Ninth Circuit Bolsters Franchisee Wage Misclassification Claims Against Franchisors

On May 2, 2019, the Ninth Circuit issued a ruling that has wide implications for California franchisors who rely on independent contractor relationships. In a unanimous decision, the Ninth Circuit held that the more rigid ABC test adopted by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court, 416 P.3d 1 (Cal. 2018), applies retroactively. The Ninth Circuit also held that the ABC test applies to franchisor-franchisee relationships, remanding the case with guidance as to how the district court should apply it to Jan-Pro, a franchisor of commercial cleaning franchises. The case is Vazquez v. Jan-Pro Franchising International, Inc., --- F.3d ----, No. 17-16096, 2019 WL 1945001 (9th Cir. May 2, 2019).

Specifically, the Ninth Circuit held that a franchisor is the employer of its franchisees under California’s wage order laws unless the franchisor establishes all of the following to affirmatively disprove employment status:

1. The franchisee is free from control and direction of the franchisor in the performance of work both under the franchise agreement and in fact.
2. The franchisee performs work outside the usual course of the franchisor’s business.
3. The franchisee is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

In examining the application of the ABC prongs to Jan Pro, the Ninth Circuit rejected the franchisor’s argument that the California Supreme Court’s decision in Patterson v. Domino’s Pizza, LLC, 333 P.3d 723 (Cal. 2014) differentiates a franchisor from other putative employers in wage claim cases. The Ninth Circuit’s skepticism as to whether Jan-Pro will ultimately be able to prove that it is not an employer under the ABC test has the potential to upend the fundamental structure of the franchise business model.

There are four takeaways for franchisors.

1. The Franchise Business Model Alone Will Not Defend Against California Wage and Hour Claims by Franchisees in the Ninth Circuit

The California Supreme Court held in Patterson that the trademark-related controls necessary in a franchisor-franchisee relationship cannot, as a matter of law, expose the franchisor to vicarious liability for torts committed by the franchisee. Patterson recognized that “systemwide standards and controls provide a means of protecting the trademarked brand at great distances.” 333 P.3d at 733. Indeed, the Lanham Act requires that a franchisor control the use of its trademarks to avoid abandonment and help ensure the public is not deceived as to the quality of the goods or services bearing the franchisor’s trademarks.

However, in Jan-Pro, the Ninth Circuit concluded that “the franchise context does not alter the Dynamex analysis” and there is no “Patterson gloss” to the ABC test. (Slip Op. at 37, 40.) Patterson has no application to Dynamex, the court reasoned, because vicarious liability has different purposes than California wage orders. While vicarious liability incentivizes a supervising entity with a right of direct control to prevent tortious conduct, wage orders “creat[e] incentives for economic entities to internalize the costs of underpaying workers—costs that would otherwise be borne by society.” Accordingly, Dynamex “eschews reliance on control . . . as a necessary condition for an employment relationship” to make it more difficult for hiring entities to evade the wage orders through novel labor arrangements. (Id. at 38-39.)

2. Franchisors in Every Industry May Face Challenges Under the ABC Test as Construed by the Ninth Circuit

Under Prong B, the franchisor must establish that it is not engaged in the same usual course of business as the franchisee. If a franchisor does not satisfy Prong B, the Ninth Circuit considers the franchisor an employer of its franchisee under California wage orders. According to the court’s analysis, a franchisor is conceivably an employer even without retaining or exercising control of its franchisees. The court identified three inquiries for Prong B:

• Whether the franchisee is necessary or merely incidental to the franchisor’s business. For example, the court suggested that Jan-Pro will fail this test because according to the court, Jan-Pro “is not simply renting out its trademark and goodwill” for a flat fee, but rather “actively and continuously profiting from the performance of those cleaning services.” (Id. at 45.)
• Whether the franchisee continuously performs services for the franchisor. For example, the court advised the district court to consider “whether Jan-Pro’s business model relies on unit franchisees continuously performing cleaning services.” (Id. at 46.)
• How the franchisor describes itself in marketing. The court pointed out that Jan-Pro’s websites and advertisements describe it as a “commercial cleaning company” that provides “cleaning services.” Jan-Pro has argued that it is in the “business of franchising,” but the court rejected this characterization, borrowing a phrase from the U.S. District Court of Massachusetts in the Awuah v. Coverall case, where the court noted that such characterization “sounds vaguely like a description of a modified Ponzi scheme.” (Id. at 47 (quoting Awuah v. Coverall N. Am., Inc., 707 F. Supp. 2d 80, 84 (D. Mass. 2010).)

The Ninth Circuit’s characterization of the Prong B analysis ignores the fundamental structure of every franchise model, a business model that has been accepted since at least the 1950s, and that was directly responsible for an estimated $451 billion in gross domestic product and 8 million jobs in the United States in 2018. The court’s Prong B analysis is troubling because it construes ordinary franchising business practices as indicia of an employment relationship.

For example, according to the court, a franchisor is potentially an employer for deriving profit from the franchisee’s business or earning a percentage of customer payments made to the franchisee’s business, i.e., the percentage-based license fee franchisors commonly charge for use of their trademarks. (Id. at 44-45.) Another indicator of an employment relationship, according to the court, is where a franchisor relies on its franchisee to continuously deliver the franchisor’s trademarked service. (Id. at 46.) Similarly, the court believes that a franchisor’s marketing of the products or services sold under its trademarks, such as Jan-Pro marketing cleaning services, is evidence that the franchisor employs its franchisee. (Id. at 47.)

3. Franchisors May Be Deemed Employers Even if They Use a Master Franchise Model

Many franchise systems have a three-tier structure with the franchisor at the top, a master franchisee or territory operator in the middle, and ordinary franchisees at the bottom. The court noted that Jan-Pro’s three-tier franchise structure does not necessarily insulate the top-level franchisor from direct liability to the unit franchisees. “As long as the putative employee was providing a service to the hiring entity even indirectly, the hiring entity can fail the ABC test and be treated as an employer.” (Id. at 40 (citing Depianti v. Jan-Pro Franchising Int’l, Inc., 990 N.E.2d 1054, 1068 (Mass. 2013).)

4. Dynamex Is Retroactive on Franchisors

The Ninth Circuit held that Dynamex applies retroactively, rejecting Jan-Pro’s arguments for prospective-only application generally or at least in its case. (See Id. at 21-29.) The court noted the general rule that judicial decisions have retroactive effect, and it cited the California Supreme Court’s silence on the issue and a California Court of Appeals decision applying Dynamex retroactively as persuasive evidence that Dynamex is no exception. The court brushed aside Jan-Pro’s argument that retroactivity depends on particular parties’ reliance interests, concluding that Jan Pro’s approach would lead to the “surprising result” that a decision applies retroactively to some parties but not to others. And construing Jan-Pro’s reliance and fairness arguments as a due process challenge, the court held that it is “neither arbitrary nor irrational” to apply Dynamex retroactively given the history and remedial purpose of California’s wage orders.

What's Next?

The Ninth Circuit has remanded the decision back to the district court for a determination on the merits. Jan-Pro may petition for re-hearing, given the stakes involved. Either way, until legislative action or additional precedent is established, franchisors with a presence in California will face some uncertainty as to how broadly this decision will apply to their California franchisees in the context of California wage orders.