Franchise Trade and Regulation Update - September 2015

Date: September 3, 2015

NLRB Issues Advice Memo Finding That Franchisor Is Not Joint Employer

By: David L. Cahn

On April 28, 2015 the National Labor Relations Board (“NLRB”), Office of the General Counsel, issued an Advice Memorandum to the NLRB’s Chicago area regional office finding that a restaurant franchisor and its Chicago area development agent are not joint employers with a Chicago franchisee.  This is an important development in light of the current pursuit by the NLRB’s General Counsel of joint employer cases against McDonald’s Corporation.  

The Advice Memo, in the case of In Re. Nutritionality, Inc. d/b/a/ Freshii, involves a union organizing effort at a Freshii “fast casual” restaurant owned in Chicago by single unit franchisee.  The franchisee terminated employees who were attempting to organize a union for the employees of the restaurant.   The Region requested advice as to whether franchisor Freshii Development, LLC (“Freshii”) or its development agent for the “Chicagoland” region is a joint employer.  

The essential thrust of the Advice Memo is that Freshii’s control over the franchisee’s operations, as implemented through the development agent, “are limited to ensuring a standardized product and customer experience, factors that clearly do not evince sharing or codetermining matters governing the essential terms and conditions of employment.”  While this was a sufficient conclusion under the NLRB’s current “joint employer” standard, the Advice Memo held that even under the more inclusive “industrial realities” standard advocated by the General Counsel in the McDonald’s cases, Freshii and the development agents are not joint employers.

The Facts That Determined The Outcome

Freshii’s franchise agreement expressly disclaims any involvement in the franchisee’s employment or labor relations practices.  More specifically, while the franchisee must comply with “System Standards,” on pain of potential termination if it fails to cure a breach of the standards within 30 days of receiving a default notice, the franchise agreement, “the franchise agreement specifies that System Standards do not include ‘any personnel policies or procedures or procedures,’ which Freshii may make available for franchisees’ optional use, and that the franchisee alone will ‘determine to what extent, if any, these policies and procedures might apply’ to its restaurant operations.”  

\While Freshii’s Operations Manual contains advice on human resources, such as hiring and scheduling employees, how to calculate “labor cost percentage” and how to project labor costs in scheduling, all of this falls in the realm of training and the franchisee is free to accept or reject the advice.  While Freshii provides a sample employee handbook, many of its franchisees (including the development agent) obtain other handbooks containing different employment policies. 

The development agent provides extensive training to the franchise owner before store opening, and some direct training to the restaurant’s staff around the grand opening, but thereafter the franchisee is solely responsible for training and supervising its staff.  The development agent conducts monthly store inspections and also informally “drops by” Freshii restaurants to monitor things like whether the employees are wearing uniforms, store cleanliness, and food preparation, and provides reports to both the franchisee and the franchisor if there are deviations from standards.  On one occasion the development agent told a different franchisee that there were too many employees working during a slow time of day, but the franchisee was not required to change its scheduling policies. 

While Freshii has a section of its website where prospective employees can apply for a job at a specific location, the only thing Freshii does with the information is forward it to the franchise owner.  The franchisee exclusively decides who to hire as its employees. 

Freshii has no standard software to monitor employee scheduling or labor costs.  This is a substantial difference from the facts alleged in the McDonald’s cases.  Individual franchisees are exclusively responsible for setting employee wages and benefits, and the complaining employees (and the union sponsoring them) were unable to produce any evidence that franchisees need to consult with Freshii or the development agent to grant wage increases, decreases, or changes to benefits.  

While the development agent can raise an issue about an employee’s performance in a review, there was no evidence that any employee had ever been disciplined or discharged by a Freshii franchisee because of a development agent’s comments.  By contrast, Nutritionality (the franchisee) has disciplined and discharged employees without consulting Freshii or the development agent.  

Finally, and most pertinently, the evidence was that when the union began to organize at Nutritionality’s store, Nutritionality’s owner told the development agent about it.  The development agent did not respond but reported it to Freshii, and neither Freshii nor the development agent communicated with Nutritionality about the organizing effort.

Legal Conclusions

Under the NLRB’s existing standard, the alleged joint employer “must meaningfully affect matters relating to the employment relationship such as hiring, firing, discipline, supervision and direction.”  Since neither Freshii nor the development agent has any meaningful impact over Nutritionality’s hiring, compensation, scheduling, discipline, or ongoing supervision, the conclusion that they are not joint employers was self-evident.  

Under the standard proposed in the McDonald’s cases and in a case pending against Browning-Ferris Industries of California, the NLRB would examine “the totality of the circumstances, including the way that separate entities have structured their commercial relationship,” to determine whether “the putative joint employer wields sufficient influence of the working conditions of the other entity’s employees such that meaningful [collective] bargaining could not occur in its absence.”  This is referred to as the “industrial realities” test.   Even under that relaxed standard, the Advice Memo states, “[B]ecause Freshii does not directly or indirectly control or otherwise restrict the employees’ core terms and conditions of employment, meaningful collective bargaining between Nutritionality and any potential collective bargaining representative of the employees could occur in Freshii’s absence.”  

Take Away

By finding that they are not, the effect is that the unfair labor practice claims against the franchisor and development agent will be dismissed.  This obviously does not suit the agenda of the union conducting the organizing drive, since it wants to organize all employees of stores operating under a trademark – regardless of franchise ownership.  Organizing the few employees in a single store is unlikely to yield sufficient union dues to be worth the time devoted by union staff.  

However, this is potentially a huge win for franchising.  The decision affirms that a restaurant franchisor’s “requirements regarding food preparation, recipes, menu, uniforms, décor, store hours, and initial employee training prior to a franchise opening are not evidence of control over [its franchisees’] labor relations but rather establish [its] legitimate interest in protecting the quality of its product and brand.”  If the NLRB follows this reasoning going forward, this sort of ruling will mean that “the sky is not falling” on traditional and reasonable franchising practices.  

Why Maintain Your Company Charter? Moe's Southwest Grill Will Tell You

By: David L. Cahn

Occasionally corporations and limited liability companies neglect to make the periodic filings required by their state of formation. Even more often, companies that open locations outside of their state of formation do not register as a foreign entity with that other state's business regulatory agency. The May 29, 2015 decision by the Maryland Court of Special Appeals in Guy Named Moe LLC T/A Moe’s Southwest Grill v. Chipotle Mexican Grill of Colorado LLC et al., No. 2270, Sept. Term 2013, is an important reminder to restaurant operators and other business owners of just how dangerous it can be for a company to ignore those basic state filing requirements. 

The Case

In 2012 the Annapolis department of planning and zoning approved Chipotle Mexican Grill’s application to open a restaurant in downtown Annapolis about 400 feet from a Moe’s Southwest Grill location owned by A Guy Named Moe, LLC (“Moe’s”). The Maryland Court of Special Appeals denied Moe’s standing to appeal this zoning approval because its limited liability company (“LLC”) had not been registered to do business in Maryland during the time period to appeal the zoning decision.  

The Facts

The Land Use Article in § 4-401(a) of the Maryland Code grants standing to petition the circuit court for judicial review of a city or county’s zoning decision to a “person” who is a “taxpayer” or a “person aggrieved” and files suit within 30 days of the zoning decision.  A “person” includes any business entity properly registered under Maryland law.  After Moe’s filed a case protesting the zoning decision for Chipotle, the Circuit Court for Anne Arundel County dismissed the suit, holding that Moe’s did not have taxpayer standing because it did not pay real property taxes to the local jurisdiction whose zoning action was being challenged on appeal. The circuit court also determined Moe’s was not “a person aggrieved” because business competition does not constitute not a sufficient grievance in zoning decisions. 

The Court of Special Appeals affirmed the dismissal, but on different grounds – that Moe’s petition was void since Moe’s did not have a right to do business in Maryland at the time of filing. Moe’s is a Virginia LLC, and all foreign LLC’s doing business in Maryland are required to register with the State Department of Assessment and Taxation (“SDAT”) in accordance with the relevant part of the Maryland Limited Liability Company Act, Corporations & Associations Code (“C.A.”)  § 4A-1002(a).  Moe’s registered in December 2015, but when it failed to file a 2006 personal property tax return with SDAT and pay the requisite $300 filing fee to remain registered, SDAT forfeited its right to operate in Maryland in November of 2006 under C.A. § 4A-1013.   For the following seven years Moe’s did not revive this registration and thus continued to do business in Maryland with no right to do so. 

C.A. § 4A-1007(a) bars unregistered foreign LLCs that are doing business in Maryland from maintaining a suit in Maryland courts. The Court of Special Appeals concluded that since Moe’s should not have even been operating its restaurant in Maryland at the time of the appeal, the appeal was “a nullity from the moment it was filed.” The SDAT did not restore Moe’s right to do business in Maryland until September 24, 2013, when the proper personal property tax returns were filed and the appropriate fees were paid. Unfortunately for Moe’s, this was already about 5 months past the 30-day deadline to appeal zoning decisions.

Take Away

Learn from Moe’s mistake and stay on top of this! Even if Moe’s attorneys did notice this issue immediately they still might not have been able to receive the requisite charter within the 30 day period to file suit because reviving a forfeited charter or foreign registration can take time. 

Be cautious and make sure your business is compliant with all state filing requirements to maintain limited liability status in any state where it is regularly doing business. As the Moe’s case demonstrates, failure to do so can cost your business the ability to protect its rights and have other substantial legal repercussions.

"You Made Your Bed, Now Lit In It!" Dickey's BBQ and Franchisees Stuck Litigating and Arbitrating

By: David L. Cahn

Takeaway: Before you enter a franchisee/franchisor agreement, try to devise an efficient and fair dispute resolution system so you don’t end up in this sticky situation.

Where and how a dispute between a franchisor and franchisee must be decided can have a major impact on the outcome of the case.  Franchisees generally want the case to be decided in the court where they live and by a jury, while franchisors want it decided in their city and by a private arbitrator or a judge.  State regulation of franchise sales intended to bolster franchisee’s rights on this issue can result in the franchisor and franchisee having to engage in both arbitration and court litigation in two different states.  We explore how franchisors and franchisees might reasonably avoid that unwieldy situation.

The Maryland Securities Commissioner, as a condition of approving a registration, routinely requires franchisors to agree that its Maryland franchisees will have the right to bring a claim in a Maryland court for violation of the Maryland Franchise Registration & Disclosure Law (the “Franchise Law”) – even if the franchise agreement requires arbitration of all claims in the franchisor’s home state.  However, what happens when a franchisor files an arbitration demand against a Maryland franchisee in its home state, and then the franchisee sues in a Maryland court alleging violation of the Franchise Law? In Chorley Enterprises, Inc. v. Dickey’s Barbecue Restaurants, Inc., the U.S. Court of Appeals for the Fourth Circuit ruled that the franchisor’s claims must be decided through arbitration in Texas, but the franchisees’ Franchise Law claims must be decided by a jury trial at the U.S. District Court in Baltimore.  

The court’s reasoning was solid and logical.  Dickey’s franchise agreement included a provision, specific to stores located in Maryland, stating that the franchisee had the right to sue in courts located in Maryland for claims arising under the Franchise Act.  Otherwise, the agreement had a broad clause requiring arbitration of all claims arising from or related to the agreement or the parties’ relationship.  The court noted that Dickey’s did not seek to obtain registration by the Maryland Securities Commissioner without including the litigation carve-out for Franchise Act claims, and it did not seek a court order declaring that the Securities Commissioner could not require such a carve-out from the arbitration provision.  Instead, it chose to include the language typically required by the Securities Commissioner so that it could sell Maryland franchises.  Accordingly, the court ruled that Dickey’s “made its own bed” and therefore would have to defend the Franchise Act claim in court. 

However, the decision was not a clear victory for the franchisee.  The next step in the dispute will be for the U.S. District Court judge to decide whether to delay the franchisees’ court case until the arbitration is completed in Texas.  (The arbitration had been stayed pending the appeals court ruling.)  If the court does so, then the franchisees will have to defend against Dickey’s claims in the arbitration and probably present their evidence showing that the Franchise Act violations, to convince the arbitrator that the franchise agreements are unenforceable.  But win or lose in arbitration, to preserve their right to have a jury trial of their Franchise Act claims, the franchisee will have to present its case a second time in court to actually get a judgment against Dickey’s.  

Is there a way to solve this mess going forward?  Franchisors registering in Maryland probably should not include an addendum provision allowing franchisees to pursue Franchise Act claims in Maryland courts.  If the Securities Commissioner demands that change, as is likely, then the franchisor should consider offering to agree that all claims (including Franchise Act claims) will be decided through arbitration, but the venue for arbitration will be in Maryland.  The location of the dispute resolution is the big issue for franchisees, and having everything decided in one proceeding is ultimately to the benefit of both parties.  Such a franchisor will benefit being able to avoid facing a franchisee group or class action in court and from having cases decided by arbitrators rather than court juries.  

For most prospective franchisees, it would be best to negotiate away the right to bring a claim under the Franchise Act in Maryland court, if the franchisor will agree that all claims will be decided through arbitration conducted in or near Maryland.  If dispute resolution is necessary, most franchisees will be better off not being stuck on “two tracks” and instead have all issues decided efficiently in a fairly convenient forum – even if that means giving up the right to have its “day in court.”