In a move with far-reaching ramifications for all businesses that license their brands to independent contractors including franchisees, the National Labor Relations Board (“NLRB”) announced on July 29, 2014 that it has authorized the filing of administrative complaints against franchise giant, McDonald’s USA LLC, for unfair labor practices involving workers at franchisee-owned restaurants. The NLRB said that it had investigated 181 cases of unlawful labor practices at McDonald’s franchise restaurants since 2012, including reports that employees were fired for participating in worker protests, and found sufficient merit in at least 43 cases to name McDonald’s as the workers’ “joint employer” creating a legal basis for holding McDonald’s responsible with the franchise owners for the labor violations. McDonald’s has more than 14,000 U.S. restaurants of which approximately 90% are franchisee-owned.

The NLRB’s announcement comes as the Board is reconsidering replacing its long-established “joint employer” test under the National Labor Relations Act. In late June, in Browning-Ferris Industries of California, Inc., a non-franchise case involving a Teamsters' union appeal of a NLRB Regional Director’s decision holding that only independent staffing company employees, and not the plant’s regular employees, could vote in a representation election at a California recycling plant, the NLRB’s General Counsel filed an amicus brief urging the NLRB to scrap its 30-year old “joint employer” standard citing franchise relationships as a reason for change. “[F]ranchising ... illustrates how the current joint-employer standard undermines meaningful collective bargaining. … Although franchisors generally claim that they have no influence over the wages franchisees pay to their employees, some franchisors effectively control such wages ‘by controlling every other variable in the business except wages,’” quoting a 2014 paper by the National Employment Law, a workers’ rights organization.

The NLRB has yet to explain why it believes McDonald’s is a joint employer, but the NLRB’s rationale is likely found in the new “joint employer” test that it is pressing for in Browning-Ferris. In its amicus brief, the NLRB’s General Counsel urges the NLRB to replace the current “joint employer” standard, which examines a company’s direct control over another company’s essential employment decisions specifically affecting hiring, firing, supervision and direction of employment, with the pre-1984 broader-based “industrial realities” test, which focuses on the “economic dependence” between two companies and assumes that a company effectively controls another company’s labor decisions if it dictates standards for every other variable of its business.

The Long Road Ahead for the NLRB and McDonald’s

Numerous constituencies have sharply attacked the NLRB’s Big Mac Attack as upending existing law in order to advance the Obama administration’s pro-union agenda. But, at this point, the development is just an announcement by the NLRB’s chief prosecutor authorizing the filing of complaints against McDonald’s. When complaints are filed, as expected by September, they will involve a cluster of franchisees in New York and others scattered around the country. There is no indication yet if the NLRB will file a one consolidated complaint or separate complaints.

It will then be a long time until a final ruling on McDonald’s “joint employer” liability. Current estimates are for a trial or trials before an NLRB administrative law judge starting possibly as early as December, 2014, that may take until spring, 2015 to conclude. Administrative hearings, while less formal than court proceedings, nonetheless involve motions, briefing, discovery, and live testimony. The full Board would probably not render its decision before mid-2015. If it concludes that McDonald’s is a joint employer, McDonald’s or the franchisee, or both, either together or separately may seek review in one of the federal appellate courts, and eventually, the matter could go to the U.S. Supreme Court, processes that could take years to complete. In other words, it might take years before a ruling is final on whether McDonald’s is the joint employer of the workers involved at the 43 cases presently under review.

Before then, national elections may disrupt the NLRB’s current agenda. Some industry groups are pressing for amendments to the National Labor Relations Act’s “joint employer” test as a more permanent solution to the problem. Meanwhile, pending a final ruling, franchisors among other businesses using licensees or temporary, outsourced and subcontracted workers – all targeted by the NLRB’s General Counsel for the expanded “joint employer” test - face considerable uncertainty on whether to pursue business as usual.

Joint Employer and Vicarious Liability

“Statutory” or “joint employer” liability makes a non-employer responsible for labor violations to the same extent as the worker’s “W-2” employer. The underlying principle is the venerable doctrine of vicarious liability or “business enterprise liability,” which shifts liability from a wrongdoer (agent) to someone else (principal). Vicarious liability’s rationale is that when someone engages someone else to act on its behalf, it should be liable to third parties for the actor’s wrongdoing to ensure recourse for the injured party in case the actor is judgment-proof. “Respondent superior," Latin for "let the master answer," rests on the same principle: the law may no longer use antiquated “master/servant” terminology, but it continues to hold an employer liable for an employee’s wrongdoing when the employee acts within the scope of his or her employment.

Franchise relationships are predicated on the assumption shared by both franchisor and franchisee at the outset of their relationship that the franchisee is an independent contractor, not an employee. Franchisees buy franchises in order to own their own business. The franchise business model neatly divides roles and responsibilities: franchisors own a system for operating a business and license a bundle of intellectual property to franchisees on the condition that franchisees adhere to prescribed operating standards. Franchisees independently choose whom they hire to execute the prescribed business model, control their own operating costs, and reap the profits of their efforts after paying overhead and franchise fees.

Unlike employment relationships, independent contractor relationships do not, as a matter of law, result in vicarious liability: liability depends on proof that the contractor is an agent with actual or apparent authority to bind the non-actor principal. Vicarious liability considers the defendant’s right to control the actor’s day-to-day activities, which no doubt is a highly subjective test.

Third parties have long sought to hold a franchisor liable for injuries sustained as a result of acts or omissions by the franchisee or the franchisee’s employees, whether due to bad food at a franchise restaurant, an accident in the franchisee’s parking lot, or sexual harassment by a franchisee’s manager. In the franchise context, a disturbing trend in vicarious liability cases is that courts are focusing on the franchisor’s detailed operating manual - a classic feature of franchise relationships that has always been understood as a means for a franchisor to protect its trademarks - as evidence of the franchisor’s right to control. Recent franchise rulings have cited the franchisor’s highly detailed operating manual to support the finding of an agency between the franchisor and franchisee and a basis for holding the franchisor liable for the franchisee’s acts or omissions. See Comeaux v. Trahan, 2012 U.S. Dist. LEXIS 158527 (W.D. La. Nov. 5, 2012); Leach v. Kaykov, 2011 U.S. Dist. LEXIS 34235 (E.D.N.Y. Mar. 30, 2011).

Trademark Rationale

The NLRB’s “new joint employer” theory echoes this disturbing rationale, that if franchisors have so many detailed rules and standards for every aspect of the franchisees’ day-to-day operation they must also control the franchisees’ employment practices thereby making them liable for their franchisees’ labor violations.

Unfortunately, the NLRB’s theory denies the trademark-rooted reasons why franchisors impose detailed rules over their licensees’ activities: to maintain product consistency and ensure the consumer’s positive experience with the brand. Every franchise is a trademark license, and it is the federal Lanham Act enacted in 1946, nearly a decade before McDonald’s sold its first burger and 25 years before the first U.S. franchise law, that requires licensors to impose quality controls over their licensees as a way of accommodating trademark owners who desire to exploit their marks through licensing without affecting the validity of their trademark rights. As the Second Circuit said in Dawn Donut Co., Inc. v. Hart’s Food Stores, Inc., 267 F.2d 358, 121 USPQ 430, 436-37 (2nd Cir. 1959): “unless the licensor exercises supervision and control over the operations of its licensees the risk that the public will be unwittingly deceived will be increased and this is precisely what the [Lanham] Act is in part designed to prevent.”

The NLRB’s “new joint employer” theory has far broader economic consequences than just franchising: it potentially affects all businesses that license their brands to independent contractors, even non-franchise arrangements, upturning everything from manufacturing licenses enabling brand owners to license product developers to expand the scope and geographic reach of their brands, to distributorships enabling suppliers to reach retail shelves by reselling branded products through dealer networks. The technical distinction between a franchise license and non-franchises license turns on whether independent contractors pay a required fee to the licensor for the right to affiliate with the licensor’s brand, but the presence or absence of a required fee is of absolutely no importance to the NLRB’s new theory, which presumes a licensor controls the licensee’s employment decisions if the licensor regulates all other aspects of the licensees’ everyday operations.

Implications for Franchisors

Even before the NLRB’s decision to pursue McDonald’s as a “joint employer,” franchisors have been sued as “joint employers” for their franchisees’ labor violations. Compare, Courtland v. GCEP-Surprise, LLC, Bus. Franchise Guide (CCH) P 15,101; No. CV-12-00349-PHX-GMS, 2013 WL 3894981 (D. Ariz. July 29, 2013) (both joint employer and vicarious liability claims rejected as basis for holding franchisor liable for alleged illegal discrimination against pregnant worker where there was no evidence of franchisor’s involvement in the franchisee’s human resources matters); with Cano v. DPNY, Inc., 287 F.R.D. 251 (S.D.N.Y. 2012) (franchisee workers granted leave to add franchisor Domino’s as defendant in lawsuit alleging wage and hour violations at franchised stores).

And the NLRB is not the only public agency to target franchising. David Weil, the Labor Department’s new Wage and Hour chief (Law360, April 30, 2014), blames the “fissured” workplace exemplified by franchise relationships for widespread wage and hour noncompliance and promises to accelerate efforts to hold companies accountable for violations suffered by individuals who may not work directly for them.

Under the current legal standard, only franchisors shown to exert a significant and direct degree of control over a franchisee’s essential employment decisions pertaining to hiring, firing, disciplining, and supervising franchisee employees are considered “joint employers” and thereby vicariously liable for a franchisee’s labor violations. While these cases always turn on their unique facts, they have yielded important lessons for franchisors: stay out of a franchisee’s employment decisions; do not set wages or employment policies for franchisees; do not require franchisees to discipline or terminate workers who disobey franchise standards. Needless to say, not all franchisors have heeded this advice in the same way or at all. Over the years, franchisors have debated the wisdom of advising franchisees, typically novice business owners, about best employment practices and this might go as far as furnishing franchisees with a template employee handbook believing the handbook to be no different than supplying recipes and setting cooking temperatures.

While the Big Mac Attack plays out, the best advice for franchisors at the moment is to completely distance all operating advice from anything that could remotely be interpreted as suggesting or recommending particular employment practices. Do not provide template employee handbooks; do not threaten to terminate a franchisee who fails to discipline or fire an errant employee for violating brand standards. Instead, use the threat of terminating the franchise agreement to encourage franchisees to make their own decisions about how to achieve full compliance with system standards. A franchisor cannot, by law, contractually disclaim its “joint employer” status. Its potential liability as a “joint employer” will ultimately depend on the way in which its own employees on its behalf interact with franchisees and their workers.