From JDSupra, Richard Reibstein discusses a recent ruling by the Massachusetts Supreme Judicial Court that the independent contractor s statute applies to the franchisor-franchisee relationship. Richard also provides ways for franchisors to avoid being employers under the statute. Richard writes:
Does the strict ABC test set forth in the Massachusetts independent contractor law apply to the relationship between a franchisor and its franchisee where the franchisor must also comply with the FTC’s Franchise Rule? That was the question that the U.S. Court of Appeals for the First Circuit in Boston asked the Massachusetts Supreme Judicial Court to answer in an appeal of a lawsuit brought by a group of store managers who claimed that 7-Eleven had misclassified them as independent contractors instead of employees. The Massachusetts high court ruled earlier today, March 24, that the FTC’s Franchise Rule only governs disclosures by franchisors to franchisees, not the manner in which franchisors control the performance of franchisees, and therefore does not preempt the state’s independent contractor statute. But while the franchise industry argued that such as decision will be the death-knell of franchising in Massachusetts and other states for individuals who wish to own and operate a franchise, the decision will not likely have the doomsday effect that the franchising industry predicted. Why? Because with the proper structuring, documentation, and implementation of the franchise relationship, franchisors should be able to classify individual franchisees as independent contractors, even in Massachusetts, as we discuss below.
The Lower Court Decision
7-Eleven was sued in federal court by certain of store managers who owned and operated 7-Eleven franchises. The store managers claimed they did not qualify as independent contractors under Massachusetts law and should have been classified as employees entitled to the benefits of an array of state wage laws. The Massachusetts independent contractor law is the strictest in the nation and unlike a nearly identical law in California, which expressly exempts over 75 occupations, there are no such exemptions in the Massachusetts statute. The store managers argued that they should have been classified as employees because of the high degree of control they argued that 7-Eleven exerted over them as set forth in their 7-Eleven franchise agreements.
7-Eleven filed a motion for summary judgment asserting the state’s independent contractor law was preempted by the FTC’s so-called Franchise Rule. Its motion relied on a decision issued by the highest court in Massachusetts involving the real estate industry, where the court had held that the state’s independent contractor law was completely preempted by a state law requiring real estate companies to supervise real estate agents. 7-Eleven conceded that it exercised some level of control over its franchisees, but argued it did so consistent with the FTC Franchise Rule. Under the Rule, a “franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.” The federal district court judge in Massachusetts agreed, finding that the state court’s real estate decision applied as well to franchisors that exercise control over franchisees. The court concluded that “[w]here there is a conflict between the Massachusetts [Independent Contractor Law] and a regulatory scheme, the specific [FTC Franchise Rule] trumps the general [Independent Contractor Law].” Patel v. 7-Eleven, Inc., No. 17-11414 (D. Mass. Sept. 10, 2020).
The decision was appealed to the First Circuit. Because the issue involved a key state law, the First Circuit chose to ask the Massachusetts Supreme Judicial Court, the highest court in that state, to provide its opinion on the question of whether the FTC Rule preempts the state’s independent contractor law.
The Decision by the Massachusetts Supreme Judicial Court
The Court began it opinion with its ultimate holding: “We conclude that, where a franchisee is an ‘individual performing any service’ for a franchisor, . . . the three-prong test set forth in the independent contractor statute applies to the relationship between a franchisor and the individual and is not in conflict with the franchisor’s disclosure obligations prescribed by the FTC Franchise Rule.”
First, the Massachusetts court stated that “[t]he plain language of the independent contractor statute neither expressly includes nor expressly excludes franchisees from its reach.” Further, the court stated that the independent contractor statute should apply even if an industry is highly regulated, unless the Legislature expressed a clear intent to exclude those engaged in a particular industry.
Second, the court observed that the FTC Rule is merely “a pre-sale disclosure rule” and “does not regulate the substantive terms of the franchisor-franchisee relationship.” Compliance with these disclosure requirements, according to the court, “does not mandate that a franchisor exercise any particular degree of control over a franchisee.” Rather, the court noted, “the regulation [simply] establishes rules for when the franchisor chooses to exercise a certain degree of control.” The court stated that franchisors are not required to exercise any control over the franchisee’s method of operation, but the FTC Rule’s disclosure obligations are [still] triggered so long as the franchisor “provide[s] significant assistance in the franchisee’s method of operation.”
Third, the court then noted that where the franchisor elects to exercise a “significant degree of control over the franchisee’s method of operation,” the FTC Rule requires such disclosure. Thus, the court concluded that there really is no “conflict” between the FTC Franchise Rule and the Massachusetts independent contractor law because the FTC Rule simply requires timely disclosures where the franchisor chooses to control or significantly assist the franchisee’s method of operation.
The court then added as follows: “A franchisor can comply with the FTC Franchise Rule to make the prescribed disclosures, and in situations where a franchisee is deemed an employee under the independent contractor statute, the franchisor can comply with its obligations under the wage statutes. Compliance with these latter obligations does not render it impossible for a franchisor to comply with the FTC Franchise Rule.”
In what is perhaps the most important part of the opinion from the standpoint of independent contractor law, the court stated: “[T]he franchisor’s election to exercise ‘a significant degree of control over the franchisee’s method of operation’ does not render every franchisee an employee under the first prong of the ABC test; the two tests are not the same. This is because ‘control over the franchisee’s method of operation’ does not [necessarily] require a franchisor to exercise ‘control and direction’ in connection with the franchisee’s ‘performing any service’ for the franchisor – [which is] the relevant inquiry under the first prong of the ABC test.” To accentuate that point, the court stated further: “Indeed, ‘significant control’ over a franchisee’s ‘method of operation’ and ‘control and direction’ of an individual’s ‘performance of services’ are not necessarily coextensive.”
The court buttressed that conclusion, which should give comfort to the franchise industry if they take the steps suggested below, by stating that courts in other jurisdictions have found franchisors electing to assert significant control over the franchisee’s method of operation to have succeeded in meeting the first prong of the ABC test or its equivalent, citing to two other 7-Eleven cases recently decided in the franchisor’s favor in California and New Jersey.
Analysis and Takeaways
The decision by the Supreme Judicial Court of Massachusetts essentially rejected the franchise industry’s effort to procure a judicial exemption from laws barring independent contractor misclassification. Now, at least in Massachusetts, and perhaps in other states, if franchisors want to avert the need to comply with wage and hour laws in their relationship with franchisees, they will be required to structure, document, and implement their franchisee relationships in a different manner than they have been doing in the past.
Now, franchisors will have to avoid needless direction and control over the performance of an individual franchisee’s services. That is by no means an unattainable objective. To the contrary, it is readily achievable, but requires a different mind-set for almost all franchisors. As the Massachusetts high court made clear, “‘significant control’ over a franchisee’s ‘method of operation’ [as mentioned in the FTC Franchise Rule, on the one hand] and ‘control and direction’ of an individual’s ‘performance of services’ [as mentioned in prong A of the Massachusetts independent contractor law, on the other hand] are not necessarily coextensive.”
Historically, franchise agreements are typically bloated with provisions retaining the right to control almost every aspect of the franchisor-franchisee relationship. When a franchisee is a company with a number of employees, the issue of independent contractor misclassification does not exist. Sizeable companies are not capable of being “employees.” But where the franchisee is an individual or single-member LLC or corporation and essentially operates as a one-person or two-person shop, perhaps with a few helpers, such control in a franchise agreement can have a huge impact on the independent contractor vs. employee classification status of franchisees.
For years, savvy businesses that engage independent contractors have utilized a process such as IC Diagnostics (TM) to structure, document, and implement their independent contractor relationships in a customized and sustainable manner, consistent with their business models and strategies, in a way that minimizes or avoids direction and control over the manner and means by which the contractor performs the services. This approach maximizes compliance with independent contractor laws. The same approach can apply with equal force to the franchise industry.
Conversion of franchise agreements from a high degree of control over the franchisee’s performance to a relationship with minimal or incidental control is both an art and a science. Most standard franchise agreements require literally hundreds of revisions and state-of-the-art workarounds. But, very few if any of those modifications are likely to have any meaningful impact on the franchise operation itself or have any impact on profitability.
The Patel v. 7-Eleven decision in Massachusetts is a clarion call to franchisors that contract with franchisees who are individuals or operate with few if any helpers. While the court’s decision is unwelcome news for many such franchisors, all is hardly lost. While changes to the structure, documentation, and implementation of the relationship with individual franchisees is not typically capable of a quick and dirty fix or a one-size-fits-all remedy, almost all such franchise businesses can dramatically minimize their independent contractor misclassification liability.