The Tangled Web: Different Tests under Texas and Federal Laws Leave Franchisors and Franchisees Wondering Whether and When They Are Joint Employers

The International Franchise Association defines franchising as a method for expanding business and distributing goods through a licensing agreement.   In the franchisor-franchisee relationship, a franchisor typically grants a license to a franchisee to conduct business under the trademark and trade name of the franchisor.  http://www.franchise.org/what-is-a-franchise. 

For obvious reasons, the franchisor has a vested interest in ensuring that the franchisee maintains the quality and integrity of the brand, which in turn, generally requires some level of oversight of the franchisee’s operations.  But how much control can a franchisor exercise before it crosses the threshold and becomes a joint employer with its franchisee for purposes of establishing liability?

The Texas Labor Code

Effective September 1, 2015, and in an apparent response to the federal government’s efforts to find joint employers behind every corner, the Texas Legislature amended seven provisions of the Texas Labor Code to clarify that franchisors (defined as any person who grants a franchise and participates in the franchise relationship), are not the employers of a franchisee (defined as any person who is granted a franchise) or franchisee employees unless a court of competent jurisdiction in Texas has found that the franchisor has exercised a type or degree of control over the franchise or the franchisee’s employees not customarily exercised by a franchisor for the purpose of protecting the franchisor’s trademarks and brands.

 

The seven sections of the Texas Labor Code that were amended are:  Chapter 21 (Employment Discrimination); Chapter 61 (Payment of Wages); Chapter 62 (Minimum Wage); Chapter 91 (Professional Employer Organizations); Chapter 201 (Unemployment Compensation); Chapter 401 (Workers’ Compensation); and Chapter 411 (Workers’ Health and Safety). 

The obvious questions raised by the amendments are: (1) what is the meaning of the phrase, “not customarily exercised”?; and (2) what test or factors will a court apply to determine whether a degree of control is or is not customarily exercised by a franchisor?

Board Law 

In the Browning-Ferris Industries decision it issued in August 2015, the National Labor Relations Board (NLRB) restated its standard for how it will determine the existence of a joint employer relationship. https://www.nlrb.gov/news-outreach/news-story/board-issues-decision-browning-ferris-industries. Under the restated standard, the Board may find that two or more entities are joint employers of a single work force “if they are both employers within the meaning of the common law, and if they share or codetermine those matters governing the essential terms and conditions of employment.”  

 

In determining whether a common-law employment relationship exists, the Board looks to the Restatement (Second) of Agency (1958) for guidance, which provides that, “a servant is a person employed to perform services in the affairs of another and who with respect to the physical conduct in the performance of the services is subject to the other’s control or right of control.”  The phrase “essential terms and conditions of employment” is broadly construed to include, for example, hiring, firing, discipline, supervision, direction, controlling scheduling, seniority and overtime, determining wages and hours, and the manner and method of work performance. 

Importantly, the Board’s decision expressly rejects its prior standard that required both the possession and exercise of the authority to control the terms and conditions of employment to find a joint employer relationship.  Now, reserved authority, even if not exercised, and indirectly exercised control, such as through an intermediary, may establish joint employer status.

The United States Department of Labor

In January 2016, and not wanting to miss a ride on the joint employer bandwagon, United States Department of Labor (DOL) Wage and Hour Administrator David Weil issued Administrator’s Interpretation No. 2016-1 (AI), wherein he sets forth the DOL’s “guidance” for determining a joint employer relationship under the Fair Labor Standards Act (FLSA). https://www.dol.gov/whd/flsa/Joint_Employment_AI.htm.  

 

The AI provides guidance regarding both vertical and horizontal joint employment.  Horizontal joint employment may be established when an employee is employed by two or more technically separate but related or overlapping employers.  For example, this analysis would apply where a server works for two separate restaurants that are operated by the same entity, and the question is whether the two restaurants are sufficiently associated with respect to the server such that they jointly employ him.

The AI identifies a number of factors when analyzing the degree of association between, and the sharing of control by, potential horizontal employers, including the: (a) existence of common ownership; (b) overlap of officers, directors, executives, or managers; (c) sharing of control over operations, including hiring, firing, payroll, advertising, and overhead costs; (d) degree to which the joint employers’ operations are intermingled; (e) supervision by one employer over the work of another employer; (f) treatment of employees as a pool of employees available to both employers; (g) sharing of clients or customers; and (h) existence of any agreement between the potential joint employers. 

 

Vertical joint employment, as defined in the AI, may exist when an employee of one employer, referred to in the AI as an “intermediary employer,” is also, with regard to the work performed for the intermediary employer, economically dependent of another employer, referred to as a “potential joint employer.”  According to the AI, where there is vertical joint employment, there is usually a contract or other arrangement, but not necessarily an employment relationship, between the intermediary employer and the potential joint employer. 

In vertical joint employment situations, one employer typically contracts with an intermediary employer to provide it with labor, and/or perform some employer functions, such as hiring and payroll.  The vertical joint employment analysis is used to determine, for example, whether a construction works who works for a subcontractor is also employed by the general contractor.

 

A threshold question in the vertical joint employment analysis is whether the intermediary employer is actually an employee of the potential joint employer, because if it is, then all of the intermediary employer’s employees are employees of the potential joint employer too, and there is no need to conduct a vertical joint employer analysis.  For example, if a farm labor contractor is not actually an independent contractor, but is an employee of the grower for which it provides services (meaning it is economically dependent on the grower as a matter of economic reality), then all of the farm labor contractor’s employees are also employees of the grower.  As set forth in the AI, it is therefore important to first determine whether the intermediary employer is an employee of the potential joint employer before proceeding with the joint employment analysis.  Interestingly, the AI requires a look at the economic reality of the relationship before proceeding to the vertical joint employment analysis, which is itself an economic reality test.

 

The AI identifies seven economic realities factors it contends should be applied to further the expansive definition of employment under the FLSA: (a) directing, controlling, or supervising the work performed; (b) controlling employment conditions; (c) permanency and duration of the relationship; (d) repetitive and rote nature of the work; (e) integral to business; (f) work performed on premises; and (g) performing administrative functions commonly performed by employers. 

According to the majority opinion in the Browning-Ferris decision, the economic realities test used by the DOL “is significantly more expansive” than the Board’s common-law test. 

The Fifth Circuit

In 2014, the Fifth Circuit applied its version of the economic realities test to determine whether a pizza and pasta restaurant franchisor was a joint employer with its franchisee for purposes of liability for alleged FLSA violations.  Orozco v. Plackis, 757 F.3d 445 (5th Cir. 2014).  In that case, a cook employed by the franchisee sued the franchisee for various FLSA violations, settled with the franchisee, and then added the franchisor owner, individually, as a defendant under the joint employer theory.  The jury ultimately returned a verdict for the cook, and the lower court denied a motion for judgment as a matter of law, resulting in the franchisor’s appeal.

 

Under its test, the Fifth Circuit evaluated whether the individual franchisor: (a) possessed the power to hire and fire the employees; (b) supervised and controlled employee work schedules or conditions of employment; (c) determined the rate and method of payment; and (4) maintained employment records.  The court was clear that a party need not establish each element in every case. 

The court agreed there was insufficient evidence for the jury to find a joint employer relationship because: (a) there was no evidence the individual franchisor maintained the cook’s employment records; (b) despite the movement of employees between the franchisor and franchisee locations, and the fact the franchisor gave advice to the franchisee on improving profitability, there was no direct evidence that the franchisor had authority to hire and fire the franchisee’s employees; (c) there was insufficient evidence to show the franchisor supervised and controlled employee work schedules or conditions of employment, even though the franchisor reviewed the work schedules, trained the cook and the franchisee, and frequently met with shift managers and provided suggestions to improve profitability; and (d) the cook testified the franchisor did not control the cook’s rate of pay.  Further, the court rejected the cook’s argument that the franchise agreement between the parties, which provided that the franchisee would at all times comply with all lawful and reasonable policies promulgated the franchisor, established sufficient control by the franchisor to create a joint employer relationship. 

The Fifth Circuit’s economic reality test is far narrower than both the DOL’s vertical joint employer test and the Board’s restated joint employer test, which places far greater emphasis on the potential for control of workplace terms and conditions, as opposed to actual control of them. 

 

Conclusion

For the foreseeable future, government agencies will more than likely continue to expand the definition and scope of the joint employer relationship, and employers will look to the courts to validate or reject the expansion, and provide meaningful guidance regarding the types of activities a franchisor can take with respect to its franchisees without losing its status as a single, not joint, employer.

Franchisors cannot insulate themselves from a joint employer finding simply by stating in a franchise agreement that the parties do not intend to create a joint employment relationship.  To the contrary, a franchisor should consult with counsel to determine its potential risk for a joint employer finding based on the realities of its relationship with its franchisee(s).  Once it does so, it can determine how, if at all, it will modify its franchise arrangements.