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Franchisees Are Independent Contractors, But Not as Easy as “ABC” in Some States

Franchisees are independent contractors. They hire and fire people. They own their businesses. They have Employer Identification Numbers or EINs, which are also known as Federal Tax Identification Numbers, and are used to identify business entities. They set the hours they work. They certainly don’t consider themselves to be employees. Seem pretty simple, right?  Not so fast. Several states use what is commonly known as an “ABC” test to determine whether or not someone is an independent contractor or an employee. The following is Massachusetts’ “ABC” test:

(A) Such individual has been and will continue to be free from control and direction in connection with the performance of such service, both under his contract for the performance of service and in fact; and

(B) Such service is performed either outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which the service is performed; and

(C) Such individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

The problem from a franchising perspective is that, while a rational person would think otherwise, an argument can be made that a franchise system fails all three prongs of the ABC Test.

While prong (A) requires the individual to be free from control, both under the parties’ agreement and in fact, under federal law, a franchisor must maintain certain controls over the use of its brand, marks and system, or risk losing trademark rights. In many cases, these are the very things that make a franchise system appealing to a prospective franchisee.

Prong (B), on the other hand, requires the individual to offer a service outside the usual course of business of the franchisor. While a franchisor, for example, is engaged in the business of selling a business model that allows local small-business owners to successfully sell a particular good or service, some may argue that franchisees are, in fact, in the same business when they sell the good or service to the public. To complicate matters, within many franchise systems, there may be a blend of both corporate owned and franchise outlets, which significantly blurs the line as to what is each company’s “usual course of business.”

The ABC test simply does not account for the symbiotic relationship that is at the heart of franchising.

Finally, with respect to prong (C), which evaluates the individual’s ability to conduct the business separately from the other entity, the termination of a franchise relationship in many instances would effectively mean the termination of that individual’s ability to continue conducting the same business. For example, if a franchisee were to be terminated, he would no longer be able to use a franchisor’s trademarks, its operating system or its trade dress. Furthermore, post-termination non-competition covenants are ubiquitous in franchise agreements, meaning a franchisee cannot continue in the same line of business when its franchise agreement ends. In these respects, a franchisee is necessarily dependent on its franchisor for the continuation of the services it provides.

The ABC test simply does not account for the symbiotic relationship that is at the heart of franchising. This incongruence between the test and the day-to-day practices of franchise systems creates an uncertainty among the franchise community, not to mention unnecessary litigation.

IFA Takes Action

The International Franchise Association recognized these problems and reached out to the American Legislative Exchange Council or ALEC. ALEC last year adopted as its official policy a “Resolution on the Misapplication of Employee Classification Laws,” recognizing that business format franchising is a major contributor to the U.S. economy and that franchising is a contractual business relationship, not akin to an employment relationship.

Noting the tremendous positive effect business format franchising has on the U.S. economy, ALEC passed the resolution, which was the basis for Georgia House Bill 548. The ALEC resolution states that any “legislation or regulations which would improperly classify franchisees as ‘employees’ is a misinterpretation of labor and contract policy and deprives franchise investors of valuable economic opportunities.”  The Georgia Legislature passed the bill unanimously and on May 1, Georgia Gov. Nathan Deal (R) signed it into law.

Given the tremendous economic impact of franchising to local economies, IFA plans to leverage this legislative win, by continuing to educate lawmakers in other states about the importance of clarifying state franchise laws regarding the independent contractor status of franchisees. ⎯

Dean Heyl is director, state government relations, public policy and tax counsel for the International Franchise Association. He can be reached at dheyl@franchise.org or 202-662-0792.

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