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Federal and state laws have historically protected franchisors from vicarious liability claims of franchisees and their employees. However, a trend is developing in which courts are interpreting their state laws to the effect that franchisors are being considered employers within their franchise system, exposing them to vicarious liability.

Successful franchise systems require that franchisors have enough control over the operations of their franchises to create brand identity and uniformity. This effort to establish standards that promote a consistent retail experience can leave a franchisor vulnerable to employment liability claims. In California, the principal test of an employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired. In the context of franchising, California law provides that to find an employment relationship the claimant must show that the franchisor exercised control beyond that necessary to protect and maintain its interest in its trademark, trade name and goodwill.

In Juarez v. Jani-King, Inc. (January 2012) ("Jaurez"), the Federal court for the Northern District of California considered whether the franchisees of a janitorial service company ("Jani-King") were independent contractors or employees. The franchisees alleged that Jani-King's tightly controlled policies and practices created an employment relationship between Jani-King and its franchisees. Athough Jani-King maintained significant control over its franchisees with the rights, among others, to directly collect payments from customers, perform billing and accounting, and handle customer complaints, the court held that these controls were no greater than necessary to protect Jani-King's trademark, trade name and goodwill. The franchisees retained the ability to hire, fire and supervise employees; determine employee compensation; decline accounts; purchase their own cleaning supplies and equipment; decide when to service accounts; and were compensated in the from of gross revenues rather than hourly wages. Given these facts, the court found that Jani-King did not exercise sufficient control over the franchisees to re-classify them as employees, and granted summary judgment in favor of Jani-King on the labor law claims.

In contrast with the Juarez decision, and indicating that there may be trouble on the horizon for franchisors doing business in California, a California appellate court in Patterson v. Domino's Pizza, LLC (June 2012) ("Patterson") reversed a trial court's summary judgment ruling and held that Domino's Pizza, LLC ("Domino's") could be liable for the sexual harassment claim of a franchisee's employee. Although the suit was brought by an employee of the franchisee, as opposed to the franchisee itself, the court analyzed the alleged employment relationship within the same framework as the Juarez court. The court explained that a franchisor may be subject to vicarious liability where it assumes substantial control over the franchisee's local operation, its management-employee relations or employee discipline. Domino's franchise agreement and franchisee manual provided detailed hiring guidelines, employee conduct standards and store operation requirements (including store hours, advertising, handling of customer complaints, signage, pricing of items and decor) which the court found substantially limited franchisee independence in areas beyond food preparation standards. The court also looked outside the provisions of the franchise documents to testimony that suggested Domino's had extensive local management control over employee conduct and discipline. The court concluded that this evidence of control raised a reasonable inference that there was a lack of franchisee management independence.

The California Supreme Court granted the franchisor's petition for review of the Patterson case, which remains pending. While the outcome and impact of the case have yet to be determined, the appellate court's analysis indicates that California may be following the trend in other states of more willingly finding vicarious liability of franchisors as employers.

Franchisors should be cautious when drafting franchise disclosure documents, franchise agreements, employee handbooks and any ancillary documents to ensure that provisions are included which give franchisees an adequate level of independence and control, particularly over day-to-day activities and employment decisions. Including policy standards which are recommended instead of mandatory, and disclaimers with respect to the independent contractor status of franchisees can also be helpful. For example, a franchisor could provide franchisees with a model employee handbook that gives franchisees the power to change provisions of the handbook without needing approval of the franchisor. While courts review vicarious liability cases with a "totality of the circumstances" approach - providing no safe harbor for franchisors - with careful drafting of franchise documents, an awareness of employment relationship red flags, and management practices which avoid unnecessary control, franchisors can minimize the risk of being deemed employers within their franchise system.

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