary based on the jurisdiction in which the claim is brought. Generally, courts and administrative agencies balance a series of factors to identify whether a person exercises sufficient control over the employment relationship to be deemed an employer. For example, courts in the Eleven Circuit (which includes federal courts in the State of Georgia) have held that whether a party qualifies as a joint employer for liability purposes depends on whether “as a matter of economic reality, the individual is dependent on the entity.” Antenor v. D & S Farms, 88 F.3d 925, 929 (11th Cir.1996). More specifically, in evaluating a claim under the federal Fair Labor Standards Act, the court will consider factors such as control, supervision, right to hire and fire, ownership of work facilities, investment, and pay-roll decisions. Antenor, 88 F.3d at 932-37. One court has held that “[t]he ultimate focus of the joint employer inquiry is the degree of control one company exercises over the employees of another company.” Lyes v. City of Rivera Beach, 166 F.3d 1332, 1341 (1991).
To mitigate joint employer risk, any perceived or actual exercise of control by the franchisee should be narrowly tailored towards ensuring that the franchisee upholds the franchise’s operating standards. Thus, many franchise agreements will make clear that the franchisee is vested with full discretion and decision making authority for all hiring, firing and other employment related decisions. The agreement may also make clear that the franchisor is not responsible for hiring and firing employees; setting working hours and employee schedules; approving and adjusting time records; determining salaries; training, evaluating and paying employees; and maintaining employment records.
The franchise agreement may impose additional duties on the franchisee to maintain the appearance of separateness between the companies, as employees are often confused about who is their employer. Thus, the franchise agreement may require the franchisee to have its employee acknowledge that they are not employees of the franchisor. The franchise agreement may also require the franchisee, in all written materials like paychecks and pay stubs, employee manuals, and employment agreements, to state that the franchisee is the employer, not the franchisor. Additionally, restrictions might be imposed on the use of the franchisor’s mark in the franchisee’s operational documents, like employee handbooks. And, the rules of interaction between the franchisor and the franchisee’s employees may also be detailed in the agreement. To ensure compliance with franchise agreement – and to minimize the risk of a potential indemnity costs – the franchisee be sure to know and abide by these requirements at all times.
As a practical matter, it would be impossible to avoid at least some facts that could support joint employer liability. Recognizing this, courts have permitted some exercise of control by the franchisor in the facts of specific cases. Indeed, courts have recognized that a franchise agreement may empower a franchisor to exercise necessary control over conformity to standard operational details, provided that it cannot take any actions that affected the terms and conditions of employment of the franchisees’ employees. Thus, while providing labor relations services would be clearly impermissible, some degree of limited involvement might not put the franchisor at risk.
Minimize The Risk Of Being An “Integrated Enterprise”
A joint employer theory is not the only way in which the franchisor may have potential liability for issues relating to a franchisee’s employees. The franchisor and franchisee could also be deemed an “integrated enterprise” with each other. To assess whether this is the case, a court will consider factors like:
- The degree of interrelation between the operations (such as sharing of management services such as check writing, preparation of mutual policy manuals, contract negotiations, and completion of business licenses; sharing of payroll and insurance programs; sharing of services of managers and personnel; sharing use of office space, equipment, and storage;
- The degree to which the entities share common management;
- Centralized control of labor relations; and
- The degree of common ownership or financial control over the entities.
While these factors are not likely to suggest an integrated enterprise in a typical restaurant franchise agreement, it is important to understand these factors to ensure that neither the franchise agreement nor the operational policies and practices can support such a finding.
Franchisors May Retain Audit Rights
Because a franchisor cannot control the precise means by which a franchisee complies with applicable employment laws, the franchisor will often still want some level of oversight in the franchisee’s operations. Franchisors typically accomplish this by reserving, in the franchise agreement, the right to conduct employment practice audits. An employment practice audit provision usually allows the franchisor to audit written documentation such as policies, handbooks, applications, required postings, and payroll processes and procedures. It also allows the franchisor to evaluate the type of training that the franchisee’s employees have received, in addition to examining the franchisee’s hiring protocols. Thus, even in cases in which the franchisee believes it has sound policies and practices in place, it may still be subject to time-consuming franchisor audits.
While the franchisee may be tempted to focus on the operational requirements and franchise fee portions of a franchise agreement, the provisions relating to the allocation of employee-related risk and franchisee’s ability to provide oversight are important obligations for a franchisee to know and understand. These provisions do not simply address some remote risk but often require continuing obligations of, and expense to, the franchisee.