Chicken Little and the NLRB: Franchisor Joint-Employers Are Falling Everywhere

<p>Like the plummeting acorn that caused Chicken Little to conclude that the sky is falling, the recent NLRB Browning-Ferris decision (&ldquo;NLRB decision&rdquo;) has triggered franchisors, and some of their franchisees, to publicly and loudly proclaim that &ldquo;franchising is doomed.&rdquo; This forewarning is at best a great miscalculation, and at worst an intentional exaggeration. <!--break--> Either way, such unreliable alarmism should not continue to be the hallmark of franchisor advocacy.</p>

<p>This does not mean, however, that it is not politically tactless for the NLRB to try to exploit its legal authority over labor relations in particular to try to redistribute income in society in general. And, this is also not to say that the NLRB decision if left to stand (and as applied in its strong form to franchising) might not result in additional costs for the franchising model. However, cries of the imminent death of franchising simply do not harmonize with even the worst potential permutation of the ultimate NLRB decision. Indeed, the seemingly well-intentioned members of the House Committee on Education and the Workforce listening to witnesses at the recent Hearing in the Fall of 2015 struggled repeatedly, outwardly, and embarrassingly to square the blatant prophesized franchising cataclysm with recent NLRB action. It was a cringe-worthy experience watching them slowly thinking out loud as they incessantly ran into obvious conceptual dead-ends, many times at the invitation of the Committee&rsquo;s testifying witnesses who, too many times, appeared unfamiliar with rudimentary franchise theory and analysis.&nbsp; &nbsp;</p>

<p>On the other hand, it is futile to argue that the NLRB decision, regardless of its final contours, will not have some impact on the costs of franchising. Like federal minimum wage legislation, for instance, the NLRB decision will shift upwards the cost curve of franchising. And, like other products and services that sustain a cost increase, the price of franchising will increase and the number of franchises, ceteris paribus, will decrease. Some of these costs will be short-run and not structural (e.g., legal fees challenging the validity of the NLRB decision), and others will be long-run and more permanent. Of the latter class, one can conceptually envision three general sub-types: one, direct quantitative costs of new functions (e.g., collective bargaining); two, direct quantitative modification costs (e.g., modifying franchise agreements); and, three, indirect qualitative modification costs (e.g., loss of control associated with modifying franchise agreements). Of course, the degree to which these costs will be incurred will depend in large measure on the ultimate NLRB rule that is essayed. In this regard, in general, there is the Pre-Browning-Ferris rule, the current Browning-Ferris rule, and the proposed Browning-Ferris rule now in Congressional legislation. That significant differences of opinion exist as to the legal scope and definition of each rule is acknowledged, but these legal differences are beyond the scope of this short note. Further, absent extreme unanticipated forms of the NLRB rule, it will not impact on the general theoretical boundaries and dynamics discussed herein.</p>

<p>The only way that the NLRB decision would be lethal to franchising is for it to impose new additional costs so significant that the aggregate costs of franchising would then surpass those associated with full vertical integration. In other words, theoretically, franchisors in an initial position will choose to market their products and services using the franchise model because it is more efficient than selling through company-owned outlets. In this regard, it is both less expensive and more productive. These benefits can be visualized by calculating the difference between the costs of selling through vertically integrated outlets and the costs of marketing through franchisees (&ldquo;franchise premium&rdquo;). Very simply, although there is a dearth of recent literature that estimates the amount of the franchise premium, the fact that: (1) it exists, (2) is positive, and (3) is substantial is beyond peradventure. It is evidenced most directly by the historical rise, longevity and usage of the franchise marketing model itself.</p>

<p><img alt="Franchisor Chicken Little" src="http://www.bluemaumau.org/sites/default/files/skyisfalling.png&quot; style="width: 330px; height: 285px; float: right; margin-left: 5px; margin-right: 5px;" />The uncertainty of the parameters of the NLRB decision, as well as the alternatives to the NLRB decision, itself is causing much of the trepidation in the franchise world. This anxiety is further exacerbated by the potential conduct choices available to franchisors after an NLRB rule is finally promulgated by the NLRB or Congress. Conceptually one can envision several alternative ultimate NLRB rules; one that would result in all franchises with any control of any nature being required to comply with the NLRA (&ldquo;strong NLRB rule&rdquo;); another that would require only franchises with labor provisions in their franchise agreements being required to comply with the NLRA (&ldquo;weak NLRB rule&rdquo;); and another that would in practice exempt all franchises from complying with the NLRA (&ldquo;prior NLRB rule&rdquo;).</p>

<p>However, this is not to say that the franchising model (even using a weak NLRB rule) would not suffer from the NLRB dispute; indeed, it would, as there would, for instance, be a deadweight loss associated with the decreased number of franchises in the face of the higher costs of franchising. This deadweight loss is a real &lsquo;hidden&rsquo; loss to society of the sales of goods and services that otherwise would have been distributed through the franchise model but would instead now either not be distributed at all or be distributed through more costly vertically integrated entities. But, under ordinary circumstances, and even under the strong NLRB rule, the deadweight loss associated with a new NLRB rule is not likely to kill franchising; instead, it will more probably merely result in a relative increase in distribution through other forms of distribution (e.g., vertical integration) to the detriment of franchising. Although history has shown that franchising is conceptually under most circumstances less costly than full vertical integration, when external events have altered relevant costs and incentives, firms have freely embraced vertical integration. Indeed, this is not always an &lsquo;all or nothing&rsquo; proposition: there are certain franchise systems that have garnered esoteric and other efficiencies by distributing through both franchise and company-owned outlets. Further, of course, the direct stakeholders would have to share the direct cost burden arising from the new NLRB decision (based on the relative elasticities of demand of the franchisors and franchisees), and ultimate consumers would in most instances pay higher prices.</p>

<p>Before leaving the issue of negative impact on the franchising model of a new NLRB rule, it is necessary to examine briefly an important hidden cost of a new NLRB rule -- the loss of internal control in the franchise model. This is what I have referred to above as the indirect qualitative modification costs (e.g., loss of control associated with modifying franchise agreements). In essence, the theoretical need for control in a qualitative sense in a functioning franchise system is undisputed, crucial and sacrosanct. For better or worse, control by the franchisor is the synergistic glue that holds together all franchise stakeholders and their conflicting economic disincentives, deterrents, and opportunistic tendencies. Specifically, as an initial proposition, as one contemplates the substitution of franchise distribution in place of distribution through corporate-owned stores, for instance, it is necessary for control to be given to both stakeholders: franchisees will be provided with control sufficient to extract marginal entrepreneurial efforts that would otherwise not be expended, and franchisors will be provided with control, in part, to prevent one of the most significant moral hazards associated with franchising, to wit, free riding.&nbsp; By affecting the historical division and ability to exercise control between franchisors and franchisees, the NLRB decision goes much further than simply causing a diminution in the franchise surplus; indeed, it strikes at the very lifeline of the franchise surplus itself.</p>

<p>And, with regard to this crucial control component, franchisors are able to respond to a modified NLRB rule in one of two ways. They can extricate themselves entirely from the comprehensive labor relations area by deleting associated sections, rules and provisions from their franchise agreements and policy manuals, or they can beef-up these requirements and take full control &ndash; practically as well as legally -- for these activities. Ironically, both of these choices have the potential to do theoretical violence to the existing franchise equilibrium: the first, at least in the short run, results in less control for the franchisor and the latter causes a depletion of control for the franchisee. To the extent franchisors or franchisees view this qualitative loss of control as denying them the benefits of the franchise model, application of a stronger NLRB rule will result in a sub-optimal amount of franchising, and, in a worst-case scenario, could severely disable the franchise model as a true alternative to full vertical integration. This is because, unlike bearing the burden of a simple direct increased cost, the loss of control goes to the very heart of the underlying dynamics of the franchise model itself.</p>

<p>We know from history that franchising has proved highly capable of withstanding repeated economic intrusions, both from without and within. Although it is not a perfectly equitable distribution system, it is, on balance, fairly efficient. Franchising didn&rsquo;t die after the California Franchise Act was enacted; it didn&rsquo;t die after minimum wage laws were enacted by cities and states; it didn&rsquo;t die when the FTC required FDDs to be produced and provided; it didn&rsquo;t die when courts began to hold franchisors liable for personal injuries that occurred on the premises of franchisees; it didn&rsquo;t die when state franchise legislation began holding franchisor officers, directors and agents liable for state franchise law violations; and, it didn&rsquo;t die when state laws were enacted requiring that franchisors have good cause to terminate.</p>

<p>My intuition here is that the final NLRB rule, after some sustained legislative and jurisprudential wrangling, will result in a rule similar to that applied in the <a href="http://www.goldlawgroup.com/nlrb-memo-franchisor-not-joint-employer-nlr… Freshii Advice Memorandum</a>. In this Advice Memorandum, a non-binding document, the franchisor was characterized by an NLRB Associate General Counsel as not a joint-employer responsible for its franchisee&rsquo;s alleged unfair labor practices. The decision in large measure pivoted off of the franchisor&rsquo;s not actively controlling the franchisee&rsquo;s labor-relations rules, regulations and conduct. To the extent the rule in the Freshii Memorandum is ultimately adopted and utilized as a new NLRB rule, the fix for franchising should be relatively easy &ndash; gradually modifying franchise agreements and operations to steer clear of labor relations matters.</p>

<p>However, even in a world in which the Freshii standard became law, although franchising would still remain a very viable option in the marketplace for distributing products and services, the standard would probably result in what could be viewed as sub-optimal modifications to franchise agreements and manuals. This, in turn, would also impact upon the less measurable crucial dynamic component of franchising &ndash; control. With less control for franchisors, for instance, the cost of monitoring compliance with franchise standards and regulations would increase, thereby leading to less monitoring, more free-riding, and less franchising. The subsequent associated resulting increased moral hazard imposed by franchisors in this cacophony of distorted incentives should not be overlooked: as franchisors sought to make up lost revenues from lost production, they would tend to enact and impose costly standards that would attempt to extract greater compensating economic rent from their franchisees.</p>

<p>So, what should franchisees be doing during this uncertainty? First, franchisees, at least at this early stage of the battle, should probably not continue to evangelize to legislators about esoteric legal precedents of law and theories of economics. If franchisors continue to seek active franchisee input at these legislative events then franchisors should ask franchisees to testify about the issues about which franchisees are best informed, including: how and why the franchisee feels different as a franchise owner than he or she would as a mere employee (e.g., entrepreneurial surplus efforts); what he or she does to contribute to the success of the location as a franchisee that he or she would not normally have done as a mere employee; and a blow-by-blow description of the labor decisions made by the franchisee each day and whether and how these hourly prolific micro-actions could be carried out by a franchisor 500 miles away from the franchisee&rsquo;s location.</p>

<p>Second, on a different note, franchisees should be on the lookout for franchisors doing the &lsquo;swap and replace&rsquo;, whereby franchisors remove labor relations franchise agreement provisions from existing franchise agreements and include instead other non-employment provisions in their place. In other words, while franchisees could end up with more franchisor control over their businesses as employment provisions are removed from franchise agreements and manuals, this increase in control will probably be only temporary, as, in the long run, franchisors will naturally attempt to replace this lost labor relations control with other new forms of control in the franchise relationship. Either way, franchisors will be motivated to add in other control-shifting provisions upon modification. In contrast to some franchise attorneys who have indicated that this is an opportunity for franchisees to extract additional control from franchisors (e.g., recent article in donuts franchisee magazine), I don&rsquo;t believe that this situation is likely to present itself. This Trump-like view of such a potential opportunity is more sensational than theoretically accurate. The franchisee lawyer&rsquo;s job during this adjustment process, to the extent it occurs on an ad hoc basis, should be to try to limit the relative diminution of the franchisee&rsquo;s rights in other parts of the agreement.</p>

<p>Third, because the NLRB dispute, as noted above, will impose new unspecified costs on the franchise model, and because franchisors will naturally attempt to shift the greater portion of the increased costs on franchisees, this battle is likely to be decided based on the relative power bases between franchisees and franchisors. Accordingly, it would probably make much more sense for franchisees to channel their efforts and resources towards franchise relationship legislation rather than to further NLRB legislative efforts. This would give franchisees their best opportunity to have a say as to how the costs of the NLRB decision &ndash; whatever its final form -- will ultimately be allocated.</p>

<p>As discussed above, the NLRB situation is likely to impose real costs on the franchising model. Although franchisors are in charge of shepherding the NLRB legislation, they should remember the fate of the shepherd boy who repeatedly tricked villagers into thinking that a wolf was attacking. It serves nobody&rsquo;s best interests to continually exaggerate the impact of the NLRB decision. Shooting straight with legislators on this highly esoteric and complicated issue &ndash; not catastrophizing -- will ensure maximum protection from the NLRB&rsquo;s misguided conduct.</p>

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<p><strong>Related reading</strong>:</p>

<ul>
<li><a href="http://www.bluemaumau.org/15108/zarco_nlrb_ruling_good_franchisees&quot; target="_blank">Zarco: NLRB Ruling is Good for Franchisees</a></li>
<li><a href="http://www.bluemaumau.org/penny_franchisor_henny&quot; target="_blank">Editorial Cartoon: NLRB falls on franchisor chicken little</a> | BMM</li>
<li><a href="http://www.bluemaumau.org/franchise_franchisor_control_without_liabilit…; target="_blank">Editorial Cartoon: ZorFox wants control of ZeeHen, without liability</a> | BMM</li>
</ul>