Stark & Stark would like to congratulate Shareholder Adam J. Siegelheim, Chair of the firm’s Franchise Practice, for being named by Franchise Times Magazine as a 2016 Legal Eagle. Mr. Siegelheim was even selected as a featured Legal Eagle.

Legal Eagles are selected each year from nominations by their clients and peers and are recognized as the top lawyers in franchising. This year’s selection focused on “around-the-clock” attorneys, who are always available for clients. When looking at this year’s list of Legal Eagles you will find “dedicated professionals who are available whenever their clients need them, steeped in knowledge about all things franchising – with plenty of interesting aspirations and outlets beyond the courtroom.”

For more information about this year’s Legal Eagle selections, please click here.

Join Stark & Stark’s Franchise Group at Booth #4768 during this year’s NRA show at McCormick Place in Chicago, IL from May 16-19, 2015. At the event, Shareholder Adam J. Siegelheim will moderate the educational seminar, How to Franchise Your Restaurant to Others: The Process Untangled, which will be held in room S404d on Sunday, May 17, from 11:30 AM – 12:30 PM.

Mr. Siegelheim will be joined by Allen Dikker, CEO of Potatopia, Phil Schram, Chief Development Officer of Buffalo Wings & Rings, and James Walker, President of Operations & Development at Johnny Rockets. This seminar will discuss in detail the process of franchising a restaurant. Attendees will learn the basics of franchising their business and walk away with a clear understanding of the process.

For more information on the event, please click here.

Stark & Stark would like to congratulate Shareholders Adam J. SiegelheimRachel L. Stark and Eric S. Goldberg, members of the firm’s Franchise Group, for being named by Franchise Times Magazine as Legal Eagles for 2015

Legal Eagles are selected each year from nominations by their clients and peers and are recognized as the top lawyers in franchising. Only 193 attorneys nationwide have the honor of being named “Legal Eagles.”

For more information about this year’s Legal Eagle selections, please click here.

The decision of the National Labor Relations Board (“NLRB”) in July 2014 to authorize the filing of administrative complaints against McDonald’s USA, LLC (“McDonald’s”), the largest franchisor of restaurants in the United States, and recent court decisions, highlight one of the hottest issues in franchise law. Are your franchisees and their employees actually your employees?

The NLRB investigated 181 cases alleging that McDonald’s franchisees and their franchisor, McDonald’s, violated the rights of workers as a result of activities surrounding fast food strikes and protests. It found “sufficient evidence” to issue a complaint in 43 of these cases, and determined that McDonald’s should be considered a joint employer with its franchisees.

The “joint employer” doctrine allows a plaintiff to hold a non-employing party vicariously liable for the employment actions of the employing party. As a “joint employer” with its franchisees, McDonald’s would be equally liable for labor violations committed by its franchisees. Until this issue is resolved, franchisors risk liability for the actions of their franchisees.

Although the NLRB has authorized the filing of complaints, this is a preliminary ruling, and the NLRB has not yet decided the “joint employer” question on the merits. Administrative law judges will make rulings after a hearing, and the losing party can appeal to the full NLRB board in Washington, D.C. NLRB decisions could be appealed to a federal appeals court, and then possibly to the U.S. Supreme Court.

In August 2014, the California Supreme Court held that Domino’s Pizza LLC was not liable for the acts of a franchisee whose manager had allegedly harassed an employee.  The decision was based largely on the terms of the franchise agreement between Domino’s and its franchisee.  However, the court stated that a franchisor “will be liable if it has retained or assumed the right of general control over the relevant day-to-day operations at its franchised locations … and cannot escape liability in such case merely because it failed or declined to establish a policy with respect to that particular conduct.”

The consequences of misclassifying individuals as independent contractors can be severe, and include: withholding tax obligations; wage damage claims; unemployment tax obligations; employment discrimination claims; workers’ compensation liability; vicarious liability; income tax liability based on presence in state; and IRS and state audits with related taxes and penalties.

Franchisors therefore need to closely analyze their business arrangements and agreements with independent contractors and franchisees to protect themselves. Maintaining a uniform system and protecting brand identity cannot become exerting control over the day-to-day operations of the franchisee’s business.

For example, contract terms should clearly state that the franchisee is not an agent of the franchisor, and that the franchisee must comply with all federal, state and local laws and regulations. The franchisee can also be required to incorporate, so that the franchisor is dealing with a separate legal entity. Other suggestions include limiting the amount of control exercised on matters that could affect franchisee employees, and not making employment decisions, including setting wages or making employment policies that affect the discipline or termination of workers.

In addition to unveiling the new iPhone and Apple Watch, Apple’s CEO, Tim Cook, also recently announced that the approximate 500 million iTunes users would also be receiving a free digital copy of U2’s latest album, Songs of Innocence. The album would be automatically downloaded and appear in each user’s iTunes library without the person having to do anything.

Analysts are estimating that this deal with U2 cost Apple approximately $100 million dollars. Apple likely calculated that the publicity and good will they expected to receive far exceeded this cost.

However, Apple’s marketing team did not anticipate the negative backlash sparked through social media and other outlets. Here is an article that refers to Apple’s approach as “invasive.”

Angry iTunes customers demanded to know how they could remove this U2 album that they did not ask for or want. Even fans who wanted the album complained about Apple downloading it onto their account without asking for their consent. In response, Apple had to develop a separate website which details the process for users to remove the U2 album from their library.

In addition to upsetting its customers, Apple also had to deal with unwanted media coverage criticizing Apple’s decision to download the music directly onto user’s iTunes library, rather than making the free download available for anyone who was interested, i.e., giving their customers a choice in the matter.

Apple’s misstep can serve as a lesson to franchise companies. Many franchise executives have the same thought process as Apple. They expect their franchisees to be thrilled by some new initiative that is going to increase their profitability, increase their sales, increase brand awareness, etc. What they do not take into account, is that franchisees, like Apple’s customers, want to feel they have a say in the process and that they are not being dictated to.

Successful franchise systems have strong franchisor-franchisee relationships. One of the quickest ways to weaken this relationship is to take steps where the franchisees feel that something is being force fed to them. A franchisor advising of a new initiative, without any input from its franchisees should expect results similar to what Apple received from their customers.

In Naik v. 7-Eleven, Inc., (U.S. District Court. D.N.J., Civil No. 13-4578), certain 7-Eleven franchisees in New Jersey alleged that they are employees, not independent contractors, of the franchisor, and that the franchisor violated the federal Fair Labor Standards Act (FLSA) and other New Jersey statutes.  7-Eleven made a motion to dismiss, which was denied by the court.

Each plaintiff entered into a franchise agreement with 7-Eleven.  Despite clear language in the franchise agreement indicating that the franchisees operated independently owned and operated businesses, the franchisees claimed that the “economic reality” was that they were employees of the franchisor and entitled to protections under the FLSA, New Jersey Wage and Hour Law and the New Jersey Law against Discrimination.

In an effort to support their claim, the franchisees relied on numerous factors, including:

  • The Franchisor asserts a high level of control over vendor and suppliers, product pricing and advertising;
  • Payroll is processed through the franchisor’s payroll system;
  • Franchisee’s required to wear uniforms designated by Franchisor;
  • Franchisor’s managers oversee Franchisee’s locations on a daily basis;
  • Franchisor controls the volume of store televisions and thermostat from their corporate headquarters;
  • Franchisees are prohibited from having active business interests in other ventures;
  • Bookkeeping and accounting is done by the Franchisor and the Franchisee cannot withdraw money without the Franchisor’s consent.

In denying the Franchisor’s motion to dismiss, the court noted that the issue of the classification of an independent contractor vs. an employee for purposes of New Jersey wage claims was still unsettled and the issue was in the process of being examined by the New Jersey Supreme Court.  However, the Court did take note that the Franchisor has exerted significant and pervasive control over the Franchisee’s operations.

While the court has yet to issue a final decision on this case, it certainly serves as a stark reminder for Franchisors  to evaluate whether the controls it exerts over its franchisees are necessary to protect brand standards or whether the controls go above and beyond this need.

The recent decision of Yogo Factory Franchising, Inc. v. Edmond Ying, et al., (US District Court D. New Jersey 2014), has been the subject of prior blog postings. We have discussed the court’s enforcement of the arbitration provision contained in the franchise agreement and the court’s re-affirmation that the New Jersey Consumer Fraud Act does not apply to the sale of franchises. Another noteworthy aspect of the court’s decision is the discussion of the heightened standard under New Jersey law to successfully assert a fraud claim.

In this case, the franchisee alleged that the franchisor made various misrepresentations during the sales process, including misrepresenting potential earnings, profits, the amount of start-up costs, and the type of support that the franchisor would provide.

Franchisee did not plead fraud claims with particularity

The court noted that when asserting fraud under New Jersey law, it must be pleaded with particularity. This is a heightened standard that requires the claimant to be very specific when alleging fraud, and does not permit general and broad claims. For example, when asserting fraud, a franchisee would not only need to assert the substance of the alleged misrepresentation, but also the date, time and place of the misrepresentation.

In this case, the court held that the franchisee’s fraud claims did not meet this standard. The franchisee did not specify which member of the franchisor made the misrepresentation and when. The court also noted that the franchisee claimed that the franchisor made material financial performance representations but did not specify exactly when and where they occurred. The court generally viewed the franchisee’s fraud claim as just asserting legal conclusions, leaving the franchisor to guess as to the ‘who, what, when, where and how of the events at issue”.

Franchisee’s allegations did not rise to level of fraud

Even if the franchisee had properly asserted its claim with particularity, the court concluded that it still failed to make a proper fraud claim. The court noted that the crux of the franchisee’s fraud claim was that the franchisor misrepresented the amount of money it would generate and the amount of support it would provide.

In rejecting the fraud claim, the court pointed out the following:

  • Two of the three franchise agreements contained an integration clause stating that the agreement constitutes the entire, full and complete agreement between the parties and the agreement supersedes all prior agreements;
  • The agreements contained a provision stating that no other representations induced the franchisee to execute the franchise agreement;
  • The franchise agreements clearly state that the investment and any success is speculative; and
  • The franchisee executed a disclosure questionnaire stating that the franchisor did not make any promise concerning revenue, profit or operating costs of the franchised locations, except as set forth in Item 19 of the Franchise Disclosure Document.

Based on these factors, the court did not see any basis for fraud. The court also concluded that under established New Jersey law, a party cannot maintain a fraud claim based on the other party’s failure to perform under a contract. The remedy is to bring a breach of contract claim – not a fraud claim.

This case underscores that if franchisors engage in some fairly common best practices (integration clauses, disclaimers to Item 19 financial performance representations, utilizing a disclosure questionnaire, etc.), they can reduce the likelihood of a franchisee maintaining a viable fraud claim under New Jersey law.

A common question that we receive from our franchisor clients is, “Can we update our FDD and franchise agreement permitting the franchisor to impose fines on franchisees for non-compliance?” The simple answer is that while you can update your documents to permit the imposition of fines, the real question franchisors should be asking is, “Are fines an effective tool to minimize instances of non-compliance with System standards?”

Recently, a hotel received unwanted attention for its policy of imposing wedding couples a $500 fine for every negative Yelp or other social media site review posted online by their guests.

As part of the policy posted on the hotel’s website, the rationale behind the fine was explained as follows:

Please know that despite the fact that wedding couples love Hudson and our inn, your friends and families may not,”… “If you have booked the inn for a wedding or other type of event . . . and given us a deposit of any kind . . . there will be a $500 fine that will be deducted from your deposit for every negative review . . . placed on any internet site by anyone in your party.

In response to the attention that this policy has generated, the hotel owners have responded that the policy was posted on its website as a joke, was never enforced and the policy has subsequently been removed from the hotel’s website. The reason this story has gone viral is the irony that a business could think that imposing fines is an effective way to limit negative reviews, rather than working to fix the service and operational issues that may prompt such negative reviews.

This story serves as an over exaggerated example of the ineffectiveness of using fines rather than resolving the underlying issue that is resulting in the behavior the fines are seeking to curtail. In the case of franchise systems, if a franchisor is considering implementing fines, it is usually because they are trying to stop a wide spread issue, and is not in response to some isolated instances involving “rogue” franchisees. This suggests that the franchisor should be focused on why the instances of non-compliance are increasing, rather than hoping that it can ignore the underlying problem and simply levy fines. While imposing a fine may result in short term results for increasing System compliance, it is difficult to imagine that it will achieve long term or permanent results if the underlying issues are not addressed.

Franchisors should also remember that when addressing non-compliance, there is not a “one size fits all” solution. If a franchisee is not following System standards because they are undercapitalized or struggling financially, it seems that imposing a fine would just be piling on to their problem. In that instance, the franchisee would view the franchisor as having no empathy and the relationship would further deteriorate. Similarly, if a franchisee is not following System standards because their business is struggling and they have become despondent and no longer keeping a close eye on their operations, imposing a fine may just lead to a franchisee’s sense of despair and increase their non-compliance.

While the use of fines may be effective in certain instances, it is difficult to see how a wholesale and indiscriminate use of fines would serve as a “silver bullet” to increase overall System compliance with brand standards. It is also difficult to see how fines could be effective in the long run, if the franchisor is not also focused on addressing the underlying behavior and issues that are resulting in the non-compliance.

The National Labor Relations Board Office of the General Counsel has created a firestorm in the franchise community with its recent decision that McDonald’s and its franchisees will be treated as joint employers with respect to allegations that they violated the rights of employees. The NLRB’s decision strikes at the heart of the franchising business model, which is based on franchises being independently owned and operated businesses.

If upheld, the NLRB’s decision could have a substantially adverse impact on the franchise industry and the overall economy. Franchise development leads to economic and job growth. One would expect business owners to be reluctant to expand through franchising if they could potentially be responsible for their franchisee’s employees. This decision could also result in increased pricing of goods and services, as a franchisor would likely need to increase its revenues to deal with this new potential liability. Increased pricing could ultimately result in decreased consumer spending and stall economic growth.

It is worth noting that the NLRB’s decision represents the first step in its administrative process. McDonald’s will have the opportunity to defend itself in an administrative hearing and will also have the opportunity to appeal that decision to the NLRB Board. Even if the NLRB upheld a decision against McDonald’s, it would then need to be enforced by a federal court.

Whether the NLRB’s Office of General Counsel’s decision withstands the scrutiny of its entire board and the federal court system remains to be seen. While this process plays out, a franchisor should take this as a cautionary reminder to regularly review its operations manual and other policies to ensure that it is not unnecessarily exerting too much control over its franchisee’s employees. Unless a policy is absolutely essential to the health of the brand and System, a franchisor should err on the side of being suggestive vs. required when creating policies that impact a franchisee’s employees.