Independent Contractors vs. Employees: Impact on Franchising

The distinction between independent contractors and employees in the wage and hour context is not new.  For decades, courts across the country have wrestled with how to legally define these relationships and distinguish them.  Over time, this has resulted in several versions of a similar legal framework and tests that require consideration and analysis of many factors that speak to the “economic realities” between the two parties. See Employees vs. Independent Contractors: FLSA Misclassification Concerns

Some critics and industries have complained this multi-factor “economic realities” test has been misapplied, or inconsistently applied, across the country, resulting in troubling uncertainty for entities trying to comply with the law.  Recently, the DOL has issued proposed rulemaking that was designed to simplify and streamline this legal framework and test for purposes of the Fair Labor Standards Act (“FLSA”).  At the same time, various states throughout the country—most notably, California and Massachusetts—have recently passed state laws that fundamentally change this legal framework and test. 

For example, both California and Massachusetts have passed laws that introduce a wholly new test for determining whether an individual or entity is an independent contractor or employee.  This new test is generally known as the ABC Test.  It creates a presumption that a worker who performs services for a company is an employee for purposes of the state’s wage and benefits laws, unless the employer can prove that the arrangement satisfies the following three requirements:

  • the worker is free to perform services without the control or direction of the company;
  • the worker is performing work tasks that are outside the usual course of the company’s business; and
  • the worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

This new test is materially different from the traditional “economic realities” test, primarily because it (1) introduces a presumption of employee status based solely on providing services for a company; and (2) shifts the burden of proof onto employers to satisfy these three requirements.  While many businesses in California and Massachusetts are likely to be directly impacted by this ABC Test (and potentially liable for additional wages and benefits of individuals previously classified as “independent contractors”), the ABC Test raises very serious, additional questions for any companies involved in franchising.

The potential impact of the ABC Test on franchising was recently addressed by the United States District Court for the District of Massachusetts in a case styled Patel v. 7-Eleven, Inc., — F. Supp. 3d –, 2020 WL 5440623, at *6-9 (D. Mass. Sept. 9, 2020).  Patel involved claims by a group of 7-Eleven franchisees that they were misclassified as independent contractors under Massachusetts law.  Both Plaintiffs and Defendant filed motions for summary judgment.  On September 10, 2020, the Court granted 7-Eleven’s motion for summary judgment, holding the Franchise Rule of the Federal Trade Commission (“FTC”) applied to determine franchisees’ status as either independent contractors or employees—not Massachusetts’ independent contractor law.

The Court in Patel reached this conclusion by first noting that the FTC Franchise Rule defines a franchise, in relevant part, as a commercial relationship or arrangement that involves a franchise seller exerting or having the authority to exert a significant degree of control over the franchisee’s method of operation.  The Court then compared this requirement to the first prong of Massachusetts’ independent contractor law, which requires an individual to be free from control and direction of the company to be an independent contractor.  In other words, to qualify as a franchise, a franchisee could not be “free from control and direction” of the franchisor—that is, could not be an independent contractor.

Given this comparison, the Court found a “tension” and “inherent conflict” between the FTC Franchise Rule and Massachusetts’ independent contractor law: “[i]t cannot be the case, as plaintiffs suggest, that, in qualifying as a franchisee pursuant to the FTC’s definition, an individual necessarily becomes an employee.  In effect, such a ruling by this Court would eviscerate the franchise business model, rendering those who are regulated by the FTC Franchise Rule criminally liable for failing to classify their franchisees as employees.” 

The Court then invoked the legal principle that specific rules will govern where there is a conflict between a specific rule and a general rule: “Where there is a conflict between the Massachusetts [independent contractor law] and a regulatory scheme, the specific trumps the general….The franchise-specific regulatory regime of the FTC governs over the general independent contractor test in Massachusetts….Accordingly, the Massachusetts [independent contractor law] does not apply to 7-Eleven in these circumstances.”

The Court’s summary judgment decision in Patel is surely not the end of the story on this issue of the new ABC Test and its potential impact on franchising business models.  Even under the traditional “economic realities” test, litigants often dispute whether the significant degree of control that franchisors must exert over franchisees constitutes sufficient control to hold franchisors liable as a “joint employer” under employment laws.  This tension about control in the franchise context will continue to be litigated in various employment related matters.  Check back here for further updates as the legal fights continue and the law develops in this area.