Hunton Employment & Labor Perspectives

On September 10, 2020, the United States District Court for the District of Massachusetts issued a Memorandum and Order granting summary judgment in favor of a franchisor in response to claims by a purported class of franchisees that they were not truly independent contractors, but employees of the franchisor.

The main issue addressed in the case was whether specific federal legal requirements that are imposed upon franchisors trump the general Massachusetts independent contractor classification statute. The federal court reasoned that applying the Massachusetts independent contractor classification statute to the franchise business model would render franchisors regulated by the Federal Trade Commission (“FTC”) criminally liable under state law for employee misclassification simply by virtue of their compliance with the FTC’s requirements.

In a dispute between a class of franchisees (the “Franchisees”) and 7-Eleven, Inc. (“7-Eleven”), the Franchisees brought suit against 7-Eleven alleging that 7-Eleven misclassified its own Franchisees as independent contractors, instead of as employees. The Franchisees brought their claims under the Massachusetts Independent Contractor Law (“ICL”), arguing that 7-Eleven could not overcome the presumption of an employee/employer relationship established by the ICL. The ICL incorporates the “ABC” test applied in many states nationwide, which presumes that an individual who performs any service is an employee of a purported employer unless the purported employer can establish that:

• The individual is free from control and direction in connection with the performance of the service, both under contract and in fact;
• The service is performed outside the usual course of the business of the employer; and
• The individual is customarily engaged in providing services of the nature provided to the purported employer independently of the purported employer.

7-Eleven maintained that the Franchisees were independent contractors because 7-Eleven provided services to the Franchisees, not the other way around, and because compliance with federal regulation makes it impossible to satisfy the ICL’s ABC test if read in the manner proposed by the Franchisees. The Court engaged in a brief analysis of whether the Franchisees or 7-Eleven provided services for purposes of satisfying the ABC test, but concluded that the service question was not ripe for summary judgment, as genuine issues of material fact remained.

The Court then turned to the issue of whether a federal regulation that makes satisfaction of the ICL’s ABC test impossible renders the ICL inapplicable. Specifically, 7-Eleven argued that the FTC Franchise Rule makes it impossible for it to satisfy the first prong of the ABC test based on the reading proposed by the Franchisees. The Court compared the first prong of the ABC test, which requires purported employers to demonstrate that individuals are free from control and direction in connection with the performance of services, with the FTC Franchise Rule, which in-part provides that the FTC Franchise Rule does not cover business relationships unless a franchisor exerts or has authority to exert a significant degree of control over, or provides significant assistance in, the franchisee’s method of operation.

The Court examined the FTC’s guidance on the FTC Franchise Rule to determine whether the “significant degree of control” or “significant assistance” required by the FTC Franchise Rule conflicts with the ABC test’s “free from control” requirement. The FTC’s guidance provides that “significant” control or assistance includes control over or assistance with:

• Store design and appearance;
• Accounting practices and establishing accounting systems;
• Sales, repair, or businesses training programs;
• Hours of operation; and
• Personnel Policies and advising on personnel matters.

The Court observed that the list of control and assistance identifiers in the FTC’s guidance was nearly identical to the examples of control offered by the Franchisees to establish that 7-Eleven could not satisfy the first prong of the ABC test.

Additionally, the Court explained that, to qualify as a franchise, the FTC Franchise Rule requires franchisees to obtain rights to, or associate with, a franchisor’s trademark. The Court further noted that federal trademark law (the Lanham Act) requires a trademark holder to maintain control over the use of its trademark to avoid constructive abandonment of the trademark. Put another way, the Lanham Act mandates that a trademark holder (the franchisor) can only maintain its trademark if it exercises control over the use of its trademark to ensure the trademark’s quality; a franchisor must require a franchisee to use or associate with its trademark (including ensuring that the trademark is used in conjunction with defined standards) to qualify as a franchise under the FTC Franchise Rule. As such, if the franchisor does not exercise sufficient control over the franchisee, the franchisor risks losing both its trademark and its franchisor status.

Accordingly, the Court held that the first prong of the ICL’s ABC test and the FTC Franchise Rule are in direct conflict, because satisfaction of the first prong of the ABC test requires the absence of control and direction, while the FTC Franchise Rule and, through extension, the Lanham Act, require the presence of a significant degree of control.

This case is not the first instance where the Lanham Act has been used to illustrate the distinction of the franchise business model. In Kerl v. Dennis Rasmussen, Inc., the Supreme Court of Wisconsin declined to impose vicarious liability against a franchisor. The court in Kerl recognized that while the Lanham Act requires a trademark holder to exercise control over the use of its trademark, in the franchise context, such control is not comprised of frequent supervision and management of a franchisee’s business, but rather, such control is a creature of contract, which sets forth operational requirements necessary to ensure the integrity of the franchisor’s trademark. The Kerl analysis was adopted by the District of Massachusetts in Depianti v. Jan-Pro Franchising Int’l, Inc.

Here, the Court cited state precedent in support of 7-Eleven’s argument, which establishes that the ICL is inapplicable where a competing statutory scheme makes it impossible to satisfy one of the prongs of the ABC test.  Even though the Court confined its holding to employee classification under the ICL, it did note that a decision establishing that qualifying franchisees under the FTC Franchise Rule are necessarily employees would “eviscerate the franchise business model,” which is a federally defined and regulated business construct.

While presently subject to threats of appeal, this decision is a significant win in the battle for the preservation of the franchise business model and a vindication of the rights of franchisors to operate in compliance with federal law.