The Legal Issues That Could Change Franchising Forever Franchising has been in the hot seat in the past year, as a number of legal and political conflicts -- minimum wage, protections for frachisees and the role of franchisors in labor disputes -- have come to a head.

Franchising usually makes it into the mainstream press when Taco Bell jams a new snack chip into its burritos. But in the past year, franchising has been making front-page news for other reasons: Several issues that have been simmering for years came to a head, pitting franchisors against franchisees and labor advocates against both.

The results of those conflicts—and their ultimate consequences for franchising as a whole—aren't at all clear, obscured by hyperbole, legalese and a lack of guidance from regulators. Whether these issues will reshape franchising for the better, as some argue, destroy franchising as we know it—or change nothing at all—remains to be seen. Whatever the case, the legal and political fights are worth watching.

The most publicized spat was the passage of California Senate Bill 610, commonly known as the fair franchising act, which, to a large degree, stemmed from a dispute between McDonald's and a franchisee. Kathryn Slater-Carter and her husband, Ed, had operated two McDonald's locations in Daly City, Calif., since 1983. In 2011, corporate headquarters notified them that the franchise agreement for their unit in the Serramonte Center mall would not be renewed upon its expiration in 2014, but that the company would continue the lease, enabling Slater-Carter to sell the unit to another franchisee and recoup some equity. The company even helped her find buyers for the restaurant, she says.

But in February 2014, McDonald's decided not to renew the lease, meaning Slater-Carter couldn't sell the business. After 30 years running the franchise, she would walk away with no payday. As a consolation prize she sold off all the equipment she could from the restaurant.

"Essentially, what it comes down to is the franchisee is the last to know and the first to be punished and first to have his pocket picked," says Slater-Carter, who still runs her other McDonald's unit. "I think when it's done with people who have conjoined interests and are working toward the same end, it's a good business model. But corporations get so big, and they have to take care of the corporation. They start to see franchisees as a necessary evil."

It's a problem franchisee advocates have shouted about for years. In fact several states, including Iowa and Rhode Island, have passed versions of SB 610, guaranteeing franchisees some equity. But many more, including Massachusetts, Vermont, Pennsylvania and Maine, have introduced similar measures that have not succeeded. Since California has such a huge franchising sector, its bill got the lion's share of the attention.

"What's happened is that over the years, attorneys for franchisors have tightened franchise agreements to the point where franchisees don't really own any equity in their business," explains Jim Coen, executive director of the Maine Franchise Owners Association, which supported the bill in Maine. "When push comes to shove, in most franchise agreements franchisees don't have anything but the equipment they buy. They have no right to the name, to their customer base, and because of noncompete clauses they can't use the skills they've learned. Yet franchising sells units by telling people they can be in business for themselves."

Slater-Carter's experience led her to hire San Rafael, Calif., lawyer Peter Lagarias, who testified in favor of SB 610, which was introduced by Sen. Hannah-Beth Jackson (D-Santa Barbara). The bill wasn't initially expected to go anywhere, but a coalition of franchisees and attorneys and associations put their support behind it and added amendments of their own.

The bill passed the state assembly in mid-August, setting off a public battle. The International Franchise Association (IFA), which opposed the legislation, began running online commercials arguing that the bill would hurt the economy. The Service Employees International Union (SEIU), which believed it would embolden franchisees to offer higher wages, began running radio ads supporting the measure. In late August, the state senate passed the heavily amended bill. But on Sept. 29, Gov. Jerry Brown vetoed the measure—a move that came as a shock to the bill's proponents.

Robert Purvin, chairman and CEO of the nonprofit American Association of Franchisees and Dealers (AAFD), which sponsored SB 610, says the coalition and its partners may seek even stronger legislation in the future but are currently regrouping. "We were honestly dumbfounded when the governor vetoed the bill," he admits. "It had passed with healthy majorities in both houses."

Meanwhile, he says, the problems the bill addresses are getting worse. "Without a right of renewal for franchisees, the franchisor can evolve the contract terms to get worse and worse and worse," Purvin says. "Franchisees really have no choice. The only way to protect their equity is to renew at whatever terms the franchisor says. Otherwise the franchisor can say they don't want that location anymore."

Michael Gray, a principal attorney at Gray Plant Mooty in Minneapolis who represents many large franchisors, disagrees. "SB 610 was a fix for a problem that didn't exist, and it had the potential to create uncertainty, which fosters litigation. The governor's veto was spot-on," he says. "There is no empirical data that this bill was needed or that this is a gross problem.

In fact, the courts in California are very protectionist and pretty good at protecting franchisees. This bill would have just created uncertainty."

The big problem, he argues, is inaccurate notions about the nature of the franchisor-franchisee relationship. "Franchising is a contractual relationship for a period of time," he says. "What has happened is that a mentality is created where a franchisee says, "I'm entitled to this franchise for longer than the term I signed,' especially if they're successful and making money. But it's a contractual relationship. Franchisees never should have the expectation that it will go longer than they signed on for.

"I equate it to a lease," Gray adds. "If you rent a place for 10 years, you can't go to the landlord at the end of the term and say, "You can't lease this to anybody else.' You leased it for a period of time. I don't know why franchising is that much different."

The IFA and others argue that equity protection for franchisees will hinder the franchisor's ability to expand strategically and could affect quality and consistency if the company is not able to close underperforming stores or terminate franchisees who are not maintaining standards.

ARE FRANCHISORS EMPLOYERS?

While SB 610 is shelved for now, another political storm is roiling in the franchise industry. On July 29, Richard F. Griffin Jr., general counsel of the National Labor Relations Board (NLRB), issued an opinion that McDonald's could be considered a "joint employer" along with franchisees while assessing 43 labor complaints. In essence, his memo states that McDonald's corporate is partially responsible for hiring and firing, setting wages and benefits, and dealing with employee behavior—tasks that have traditionally been left to the discretion of franchisees.

Critics fear that if this ruling is implemented widely, it will erode the independence of franchisees, as franchisors exercise more control. Some are concerned that it will cause systems to abandon franchising altogether.

IFA president and CEO Stephen Caldeira stated in a press conference in October that franchising is under attack by "unelected bureaucrats and union bosses" and that Griffin's opinion is "deeply flawed and terribly misguided. … If implemented, his opinion would stunt job growth and create widespread uncertainty. We fear the general counsel has opened a Pandora's box of costly labor complaints. By proposing such seismic changes, this supposedly independent body is caving to the [SEIU] and is undermining the franchise business model. It must be rejected before it does irreparable harm and before it does damage to the economy."

Caldeira pointed out that since the July ruling, 61 other labor charges have been filed against 27 other franchisees, though it's difficult to tell if those were spawned by the opinion or if they are just part of the 20,000 to 30,000 complaints the agency receives each year.

The IFA and 129 members of Congress sent Griffin letters asking him to clarify his thoughts. The IFA also announced plans to file a request under the Freedom of Information Act for any advice memoranda to help elucidate his ruling. At press time, the NLRB had not clarified its position or issued any other statements on the opinion.

The AAFD's Purvin is also not a fan of the NLRB ruling, although he says it relates to the SB 610 debate. "Franchisor and franchisee agreements have become incredibly controlling; that's why we're beginning to see horrific rulings like the NLRB opinion," he says. "It comes from an evolution of excessive control that developed over 150 years of franchising. As late as 1950, most franchisees were truly independent contractors. Increasing brand standards created a lot more uniformity and consistency in franchising, which was a great thing. But it's become too much—so much so that now it can be alleged that franchisees are not even business owners at all, that they are employees of the franchisor."

Adds attorney Gray: "There have been tweaks to the franchise model before, but this is talking about fundamentally changing the franchise relationship. And since it's built on contracts, once you start throwing external forces on the system that it doesn't anticipate, it can get very messy."

Still, Gray isn't worried about the opinion, predicting that it will spend a long time in court before being struck down. He thinks it's a gambit by unions to have franchise and fast-food employees, who are notoriously hard to organize, classified as a single group, which may help in unionization efforts. He points to a 2014 case in the California Supreme Court, Patterson v. Domino's Pizza, in which an employee sued the franchise after claiming that her supervisor sexually harassed her. The court ruled 4-3 that the franchisor couldn't be held liable as an employer. Gray believes any similar suits will meet the same fate.

"Personally, I don't think this NLRB ruling is going to happen," he says. "We're talking years and lots of legal hurdles. When Griffin sent this memo out, alarm bells went off unnecessarily. It's a memo, not a ruling. The sky is not falling."

THE BATTLE OVER MINIMUM WAGE

Another major issue that has been brewing in the past year is the minimum wage, galvanized by strikes by fast-food workers. Gray says the issue is simply another flank in the same battle that is animating the NLRB ruling.

"Increasing the minimum wage is a means of providing a perceived benefit to a large number of people," he argues. "Those people are then amenable to unionization, because the unions can say, "We did that for you—join us and see what other ways you can benefit.'"

Coen of the Maine franchise owners' group agrees that the minimum-wage movement is about union power, but he believes it also ties into fair franchising legislation and helps explain why the SEIU supported SB 610 and other franchising acts that improve franchisee equity. "The unions realize that if they can help franchisees increase their margins, then the franchisees can pay their employees a higher wage," he says. "And I really think franchisees will pay higher wages instead of pocketing that income. The customer service experience at the counter is so important, franchisees want the best people they can get. The ones making minimum wage are cleaning tables or in the back. Franchisees shouldn't be afraid of unions. They should be worried about protecting their equity."

The test case is Seattle's minimum wage act, passed in June. The law gives companies with 500 or more employees three years to raise their wages to $15 per hour; smaller businesses have up to seven years to increase pay. But the law treats franchisees as a single unit, with Subway, Burger King and dozens of other franchisee-owned businesses subject to the three-year phase-in—a situation the IFA is taking to court.

These cases seem to be dividing the franchise world along political lines, but Purvin has hopes that the franchise community will sit down and work through its issues instead of letting government intervene.

"Most franchisees have bet the farm on their brands," he says. "We want the system to work to our mutual advantage. I would much prefer this happen at the conference table, not the legislature. Until franchisors are willing to have that dialogue, though, there need to be rules, and the parties involved need to act in good faith."