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.