The constant concern for employers is what next trend in litigation or what next decision by a court could lead to widespread litigation for which employers may not have prepared. Of late, it was litigation over the Fair Labor Standards Act (FLSA) and its application to sales representatives in the pharmaceutical industry, with the ultimate question being whether pharmaceutical sales representatives are entitled to overtime.

This past April, after years of litigating this issue, the U.S. Supreme Court heard argument on whether pharmaceutical sales representatives are covered by the salesperson exemption. Early this summer, the Supreme Court should resolve the application of the salesperson exemption to pharmaceutical sales representatives, although issues relating to other exemptions will remain. See Christopher v. SmithKline Beecham dba GlaxoSmithKline , No. 11-204, U.S. Supreme Court.

In the franchise/employment law world, there are two areas of litigation that have arisen in the last 18 months that require diligent observation. First, a handful of decisions have concluded that a franchisee was considered an employee of the franchisor for purposes of employee wage-and-hour and wage-payment laws, as well as for purposes of vicarious liability. See Awuah v. Coverall North America , 707 F.Supp.2d (D.Mass. 2010) and Hayes v. Enmon Enterprises , 2011 WL 2491375 (S.D.Miss. June 22, 2011). Second, there have been a number of decisions, with differing results, regarding whether a franchisor is a joint employer of a franchisee’s employees, for purposes of liability in employment discrimination cases. See Myers v. Garfield & Johnson Enterprises , 679 F.Supp.2d 5989 (E.D.Pa. 2010) and McFarland v. Breads of the World , 2011 WL 801815 (S.D. Ohio Feb. 1, 2011).

It must be noted that there is a common theme through most of the cases that have seen potential exposure for franchisors: The franchise tends to be a franchise that provides direct consumer services, such as janitorial services or tax advisory (accounting) services, although there is one case involving a Subway franchise in the discrimination context.

There are actions that a franchisor can proactively take to reduce or eliminate this potential liability. However, to do so, the franchisor will have to relinquish certain controls or restrictions over the franchisees that it may be unwilling to release.

Franchisees as Employees of Franchisor

In Massachusetts, franchisees of the Coverall janitorial franchise system successfully argued that they were employees and not independent contractors under the Massachusetts Independent Contractor Statute. The court reasoned that because the franchisor provided equipment, billed and collected for the franchisee’s services and contracted directly with the franchisee’s customers, the franchisee was an employee of the franchisor, and not an independent contractor. The Awuah decision has led to additional litigation in Massachusetts, including the determination that the franchisor, Coverall, is liable to the franchisee for minimum wage, overtime and wage-payment and collection penalties.

In another case involving the Jani-King janitorial franchise system, a district court in Mississippi examined the relationship between a franchisor and franchisee to determine if an employment relationship existed between them, so as to establish vicarious liability in a personal injury case. In Hayes , the Jani-King franchise agreement contained provisions that impinged upon the franchisee’s customer relationships. Specifically, the franchise agreement permitted the franchisor to take over any job that its franchisee performed inadequately. In addition, the franchise agreement controlled the training of the franchisee and the franchisee’s employees, the location and appearance of the franchisee’s place of business, and the policies, practices and procedures and standards by which the franchisee operated. Based on these facts, the court denied Jani-King’s motion for summary judgment, concluding that the franchisee was arguably an employee, and permitting the issue of vicarious liability to go to the jury.

Importantly, the Coverall and Jani-King franchise systems are distinct from many other franchise systems, in that the franchisees and their customer relationships are tightly controlled and monitored by the franchisor. The two primary facts that led the court to its decision in Awuah was that the Coverall franchise system required the franchisee’s customers to enter into contracts with Coverall and the customers then paid Coverall directly, not the franchisee. Similarly, the court in Hayes concluded that the franchise agreement demonstrated a level of control over the franchisee’s physical conduct that was too great to consider the franchisee an independent contractor. Given these facts, the Awuah and Hayes decisions have narrow application and would not be pertinent to a franchise system where the franchisee is provided with independence with respect to customer relations.

Franchisors as Joint Employers

Another potential concern for franchisors is being legally classified as a joint employer of an employee of the franchisee. A joint employer relationship is found when one employer, while contracting in good faith with an otherwise independent company, has retained for itself control of the terms and conditions of employment of the employees who are employed by the other employer. The joint employer concept recognizes that the business entities involved are in fact separate but that they share or co-determine those matters governing the essential terms and conditions of employment.

District courts in the Third Circuit have established three factors to analyze in determining whether a joint employer relationship exists: (1) authority to hire and fire employees, promulgate work rules and assignments and set conditions of employment, including compensation, benefits and hours; (2) day-to-day supervision of employees, including employee discipline; and (3) control of employee records, including payroll, insurance, taxes and the like. No single factor is dispositive and a weak showing on one factor may be offset by a strong showing on the other two.

Most franchisors, through either their franchise agreement or policies and procedures, maintain some degree of control over the workforce of their franchisees — ranging from requiring a background check or minimum qualifications to having the employees’ final work product approved by the franchisor. Where the franchisor falls on this paradigm will largely determine whether the franchisor is risking joint employer liability.

Importantly, franchisors cannot rely solely on the existence of a franchise agreement to avoid joint employer liability. See EEOC v. Papin Enterprises , 2009 WL 961108 (M.D.Fla. April 7, 2009). In fact, as stated above, the franchise agreement and the rights reserved by the franchisor therein may create joint employer liability. By way of example, in Papin , the district court denied the franchisor’s (Subway) motion for summary judgment on the issue of joint employer liability. The plaintiff alleged that the franchisee and Subway discriminated against him based upon religion by requiring him to remove a piece of jewelry from his nose for reasons of food safety. Subway’s franchise agreement contained a procedure that reserved for the franchisor the right to waive the no-jewelry policy. The court in denying Subway’s motion reasoned that a jury could conclude that Subway was a joint employer because Subway had the right to waive the no-jewelry policy.

Similarly, the Eastern District of Pennsylvania denied a motion to dismiss by a franchisor, Jackson-Hewitt, concluding that the plaintiff had sufficiently pled joint employer liability in a Title VII sexual harassment case in Myers . The district court concluded that the franchisor exerted significant control over the franchisee’s employees through the franchise agreement and policies and procedures, including requiring compliance with detailed policies, training and office procedures, and by reviewing the employee’s work product (tax returns) prior to filing.

In contrast, a district court in Ohio ruled that the franchisor, Panera Bread, was not a joint employer in a Title VII race discrimination claim in McFarland . The district court concluded that the franchisor was not a joint employer because there was no evidence that the franchisor played any role in the franchisee’s employee relations issues, including day-to-day supervision of the franchisee’s employees. Likewise, in an FLSA case, the Western District of Pennsylvania held that the training and supervision of another’s employees is not enough to establish joint employer liability in Lepkowski v. Telatron Marketing Group , 766 F.Supp.2d 572 (W.D.Pa. 2011).

Addressing and Avoiding Liability

Depending upon the franchise system, actions to avoid the liabilities described in this article can be easy or quite difficult to implement. Both the franchise agreement and the policies and procedures of the franchise system must be analyzed to determine whether any of the restrictions therein can be adjusted to reduce or avoid liability.

For instance, to avoid wage-and-hour liability to franchisees, a janitorial service franchise should consider whether it would be more effective to have the franchisee enter into contracts with the customer and/or collect the fees for services rendered. Allowing the franchisee to enter into the contracts with customers, while still protecting the right of the franchisor to serve the customers with a restrictive covenant, would be more effective and would reduce exposure. Or, to avoid joint employer liability, a franchisor might consider relinquishing the right to review a franchisee’s employees’ work product, but require the franchisee to hire a qualified employee to review the work. Given the particular circumstances necessary to establish liability in these two areas, it is unlikely that this litigation will become as widespread as the pharmaceutical sales representative litigation; however, franchisors and other employers in a potential joint employer relationship should take steps to analyze and address the potential liability. •

James B. Shrimp is a partner in the litigation department of High Swartz in Norristown, Pa., where he has an extensive litigation practice, representing primarily corporate clients in a variety of matters, including employment discrimination, franchising, trademark, construction and commercial law. He can be reached at jshrimp@highswartz.com.