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Franchise Round-Up

Franchise executives and professionals recently gathered at the Union League in Philadelphia at the Franchisor Round-Up to discuss what 2017 holds for the franchise industry.  The Round-Up focused on practical changes franchisors can implement to best position their brands for the legal and regulatory uncertainties that lie in the not so distant future.

Legislative Update and Outlook

The Round-Up discussed the ramifications of Donald Trump’s election, with a focus on recent efforts by the Department of Labor and National Labor Relations Board with regards to joint employer and wage and hour modifications.  With Trump’s election, a new Secretary of Labor with pro-franchising views will be sworn in and franchisors should immediately see a change in views and directives coming from the Department of Labor. However, the current makeup of the NLRB and its general counsel will not immediately change, as Obama’s appointees will continue to hold a 3-2 majority on the NLRB’s board.  Additionally, Richard Griffin, an Obama appointee and champion of labor, will continue to serve as the NRLB’s General Counsel through 2017, and in such capacity, will be continue to be responsible for the investigation and prosecution of unfair labor practice cases and for the general supervision of the NLRB field offices in the processing of cases.

To reset the directives established by the DOL and NLRB under Obama Administration which threaten the franchise model, the Republican-controlled Congress will have the opportunity to pass law ending the joint employer issue once and for all.

Wage and Hour Issues

Attendees also discussed the $15/hour minimum wage movement and the Department of Labor’s final rule regarding overtime regulations, which would require franchisors and franchisees alike to pay overtime to managers and other administrative employees making less than $47,476 per year beginning on December 1, 2016.  The DOL’s efforts to push through the new rule was enjoined by a federal court on November 22, 2016.  With the pending Trump Presidency and Republican-controlled Congress, it is unclear whether the new rule will ever come into effect or if Congress will seek to provide a legislative fix.

Additionally, the Round-Up panel discussed the Saladworks case pending before the Pennsylvania Supreme Court with joint employer implications. As discussed, the franchisee in the case failed to maintain unemployment insurance and the Supreme Court decided to take a discretionary appeal on the question as to whether franchisors are to be considered joint employers for the unemployment insurance purposes.  In a win for franchisors, the Pennsylvania Supreme Court, after briefing and argument, dismissed the appeal as “improvidently granted”.  This result leaves in place what we thought was well settled law in Pennsylvania that the franchisor is not generally liable for the acts or omissions of its franchisees.

Participants discussed the effects that these potential threats may have on the franchise industry, including a push to reclassify former salary employees as hourly employees, and to integrate automated technologies which reduce or otherwise remove the human element from operations.  An unintended consequence of these measures is a loss of jobs.

Joint Employment and Vicarious Liability Issues

The Round-Up also focused on the threats to the franchise model stemming from joint employment and vicarious liability, particularly in light of the NLRB’s decision in Browning-Ferris Industries, which expanded the scope and analysis in determining whether a party constitutes a joint employer.  Prior to Browning-Ferris Industries, the joint employer standard focused on whether a party actually exercised control over an individual’s essential terms and conditions of employment, including the hiring, firing, discipline, supervision, direction, wages and hours worked, scheduling, seniority, overtime, work assignment, and determining manner and method of performance.  Browning-Ferris Industries expanded this standard to provide that the list of essential terms and conditions is non-exhaustive and that every inquiry is “fact specific”.   This finding allows a judge or factfinder to expand the universe of essential terms and conditions of employment on a case by case basis, increasing the likelihood of a finding of joint employment.

Additionally, of particular concern to the franchise industry, Browning-Ferris Industries held that control may be found in attenuated and indirect methods, which could include the required use of specific practices and standards, or the reserved right to require such use.  As a result, employees of franchisees have a potential legal basis to bring labor claims against franchisors.

As a result of Browning-Ferris Industries, franchisors need to pay attention to potential hot spots within their own system which have the potential of increasing a finding of joint employment, including the following:

1. Employee Handbooks
2. Employment Matters – Hiring, Firing, Compensation and Discipline
3. Work Schedules and Staffing/Profitability Advice and Software
4. Mandatory POS Systems/Ownership of Hardware, Software and Data
5. Franchisee and Franchisee-Employee Training
6. Job Postings and Listings
7. Operating Manuals and Other Communications
8. Reviews and Inspections
9. Pricing Information and Controls
10. Inventory Levels, Insurance and Repairs
11. Employee Uniforms
12. Paychecks
13. Workplace Posters
14. Master Vendor Contracts (i.e. credit cards) and Apps

Franchisors should audit and review their systems from the joint-employment/vicarious liability perspective, with careful attention paid to operating and training manuals, franchisee employee training materials and policies, and franchisee support and communications employed by the franchisor.  Operating and training manuals need to clearly define which directives are recommended and which are mandatory, particularly in regards to areas touching upon employee matters, and include necessary disclaimers and legends.  A franchisor should also review its training policies regarding the franchisee’s employees, including the hiring, firing and scheduling of the franchisees employees.

Attendees discussed ways a franchisor can decrease the likelihood of a finding of joint employment, including:

1. the creation of franchisee based groups which provide support and resources to other franchisees;
2. ensuring that field representatives are properly trained regarding interactions with franchisees’ employees;
3. contracting third party sources to conduct training; and
4. including proper disclaimers and legends.

Franchisors need to balance risk of a joint employment finding against the need for better training and other ethical concerns.  For instance, in certain systems, the need for a franchisor to train the franchisee’s employees may outweigh any risk of a finding of joint employment.

Proposed NASAA Item 19 Changes

The Round-Up also focused on the changes to be implemented by the NASAA’s revised Item 19 guidelines.   As provided for in the handout, the NASAA Item 19 changes propose, in part, to:

1. prohibit franchisors with operational franchise outlets from disclosing a gross sales FPR based on company-owned outlets alone;
2. permit franchisors without operational franchise outlets to disclose a gross sales FPR based on company-owned outlet data, but only if the franchisor also discloses “material financial and operational characteristics of the company-owned outlets that are reasonably anticipated to differ materially from future operational franchise outlets”;
3. permit a franchisor to make an FPR disclosing gross profit or net profit based on company-owned data alone, regardless of whether the franchisor has any operational franchise outlets, so long as the franchisor has a reasonable basis to do so, provided the franchisor supplements this disclosure with (a) gross sales data from franchised outlets (regardless of whether the franchisor has reliable franchisee data), (b) actual costs incurred by company-owned outlets, and (c) most notably, information or adjustments that “reflect all actual and reasonably expected material financial and operational differences between company-owned outlets and operational franchise outlets;
4. require a franchisor disclosing data from a subset of its best performing outlets to also include data from “one or more corresponding subsets of its lowest performing outlets”;
5. require the franchisor to disclose the median of numbers in the average when the franchisor includes system-wide performance averages, and if the franchisor is disclosing average gross sales, it also has to disclose the highest and lowest numbers in the range; and
6. prohibit “a franchisor with fewer than 10 substantially similar company-owned outlets and franchised outlets as of the end of the franchisor’s last fiscal year” from making an FPR based “on a subset of those outlets.”

As discussed, in preparing an Item 19, a franchisor should understand which information franchise prospects want and what its direct competitors are disclosing.   Franchisors should add in metrics that work for their system and publish financial performance information that the franchisor can verify and will ultimately stand up in court.

FASB Accounting Standards and Changes

Finally, the Round-Up attendees discussed the proposed FASB Accounting Standard concerning the recognition of initial franchise fees which will go into effect in 2018 for public companies and 2019 for private companies.  Under the proposal, auditors may require franchisors to recognize initial franchise fees over the course of the initial term of the franchise agreement, as opposed to recognizing the full fee at the time of opening.  This change could result in franchisors failing to meet net worth requirements in bank covenant agreements.  Franchisors may also suffer from reduced assets and greater liabilities, resulting in a lower net worth on their balance sheet.  Franchisors that show a negative net worth in their audited financials often face impound conditions in certain franchise registration states, as well as additional questions from franchisee prospects regarding the strength of the system.  This is a particular concern for emerging franchisors that do not have strong financial statements or a history of operations.

As a result, franchisors need to be proactive and begin planning now on how to best address these changes.  Round-Up attendees discussed several ways to work around the proposed FASB standard changes, including the restructuring/recharacterization of the initial franchise fee (such as a training fee, site fees, etc.), which can be recognized on an earlier basis.  For instance, a franchisor could split its initial franchise fee into an initial franchise fee and a training fee, with a greater sum allocated to the training fee to provide for an earlier recognition of the fee.  The downside to this strategy is that brokers, which are paid a percentage of the initial fee, may have less interest in pushing their leads toward your brand.  At a minimum, a franchisor needs to consider these approaches far enough in advance of the 2018/2019 implementation date.