Franchisors and the Specter of Joint Employer Liability for Franchisee Misconduct

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By Katarina E. Wiegele

The federal judiciary has generally concluded franchisors do not qualify as employers for purposes of wage liability under the Fair Labor Standards Act.1 However, this is not a rigid, per se rule. The latest rulings on the issue demonstrate federal courts' and agencies' readiness to evaluate the actual nature of franchise relationships and to assess the level of control a franchisor exercises over a franchisee's day-to-day employment decisions--and have put the spotlight on franchisors in the fast food industry.

In considering whether franchisors can be liable for the unlawful acts of their franchisees, courts have applied well-established joint employment principles to the franchise model.2 These precedential decisions clarify the mere existence of a franchisor-franchisee relationship does not establish joint employment. Moreover, they explain the issue as to whether a franchisor is an employer of a franchisee's employee is a fact-intensive inquiry and identify operational control as the focal point of the liability issue. As courts provide greater clarity as to what does and does not constitute sufficient operating control, businesses operating through franchise agreements may examine the franchisor's role in a franchisee's business, assess potential liabilities and modify their conduct accordingly.

Economic Realities Test for Employer Status

Liability under the FLSA is predicated on the existence of an employment relationship.3 Accordingly, the threshold issue in any FLSA action is whether the named defendant employed the named claimant. Under a joint employment theory, two or more individuals and/or corporate entities may control various aspects of a worker's employment and, thereby, jointly employ the individual.4 All joint employers are individually responsible for FLSA compliance and are jointly and severally liable on any resulting judgment.5

To determine if a party is an employer within the meaning of the FLSA, federal courts consider the economic realities of the work relationship on a case-by-case basis.6 For a finding of joint employment, each individual or entity alleged to be an employer must meet the economic realities test.7 Relevant factors are not exhaustive, and a plaintiff need not satisfy all factors to establish an employment relationship exists. Moreover, courts have “identified different sets of relevant factors based on the factual challenges posed by particular cases.”8 Because courts review the totality of the circumstances, the narrow four-factor economic reality test, which was first articulated by the U.S. Court of Appeals for the Ninth Circuit in Bonnette v. California Health and Welfare Agency and enunciated in Carter v. Dutchess Community College, may initiate--but does not conclude--the analysis.9

Recognizing managerial efforts to evade FLSA coverage by distancing themselves from workers, the U.S. Court of Appeals for the Second Circuit has distinguished the concepts formal control--formal right to control the day-to-day physical performance of work--and functional (or operational) control--involvement in the day-to-day operation of the company.10 Case law discussing operational control reveals that a corporate officer or owner who has some degree of involvement in a company's day-to-day operations and employment practices may be an employer subject to individual liability for FLSA violations and that ownership, in the absence of such involvement, is insufficient.11

The Second Circuit's decision in Irizarry v. Catsimatidis provides some clarity as to what conduct suffices.12 The court stated, “A person exercises operational control over employees if his or her role within the company, and the decisions it entails, directly affect the nature or conditions of the employees' employment.”13 For a finding of liability, a company owner need not be responsible for managing company employees or directly come into contact with the employees, their workplace or work schedules. He or she need not exercise control over employees constantly; restricted or occasional control may suffice.14 In articulating the standard more generally, the Second Circuit declared, “[W]e must be mindful . . . to ascertain that the individual [defendant] was engaged in the culpable company's affairs to a degree that it is logical to find him liable to plaintiff employees.”15

Franchisors and the Issue of Operational Control

Historically, federal courts have looked beyond the contract language of franchise agreements to determine whether franchisors acted as employers within the meaning of the FLSA. Developing law on franchisor liability shows judges are scrutinizing franchisor-franchisee relationships consistent with the above analytical framework to determine who makes day-to-day decisions on employment issues at the franchise level. These precedential rulings have begun to shed light on the kind and degree of control a franchisor must assert to render it potentially liable for the unlawful employment acts of a franchisee.

The Fifth Circuit and the Southern District of New York have settled that a contractual franchise relationship does not, in itself, establish joint employment and have identified control over the day-to-day operations and employment practices of the franchise as the heart of the franchisor liability issue. In Orozco v. Plackis and Cano v. DPNY, Inc., the responsibilities enumerated in the four-factor economic realities test and case law discussing operational control guided the inquiry as to whether a franchisor's actions were sufficient for a finding of joint employment based on the totality of the circumstances. The courts considered the scope of franchisors' authority over business operations and employees and franchisors' actual exercise of that power. Collectively, these analyses distinguish between the provision of tools and advice for operation of a successful franchise--the hallmark of a uniform turnkey model--and direct oversight with respect to franchisee business operations and employment practices that is indicative of employment.

Control Over Day-to-Day Franchise Operations and Employment Practices

A franchisor exercising operational control makes decisions that directly affect workplace conditions. Evidence of authority over management and direct oversight of franchisee business affairs in general is relevant. Courts may consider whether the franchise owner gives instructions to managers, exercises financial control over the business, or possesses the power to shut down or to sell the business.16 In assessing control over employment practices, the federal courts asked whether individual franchise owners (1) had the power to hire and fire employees; (2) supervised and controlled employee work schedules or conditions of employment; (3) determined the rate and method of payment; (4) maintained employment records.17

Franchisor Liability in Cano v. DPNY, Inc.

In applying joint employment standards in Cano, the U.S. District Court for the Southern District of New York ruled plaintiffs had pled sufficient facts to state a plausible claim against a franchisor, Domino's Pizza, Inc. Taken together, allegations that the international corporation created management and operation policies and practices, promulgated and implemented compensation and hiring policies, and had the right to inspect stores to ensure compliance with policies, including those related to day-to-day conditions of employment, were sufficient to survive a motion to dismiss. Plaintiffs claimed the franchisor not only provided training materials for managers and employees but also provided posters directing task performance and monitored employee performance via mandatory computer hardware and software. Based on the franchisor's authority over management and direct oversight of employees, the district court made the precedential decision that Domino's franchisor status was not a bar to FLSA liability.

No Franchisor Liability in Orozco v. Plackis

The Fifth Circuit's finding of no franchisor liability in Orozco recognized limits on joint employer liability under the franchise model.18 It identified the importance of uniform marketing and operational plans, broad policies, franchisor-franchisee communication and franchisor assistance to the success of the franchise. Specifically, the court determined non-binding advice regarding hiring and firing decisions is not sufficient to establish the first prong. With respect to prong two, the court reasoned setting broad policies for the entire franchise, reviewing employee schedules, providing training to new franchisees and their employees and temporal proximity between franchisor-franchisee meetings do not demonstrate a franchisor had actual control over franchisee employees. As to prong three, the court stated a franchisor's awareness of a franchisee employee's salary does not amount to a decision regarding pay. The court's message is clear--the mere fact that a franchise owner communicates with a franchisee or proffers advice does not always render the franchisor an employer for FLSA purposes.

As indicators that the existence of a franchise agreement does not preclude application of joint employment standards, these decisions may prompt franchisors to carefully evaluate the language of their agreements and employee handbooks, their relationships with franchisee workers and their role in franchised businesses and to determine whether or not they should step back and limit their control over employment. Furthermore, franchisors and franchisees might have greater confidence in using class-action waivers in employment arbitration agreements to protect against class-action litigation where the NLRB declined to challenge the Fifth Circuit's D.R. Horton ruling (see 136 DLR A-14, 7/16/14, “No High Court Review Sought in Horton; Fifth Circuit Nixed NLRB Class Waiver View”).19

Joint Employment and the Fast Food Industry's Franchise Model

Recent FLSA rulings are not the only cause for alarm in the franchise community. A July 29 decision by National Labor Relations Board General Counsel Richard F. Griffin authorized issuance of 43 unfair labor practice complaints alleging national franchisor McDonald's USA LLC is a joint employer of franchisee restaurant employees (145 DLR A-1, 7/29/14, “NLRB General Counsel Acts on McDonald's, Moving 181 Cases on Joint Employer Issue”).20 In view of this development and David Weil's May 2010 report to the Department of Labor discussing the effects of franchising on FLSA compliance, an increase in employment cases alleging joint employer liability against fast-food franchisors may be in the cards.21 Ultimately, potential liability for the unlawful acts of franchisees may have a chilling effect on the franchise model as franchisors grapple with how to effectively implement business standards and enforce uniform marketing and operational plans (174 DLR A-9, 9/9/14, “House Panel Considers Impact on Franchises of Broadening NLRA Joint Employer Liability”) (177 DLR C-1, 9/12/14, “To Unions, McDonald's Joint Employer Status No Slam Dunk, as Fast Food Push Intensifies”).

In a July 2014 Bloomberg BNA interview, Joel Griswold, partner in BakerHostetler's Chicago office, advised, “As a general proposition, plaintiffs look for the biggest classes and the deepest pockets. It is only natural that they gravitate towards naming franchisors as defendants. In the meantime, it is important for franchisors (and other entities vulnerable to being named as joint employers) to stay current on how courts are analyzing joint employment issues in their respective jurisdictions and to act accordingly” (2014 FLLTI, 7/16/14, “Joel Griswold Highlights Employer Liability Issues in Professional Sports, Unpaid Internships and Food Franchises”).

1 Orozco v. Plackis, 22 WH Cases 2d 1653, 2014 BL 186406, at *6 (5th Cir. 2014); Reese v. Coastal Restoration & Cleaning Servs., Inc., 2010 BL 296701 (S.D. Miss. 2010); Singh v. 7-Eleven, Inc., 2007 BL 251133 (N.D. Cal. 2007); Howell v. Chick-Fil-A, Inc., 1 WH Cases 2d 1357, 1993 BL 337 (N.D. Fla. 1993); Donovan v. Breaker of Am., Inc., 566 F. Supp. 1016, 1019, 26 WH Cases 615 (E.D. Ark. 1983).

2 Orozco, 2014 BL 186406, at *2; Cano v. DPNY, Inc., 287 F.R.D. 251, 2012 BL 296817 (S.D.N.Y. 2012) (granting plaintiffs' motion for leave to file a second amended complaint to add Domino's Pizza, Inc., Domino's Pizza, LLC, and Domino's Pizza Franchising, LLC as defendants).

3 29 U.S.C. § 203(d)-(e), (g) (providing expansive definitions of “employer,” “employee” and “employ” to effectuate the FLSA's broad, remedial purposes); see Tony & Susan Alamo Found. v. Sec'y of Labor, 471 U.S. 290, 296, 27 WH Cases 209 (1985). Section 203(d) broadly defines “employer” as “any person acting directly or indirectly in the interest of an employer in relation to an employee.”

4 29 C.F.R. § 791.2(a) (stating “[a] single individual may stand in the relation of an employee to two or more employers at the same time . . . A determination of whether the employment by the employers is to be considered joint employment or separate and distinct employment for purposes of the [FLSA] depends upon all the facts in the particular case”); DOL Wage-Hour Opinion Letter, 5/11/01 (listing relevant factors in determining whether an entity is a joint employer as “the power to control or supervise the workers or the work performed; the power, whether alone or jointly or directly or indirectly, to hire or fire or modify the employment conditions of the individual; the degree of permanency and duration of the relationship; the level of skill involved; whether the activities the workers perform are an integral part of the overall business operations; where the work is performed and whose equipment is used; and who performs payroll and similar functions”).

5 29 C.F.R. § 791.2(a); DOL Wage-Hour Opinion Letter, 9/22/98 (clarifying “all joint employers are responsible, both individually and jointly, for compliance with the FLSA with respect to the entire employment for the particular workweek, notwithstanding any contrary arrangement by the parties”); DOL Wage-Hour Opinion Letter, 1/07/99.

6 Rutherford Food Corp v. McComb, 331 U.S. 722 (1947).

7 Orozco, 2014 BL 186406, at *2 (citing Gray v. Powers, 673 F.3d 352, 354-55, 18 WH Cases 2d 1441, 2012 BL 48488 (5th Cir. 2012) (applying four-factor test)); Thompson v. Real Estate Mortg. Network, 748 F.3d 142, 149, 22 WH Cases 2d 453, 2014 BL 92870 (3d Cir. 2014) (citing Hickton v. Enter. Holdings, Inc., 683 F.3d 462, 19 WH Cases 2d 385, 2012 BL 162885 (3d Cir. 2012)); Irizarry v. Catsimatidis, 722 F.3d 99, 104, 20 WH Cases 2d 1674, 2013 BL 181264 (2d Cir. 2013), cert. denied, 134 S. Ct. 1516, 188 L. Ed. 2d 450, 2014 BL 64174 (2014) (citing Barfield v. N.Y.C. Health & Hosps. Corp., 537 F.3d 132, 13 WH Cases 2d 1721, 2008 BL 166495 (2d Cir. 2008)); Aimable v. Long & Scott Farms, 20 F.3d 434, 2 WH Cases 2d 49 (11th Cir. 1994) (citing Patel v. Wargo, 803 F.2d 632, 635, 27 WH Cases 1457 (11th Cir. 1986)).

8 Barfield, 537 F.3d at 141-42.

9 Carter v. Dutchess Cmty. Coll., 735 F.2d 8, 26 WH Cases 1239 (2d Cir. 1984) (stating test includes inquiries into “whether the alleged employer (1) had the power to hire and fire the employees, (2) supervised and controlled employee work schedules or conditions of employment, (3) determined the rate and method of payment, and (4) maintained employment records” (citing Bonnette v. Cal. Health & Welfare Agency, 704 F.2d 1465, 26 WH Cases 152 (9th Cir. 1983))).

10 Irizarry, 722 F.3d at 107-10 (discussing operational control); Barfield, 537 F.3d at 145 (citing Ling Nan Zheng v. Liberty Apparel Co., 355 F.3d 61, 70, 9 WH Cases 2d 336 (2d Cir. 2003) (formulating a 6-factor functional control test)); Herman v. RSR Sec. Servs. Ltd., 172 F.3d 132, 5 WH Cases 2d 257 (2d Cir. 1999).

11 Irizarry, 722 F.3d at 108-09 (stating “most courts have endeavored to strike a balance between upholding the broad remedial goals of the [FLSA] and ensuring that a liable individual has some relationship with plaintiff employees' work situation”).

12 Id. at 116-17 (holding a supermarket chain chairman and CEO, who hired and supervised managerial employees and had overall financial control of the company, possessed and exercised “operational control” over managers' employment to such a degree that he qualified as plaintiffs' joint employer and was liable for the company's FLSA violations, even though the owner was neither personally responsible for the wage violations nor directly managed or interacted with plaintiffs-employees).

13 Id. at 110.

14 Id.; Herman, 172 F.3d at 139 (stating that employer status “does not require continuous monitoring of employees, looking over their shoulders at all times, or any sort of absolute control of one's employees,” that “[c]ontrol may be restricted, or exercised only occasionally” and that evidence of “authority over management, supervision, and oversight of [business] affairs in general” is relevant in the totality of the circumstances).

15 Irizarry, 722 F.3d at 111, 117 (stating “[o]wnership, or a stake in a company, is insufficient to establish that an individual is an 'employer' without some involvement in the company's employment of the employees”).

16 See Id. at 112, 116.

17 Orozco, 2014 BL 186406, at *2; see Irizarry, 722 F.3d at 114-15.

18 Orozco, 2014 BL 186406, at *5 (stating “[w]e do not suggest that franchisors can never qualify as the FLSA employer for a franchisee's employees; rather, we hold that Orozco failed to produce legally sufficient evidence to satisfy the economic reality test”).

19 D.R. Horton, Inc. v. NLRB, 737 F.3d 344, 197 LRRM 2637, 2013 BL 335349 (5th Cir. 2013) (concluding NLRB erred in finding D.R. Horton, Inc., violated employees' NLRA right to engage in concerted activity for mutual aid or protection by requiring employees to execute arbitration agreements that waived the right to pursue class or collective claims in arbitral and judicial proceedings).

20 “NLRB Office of the General Counsel Authorizes Complaints Against McDonald's Franchisees and Determines McDonald's, USA, LLC is a Joint Employer,”

21 “Improving Workplace Conditions Through Strategic Enforcement, A Report to the Wage and Hour Division,” David Weil, Principal Investigator, Boston University, 44-49, (stating “the average back wages per investigation for franchised outlets is larger than that for company-owned outlets”).