Joint Employer Update – NLRBeef with Franchising

Lane Fisher

By: Lane Fisher, Partner, Fisher Zucker

On October 27, 2023, the National Labor Relations Board (NLRB) published a rule establishing a new standard for determining whether entities will be considered “joint employers” of a group of employees for collective bargaining purposes. This rule essentially overturns the previous NLRB rule that took effect in April 2020. A one-page document summarizing the new rule and the recommended actions for franchise systems can be found here.

While well-intentioned, the new rule threatens a key tenet of the franchising model and creates a number of unintended negative consequences for franchisors, franchisees and consumers. To that end, the International Franchising Association (IFA) and other industry groups submitted comments and requested some sort of carveout or additional clarification to protect the franchise model, but the NLRB declined. Therefore, unless Congress overturns this rule, we will be left with a new standard that is broader and more confusing than the “substantial direct and immediate control” required under the 2020 rule.

In short, the franchise relationship is already highly regulated by the federal government, specifically the Federal Trade Commission (FTC), as well as by a number of states. This regulatory framework protects franchisees while solidifying their status as independent business owners that operate within a franchise system but are ultimately responsible for the success of their business through their management of employees and day-to-day operations. By introducing a new rule that undeniably increases the chances of determining that a franchisor will be considered the employer of their franchisees and/or their employees, the NLRB has introduced a totally separate and often contradictory lens within which the franchise relationship must be analyzed.

As described below, the new NLRB rule prevents franchisors from establishing reasonable controls in two critical areas unless they are willing to risk being deemed an employer of their franchisees and/or their employees: (1) ensuring brand uniformity and enforcing minimum system standards, and (2) monitoring and managing franchisee compliance with industry-specific laws, regulations, and licensing requirements.

Overview of the 2023 Rule

Essential Terms and Conditions of Employment

Under the 2023 rule, an entity will be deemed to be a joint employer for purposes of collective bargaining if it has authority to control “essential terms and conditions of employment.” One of the positive impacts that came out of the NLRB’s comment period is that the proposed rule was modified to specifically list the seven terms and conditions that meet this threshold and affirmatively stating that the object of control must be tied to one of these seven terms. The seven terms are as follows:

1 Wages, benefits, and other compensation;

2 Hours of work and scheduling;

3 The assignment of duties to be performed;

4 The supervision of the performance of duties;

5 Work rules and directions governing the manner, means, and methods of the performance

of duties and the grounds for discipline;

6 The tenure of employment, including hiring and discharge; and

7 Working conditions related to the safety and health of employees.

Of these seven terms, four of them (#1, #2, #3, and #6) represent standard employer functions that should not impact the vast majority of franchise systems unless they are interpreted very liberally by the courts. Another term, the supervision of the performance of duties (#4), should also not pose a major problem unless this impacts a franchisor’s reserved rights to inspect and audit its franchisees, which is critical to ensuring brand standards are met. However, the final two terms and conditions of employment (#5 and #7) pose challenges under the new rule.

Working Conditions Related to Safety and Health of Employees (#7)

Most franchise agreements require franchisees to comply with brand standards set forth in the franchise agreement and operations manual, which often include requirements related to health and safety. Additionally, the vast majority of franchise agreements require franchisees to comply with all applicable laws and regulations, including laws related to health and safety, and permit the franchisor to terminate the franchise agreement if these obligations are breached. Under the new rule, these requirements trigger exposure to joint employment determinations, as franchisors are effectively prohibited from indirectly controlling or even reserving the right to control working conditions related to health and safety.

Through this element, the NLRB has created a framework that harms not only franchise systems but also consumers. Franchisors are often better positioned than their franchisees to understand how to proactively develop policies and operational procedures to minimize health and safety risks to the public. They also have more experience in responding to these types of issues or directing their franchisees how to act, especially in industries (healthcare, service, etc.) with specific requirements above and beyond operating a business generally. By incorporating this broadly worded element in the new rule, Franchisors will be forced to revisit commonly incorporated contractual terms in their franchise agreements and will be reluctant to set operational standards related to health and safety to the detriment of their franchisees and the ultimate consumers.

Work Rules and Directions Governing the Manner, Means and Methods of Performance of Duties and the Grounds for Discipline (#5)

Finally, and most importantly, term and condition #5 (work rules and directions governing the manner, means, and methods of the performance of duties and the grounds for discipline) will create significant challenges when applied under the new standard. One of the critical components of every franchise system is the establishment of baseline standards designed to provide the consumer with the desired brand experience. The NLRB’s use of nebulous terms like “manner, means, and method” jeopardizes this cornerstone element of franchising by creating increased risk of joint employment exposure.

In fact, the FTC’s Franchise Rule sets forth three definitional elements of a franchise, and one of those is that the franchisor “will exert or has the authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.” The FTC therefore recognizes that this element is a natural and essential component of the franchise relationship; however, under the NLRB’s new rule you will be considered a joint employer if you reserve the right to control the manner, means, and methods of how day-to-day job functions are performed. This frustrating contradiction explains why the franchising community voiced strong opposition to this terminology through the issuance of comments in the rule making process, and underscores the conflict between the new rule and existing franchise law.

The Shift to Indirect Control and Authority to Control

The most significant change to the 2020 rule comes not from the list of terms and conditions of employment, but from the fact that a franchisor could be considered a joint employer even if they don’t actually exercise control related to these terms and conditions. Instead, the new standard will look at whether a franchisor has the authority to control the essential terms and conditions of employment (generally through reserved rights in the operations manual or franchise agreement).

A franchisor tasked with maintaining a uniform system that presents a certain image and level of quality to the public must inherently reserve a number of rights in its franchise agreement that it hopes never to exercise. Similarly, a franchisor’s operations manual must not only establish baseline standards to protect its brand, but also include the ability to take action against franchisees that do not maintain these standards and end up harming the image of the rest of the system. An inability to reserve these rights essentially prevents a franchisor from responding to the types of real-world problems that come up in the operation of nearly every type of business. To contrast, the 2020 rule looked at whether a franchisor exercised substantial direct control, which would be an indicator that a franchisor is actually stepping into the role of an employer by managing day-to-day operations as a regular course of business.

Additionally, the new standard makes it clear that it applies to both direct and indirect control – from a franchising perspective, this removes the distinction between whether a franchisor directly controls the franchisee’s employees or whether it does so through the franchisee. While this poses less of a problem than the authority to control analysis described above, franchisors tasked with protecting the brand may have a legitimate need to respond to an isolated health and safety issue or another performance-related issue involving a franchisee’s employee. While such a response should be coordinated in tandem with the franchisee, the franchisor’s actions could still be construed as indirect control.

For this reason, the 2020 rule specifically excluded control that is “only exercised on a sporadic, isolated, or de minimis basis.” With respect to franchising, this exclusion is entirely appropriate and necessary to ensure that a franchisor has the ability to step in when a serious issue has arisen that threatens the brand or system as a whole. However, this exclusion makes it clear that these types of interventions are reserved for isolated incidents rather than as an ordinary course of business, which correctly addresses the difference between a franchisor protecting their brand and an employer dictating the activities of its employees.

Primary Consequences for Franchising Industry

As noted above, the new NLRB rule fails to address two critical components of a franchise system that are wholly independent from the legal definition of an employer-employee relationship: (1) brand uniformity and minimum system standards, and (2) compliance with industry-specific laws, regulations, and licensing requirements. By making it substantially more difficult for franchisors to protect these components, the new rule creates two possible negative consequences for franchisees.

Ability to Promote Brand Uniformity and Maintain System Standards

While several commenters, including the IFA, noted the importance of franchisors protecting their brands and their marks, it is clear that the NLRB failed to fully grasp the scope of what that entails. The new rule states that “many forms of control that franchisors reserve to protect their brands or trade service marks (like those dealing with logos, store design, décor, or product uniformity) will typically not be indicative of a common-law employment relationship.”

By essentially reducing a brand to a color scheme and a logo, the NLRB has ignored some of the most critical components of what makes a franchise system succeed. Yes, the actual mark is what is most visible to the public, but the standards behind that mark are what gives it value and what lets the public know what they can expect when they interact with any franchise in the system. Methods of operation, customer service, and proprietary processes are all components of a franchisor’s brand that they need the right to protect. In some industries, particularly service-focused industries without brick-and-mortar locations, these are arguably the most important components of the system to regulate.

Instead, the NLRB is now creating a framework where a franchisor could be deemed an employer by reserving rights related to “the manner, means, and methods of the performance of duties. . .” – under this standard, protecting the brand will be a greater challenge, harming both the other franchisees that comprise the system as well as the general public.

Ability to Ensure Compliance with Laws and Regulations

Though not as significant, a second area of concern relates to compliance with (often industry-specific) laws, regulations, and minimum licensing requirements. Franchising is a business model that cuts across nearly every industry that comprises the U.S. economy, and many franchisees are entrepreneurs that are first entering a new industry when they buy a franchise. While the vast majority of franchise agreements are structured so that franchisees are ultimately responsible for compliance with applicable laws and regulations, they understandably account for a level of support and guidance from franchisors.

To that end, it is critical that franchisors be able to step in when there are compliance issues. This is essential for not only protecting the brand as described above, but also for protecting the consumers that are often the intended beneficiaries of these laws and regulations. While some issues do not impact the defined terms and conditions of employment, it is clear that many do (particularly with respect to the methods of performance and health and safety issues). Whether it involves licensed professions in the financial industry or workplace safety issues in the medical or home service industries, many franchisors have a legitimate need to reserve the right to ensure franchisees comply with relevant laws and regulations.

Impact on Franchisee Autonomy and the Franchise Relationship

If the rule takes effect in its current form, franchisors will essentially be stuck between a rock and a hard place. They can either accept the fact that they will be deemed a joint employer for collective bargaining purposes or they can modify their contracts, manuals, and operational practices to ensure that they do not meet the joint employer threshold under the new standard. Both of these would have negative consequences for franchisees.

If a franchisor accepts its role a joint employer, the logical next step is to dramatically increase the amount of control over franchisee operations to minimize any labor-related issues with its newfound employees. This means less independence for franchisee operators and increased fees to defray what will likely be substantial costs for franchisors. On the other hand, a franchisor that does not wish to be deemed a joint employer will be less willing to provide operational direction, employee handbooks, or educational materials, reducing the level of support that franchisees receive.

While the NLRB states that it is “mindful that applying the final rule will require sensitivity to industry-specific norms and practices,” the current version of the rule is drafted to avoid this level of nuance and relies on the courts to uniformly apply its broad standard without any additional guidance. For this reason and all of these reasons listed above, Congress should step in and prevent the rule from taking effect in its current iteration in order to avoid substantial harm to the franchising community and its consumers.

Tagged in: ,