Franchisor Control Problems and the Alexander Haig Solution

A recent case in California federal court, Vann v. Massage Envy Franchising LLC, 2015 WL 74139 (S.D.Cal. 2015), has given franchisors a win on a fact-specific application of the "employer control" issue in a vicarious liability setting. In this case, Mr. Vann, a massage therapist who worked at various Massage Envy franchisee spa locations, filed a class-action complaint against the franchisor MEF, and two franchisees, alleging violations of California's minimum-wage laws.

The Court in Vann, in ruling that the facts did not support finding the franchisor to be an employer under the minimum-wage laws, noted that "California courts analyze the employment relationship between franchisors, franchisees, and employees under an agency theory" and that "the question of whether the franchisee is an independent contractor or an agent is ordinarily one of fact, depending on whether the franchisor exercises complete or substantial control over the franchisee."

Although the Vann decision is indisputably a franchisor victory, it would be an expensive mistake for franchisors and their advocates to interpret the case as signaling any serious shift in the way that agencies, courts and legislatures around the country (or even other courts and agencies in California) view the issue of franchisor vicarious liability, conceptually or practically. The limited comments in this article, in discussing franchisor vicarious liability, focus solely on upon the situation where the franchisee (or its employee) indisputably violates some common law or statutory duty (e.g., acts negligently, discriminates or fails to pay certain taxes based on employment), and not on the circumstance where the franchisor has itself directly violated a common law or statutory standard. Further, the franchisor vicarious liability discussed herein is not meant to include its close cousin, strict liability, since the underlying conduct associated with franchisor vicarious liability (as carried out by the franchisee) is assumed to itself have been independently wrongful.

At bottom, the perennial dispute in franchisor vicarious liability cases pivots off of application of what can be characterized as the "control test," which basically asks whether the relevant franchisor has sufficient existing and potential control over its franchisees' operations to justify its being held legally accountable for certain wrongful conduct of its franchisees. So, for instance, in an employee tort case, where a pizza franchisee negligently runs over a bystander during a delivery run in order to meet a guaranteed delivery time, the legal decision whether to hold the franchisor jointly liable with the franchisee for injuries to the bystander turns upon the level and quality of control that the franchisor exercised or could have exercised over the franchisee. A similar control analysis would govern the situation where an employee of the franchisee, rather than the franchisee, was driving.

The current control test derives from historical common law agency principles, whereby courts viewed an agent in a work context as falling within one of two potential categories: either an employee (servant), or an independent contractor. A conclusion that the agent was an employee, rather than an independent contractor, created potential liability for the master or employer for acts carried out by the employee within the scope of employment under the doctrine of respondeat superior. Very simply, where the principal controlled the conduct of its agent the principal was liable as a master, and where the principal did not control the agent's conduct, the principal incurred no respondeat superior liability, since the agent was merely an independent contractor, not an employee.

When franchising was in its infancy, it was relatively easy and noncontroversial for courts to push round pegs into square holes in franchise vicarious liability cases; few courts presented with the innovative franchise model for the first time could convincingly conclude that the franchisor did not exercise significant control over its franchisees vis-à-vis the control that a principal would normally exercise over an independent contractor or even an employee. As time passed, however, the economic importance of franchising skyrocketed. As the economic consequences of franchisor control cases increased, so did legal and political scrutiny of the cases themselves. The vicarious liability concept of control that historically had appeared so methodically capable of distinguishing employees from independent contractors was unable to reconcile the control nuances of the curious franchisor-franchisee relationship. In this regard, although almost every franchise agreement explicitly stated that the franchisee was solely an independent contractor, the other 99.9% of the franchise agreements (incorporating explicitly relevant interminable system standards manuals) included provisions describing how the franchisee's business (and personal) life would be governed by franchisor demands, prohibitions, and standards. The analytical and intellectual indigestion associated with this incongruity gave way to another new battle-front in the franchisor-franchisee war.

Instead of jettisoning the control test or theoretically altering it to more closely reflect the distinctive business realities of the franchise relationship, courts began to play the "if it looks like a duck" game: "if it looks like control, then it must be control." In knee-jerk fashion, courts appeared to latch onto every aspect of control exercised by franchisors that would, in non-franchise contexts, have readily supported a finding of vicarious liability. Because the franchise model is based so heavily on the franchisor's fundamental economic need to control so many aspects of its franchisees' operations, courts' frequent findings of "sufficient control" for purposes of vicarious liability arguably gave way to many false positives – instances of findings of control in the franchise context that arguably should not have triggered vicarious liability given the original and historical policy reasons underlying the vicarious liability doctrine.

In the face of determined criticism by franchisor advocates of what appeared to them to be mistaken rulings against franchisors in vicarious liability cases, some courts began to actively adopt franchisor lawyers' arguments that drew "distinctions upon distinctions to nowhere" to ultimately conclude that sufficient control had not been demonstrated by the plaintiffs. Hypothetically, a franchisor could escape the clutches of vicarious liability by arguing that, unlike other franchisors which had previously been found to have exercised control by requiring their franchisees to wear blue-starched button down shirts, it had no standards requiring franchisees to wear uniforms; ergo, no control. And so it went, leading to cases like Vann, which despite being long on some type of analysis, never quite answered the question how many angels can dance on the head of a pin. The case was predictably short on long-range guidance, certainty and predictability. And, to the extent there is some small measure of predictability associated with the case, it is for the most part lethally limited to the particular language and narrow purposes of the specific California statute that was in issue in that case.

Making matters worse for franchisors is that the historical common law control test is now being utilized to determine franchisor liability not just in tort cases, but also under prolific liability-creating state and federal statutes governing taxes, minimum wages, discrimination, unionization, and unfair labor acts. With regard to the latter, the recent pronouncements from the General Counsel of the NLRB, as well as the many associated tag-along NLRB administrative complaints filed against franchisors by the NLRB, show that under a newly-adopted control-test, franchisors, at least for now (until after all relevant anticipated appeals have been completed or "corrective" legislation passed), can be held liable as joint-employers under the NLRA. Under the NLRB's bastardized control test, franchisors will be held liable for their franchisees having interfered with union drives and for engaging in unfair employee discipline.

What torments franchisors, justifiably, is that the control test places them between Scylla and Charybdis: on the one hand, to efficiently operate a successful franchise they must exercise control over countless aspects of the operations of their franchisees, but on the other hand, to side-step liability under the common law and scores of statutes, they cannot exercise "too much" control. What makes matters even worse for franchisors is that historically they have not been successful in providing to courts and legislators (or anyone) a convincing and coherent economic case for why they need to have so much control over their franchisees' operations.

How difficult is it to provide a common-sense layman's explanation of the need to monitor and discipline franchisees' conduct in order to avoid the unique costs associated with moral hazard and adverse selection that are inherent in the franchise model? Worse yet for franchisors is that the intuition on this point falls heavily on the franchisees' side: what independent businessman would not be incredibly perturbed, and in turn throw a political tantrum, in the face of constant costly interference from a non-owner whose personal investments are not at stake in the operations of the business?

Franchisors, wearing expensive, complex and highly-effective perceptual blinders manufactured by their corporate lawyers, incessantly and impulsively fall back on the profoundly insincere argument that, as a matter of fact, they simply do not exert control over their franchisees; if pushed, they will usually maintain only that they exercise merely limited control and that this circumscribed control is necessary to protect and ensure the vitality of the system's trademark. In reality, however, corporate franchise lawyers compete with each other annually during FDD season to win the contest of which lawyer can devise the greatest number of proposed new contractual terms that will give added control over franchise operations to their franchisor clients vis-à-vis their clients' franchisees. Legitimate economic and legal justifications for control have been to some extent displaced by unconscious pathological urges to abstractly maximize all aspects of franchisor control. Control, not efficiency, has illegitimately ascended to the throne in the franchisor kingdom.

We know from history that such myopic control-seeking endeavors do not always pay off in the long run. Control for control's sake – totally detached from market justifications -- is costly, inefficient, and causes needless franchisee-franchisor friction. Although there are palpable and justifiable reasons for franchisors to exercise some reasonable measure of control over their franchisees, these rationales are not infinitely conceptually malleable; they do not stretch senselessly to encompass gratuitous and oppressive (or "supra-optimal") levels of control. A dollar obtained by a franchisor in the short run through instances of opportunistic control probably is worth merely a few cents in the long run after market forces have fully and accurately discounted the abuse. However, the astute short-run profit-maximizing franchisor in this instance would reply that, in the long run, we're all dead, as Adam Smith noted.

As subsequent mutated iterations of the control test continue to be created, further distorted, and then reapplied by legislatures and government agency personnel around the country, and as courts continue to apply the historical vicarious liability standards in an analytical black box, without reference to the unique and esoteric aspects of the franchise model, the ultimate costs of franchising – which should include those costs reflecting a franchisor's potential liability as a joint employer under all state and federal statutes -- will remain hidden, disguised and unpredictable. This will gravely hinder not only potential franchisors when considering what model of distribution to employ, but also potential franchisees when considering whether to purchase a franchise or go into business on their own.

In a free-market economy, visibility, predictability and rationality must prevail – even in the franchise industry -- so that prices and costs will accurately signal market participants to make welfare-enhancing purchasing and sales decisions that will allocate resources most efficiently. Without accurate numbers reflecting franchisor liability under all potential joint-employer scenarios everyone will needlessly and unquestionably suffer -- franchisors, franchisees and consumers alike.

Toward this end, franchisors need to do a much better job of explaining to everyone why the economics of franchising requires that they possess so much actual and potential control over franchisees. Franchisors that made such an admission would not necessarily suffer the same fate as Alexander Haig who admitted very publicly that "I am in control." However, understandably, such an explanation would strike politically incorrect tones: control over the conduct of independent persons and entities is generally antithetical to free market and democratic principles. In addition, such an admission would require franchisors to recognize, and conduct themselves in conformance with, the distinction between reasonable and unreasonable control. Franchisors would need to actively modify their systems by pulling back from supra-optimal levels of control of franchisees.

Further, such an admission by franchisors regarding control could arguably seriously undermine franchisors' active efforts to defeat proposed state franchise relationship laws. However, as time passes, and as the true colossal costs of potential franchise unionization in particular become known, and also as intrusive NLRB copy-cats begin to appear on the franchise scene, the franchisors' choice to benefit from making this obvious admission may cease to be within their control.

For a detailed summary of Vann v. Massage Envy Franchising LLC, 2015 WL 74139 (S.D.Cal. 2015), read it here.