The far-reaching implications of this decision could change the existing franchise business model.
This article was published on August 2, 2016 in the Corporate, Employment, Food & Beverage, Hospitality and Pennsylvania sections of Law360.
Is a franchisor a statutory employer of its franchisee’s employees? The Workers’ Compensation Appeals Board thinks so, and the Pennsylvania Supreme Court has recently agreed to hear the appeal of Saladworks, LLC v. Workers’ Compensation Appeal Board (Gaudioso & Uninsured Employers Guaranty Fund), 124 A.3d 790 (Pa. Commw. 2014).1 In doing so, the Pennsylvania Supreme Court becomes the latest judicial body to weigh in on a legal issue that may significantly impact the traditional independence a franchisor enjoys from its franchisees.
A Progressive Assault on the Franchise Business Model
The liability boundary between franchisor and franchisee was fairly settled until recently, when the U.S. Department of Labor and the National Labor Relations Board (NLRB) General Counsel began to issue guidance2 suggesting that the analysis should change in order to repair what Dr. David Weil, the first — and current — administrator of the Wage and Hour Division of the U.S. Department of Labor described as “The Fissured Workplace.”3
Similarly, in the last four years, federal agencies and large municipalities have changed or enacted new laws that do not recognize the business distinction between a franchisor and a franchisee.4 The NLRB has pursued unfair labor practices charges against McDonald’s for the conduct of its franchisees,5 arguing that McDonald’s, a franchisor, is a joint employer of its franchisees’ employees. Additionally, cities like Seattle have raised minimum wages with laws that define small businesses as large businesses simply because of their association with franchisors.6 The Workers’ Compensation Appeals Board’s decision in Saladworks is emblematic of these recent trends in which precedent is changed or ignored in order to reach a desired end result. The Pennsylvania Supreme Court’s decision could materially affect the franchise business model in Pennsylvania.
Saladworks’ Slippery Problem
Frank Gaudioso slipped and injured both of his knees while working at a Philadelphia Saladworks restaurant. He then petitioned for benefits against Saladworks, although the name was later amended to reflect the franchisee, G21, LLC d/b/a/Saladworks (G21). He also filed a separate claim against the Uninsured Employers Guaranty Fund (UEGF), which then sought to join the franchisor, Saladworks, as “an additional employer, agent, [and] statutory employer of the Claimant.” Saladworks moved to strike the joinder petition.
The Workers’ Compensation Judge (WCJ) granted Saladworks’ motion because the WCJ “[did] not see any at-will employment relationship [and was] not aware of any case that holds a franchisor is an employer.” The WCJ heard extensive testimony from Saladworks’ director of franchise administration, who made clear that Saladworks is not in the business of selling salads, but rather “sell[s] franchises to prospective franchisees to open up their business with the Saladworks’ concept.” She testified that Saladworks did not know the identity of any employees, did not provide any employee training, and did not have any control over hiring or firing. Saladworks merely provided franchisees with marketing materials and other assistance in opening a Saladworks franchise. The company also ensured that franchisees maintained certain kinds of insurance, advertised in appropriate ways and ran the business in accordance with the franchise agreement. Taking all of this into account, the WCJ concluded that Saladworks, as a franchisor, could not be considered an employer of Gaudioso.
Viewing a franchise relationship as though it were a construction contract, the Workers’ Compensation Appeal Board (the Board) disagreed, finding that Saladworks could be considered a statutory employer and therefore be held liable for Gaudioso’s injuries.7 The Board criticized the WCJ for only analyzing Saladworks under the “control” test. Instead, the Board stated, the WCJ should also have considered whether Saladworks was a statutory employer under section 302(a) of the Workers’ Compensation Act.8 The Board focused on the franchise agreement’s requirement that the franchisee maintain workers’ compensation insurance, which the franchisee failed to do. The Board stated that Saladworks “had a contractual obligation to ensure that G21 had the appropriate workers’ compensation insurance coverage in place, which would have protected Saladworks from liability in this case.”
Further, the Board noted:
[The] purpose of the statutory employer doctrine is to place responsibility for payment on the first entity in a contractor chain when an injured employee’s direct employer, the subcontractor, fails to secure workers’ compensation insurance. Am. Rd. Lines v. WCAB (Royal), 39 A.3d 603 (Pa. Cmwlth. 2012). Our determination that Saladworks is a statutory employer supports that purpose as well as the humanitarian purposes of the Act.
All of this led the Board to conclude that Saladworks was a statutory employer under the Workers’ Compensation Act and therefore could be held liable for Gaudioso’s injuries.
Even without the insurance clause in the franchise agreement, Pennsylvania law would have required the franchisee to procure workers’ compensation insurance. The franchise agreement merely acknowledged what the franchisee was already obligated to do; it did not create any new obligations on the part of the franchisor or the franchisee. And, the Board’s dressing of its decision in the garb of “humanitarian purposes” simply does not make any sense. A finding that the franchisor was not a statutory employer would not have left the claimant without a remedy. Under Pennsylvania law, the UEGF would have compensated Gaudioso for his injuries once it was determined they were legitimate, that they occurred during the course of his employment, and that his employer lacked the required insurance.
Judge McGinley of the Commonwealth Court reversed the Board’s decision, finding that Gaudioso was not an employee of Saladworks and therefore Saladworks could not be found liable for his injuries.9 The court noted that the “key question is whether the work performed by G21 under the Agreement was a regular or recurrent part of the business, occupation, profession, or trade of Saladworks.” The court found that Saladworks’ “main business is the sale of franchises to franchisees that desire to use its name and ‘System’ and marketing expertise. . . . [I]t is not in the restaurant business or the business of selling salads.” Therefore, the court reversed the judgment of the Board and reinstated the judgment of the WCJ that Saladworks was not a statutory employer.
Are Pizza and Salad Really That Different?
The most troubling part of the Board’s decision, as was noted by Judge McGinley in footnote nine of his decision, is that the Board reached the exact opposite conclusion on very similar facts just a year before. In Dorvil v. Prof Pizza It’s a Domino’s Pizza, 2013 PAWCLR (LRP) LEXIS 213 (Pa. Workers’ Comp. App. Bd. 2013), the Board determined that a franchisor was not a contractor for purposes of section 302(a) of the Workers’ Compensation Act. As Judge McGinley stated, “[i]t is unclear why the Board reached the opposite conclusion in the present case [the Saladworks case] which was decided approximately one year later.”
In Dorvil, the claimant was injured in a car accident while delivering pizzas for Professional Pizza Inc. (Professional), a franchisee of Domino’s. Professional did not have workers’ compensation insurance, and Dorvil petitioned for benefits under the UEGF, which then filed a joinder petition seeking to join Domino’s. The WCF granted the joinder claim and found Domino’s liable. In its short decision overturning the WCJ’s decision, the Board noted that Domino’s had no control over the franchisee’s employees but merely provided training and a manual to franchisees to instruct them on how to run the business. Like Saladworks, Domino’s could terminate a franchise and could inspect franchises to ensure they are running their businesses in accordance with the franchise agreements. The Board explicitly found that the “franchisor/franchisee relationship is distinct from a contractor/ subcontractor as implicated in 302(a) and that Section does not apply.”
How it is possible that the same Board that decided Dorvil could decide Saladworks just one year later and reach the exact opposite conclusion on a similar set of facts? What happened over the course of that year to evince such a drastic change, one that could have far-reaching implications for franchises across Pennsylvania?
PA Supreme Court to Answer the Question?
Now that the Pennsylvania Supreme Court has agreed to hear the appeal in Saladworks, the court almost certainly will address the Board’s sudden change from the decision in Dorvil to its decision in Saladworks. Further, the court may give a definitive answer to the question of whether a franchisor can be considered a statutory employer under section 302(a).10
The franchisor-franchisee relationship is different from the contractor-subcontractor relationship. Section 302(a) was enacted to prevent contractors from claiming they were not liable for employees who were injured on jobsites while doing work for a subcontractor. Generally, a subcontractor is in the same business as the general contractor — to build whatever it is they have been hired to build. The general contractor has hired the subcontractor because it is more convenient to hire a specialist to do certain work rather than have the general contractor do all the work itself. A franchise relationship, on the other hand, is more of a trademark license than a work subcontract. As Judge McGinley pointed out, franchisors are in the business of selling franchises; they are not in the business of selling pizza or salads or whatever else their franchisees are in the business of doing. A franchisor exerting no control over the employees of its franchisees should not be considered a statutory employer under section 302(a).
Was the Board’s decision a reflection of the recent national trend to tear down the legal independence between franchisor and franchisee, or was it just a bad legal decision? The Board’s refusal to follow its own precedent suggests it may be the former. If so, the Pennsylvania Supreme Court has a chance to buck that trend by affirming the Commonwealth Court’s decision. Will the court follow the recent progressive trend that moves away from the traditional view of a legally distinct franchisor-franchisee relationship and embrace a view that connects the franchisor and the franchisee’s employees much more closely than ever before under Pennsylvania law? If it does, there are far-reaching implications of this decision that could change the existing franchise business model. For instance, if a franchisor is deemed to be the statutory employer of its franchisees’ employees, could it also be vicariously liable for its franchisees’ acts and/or omissions? Will franchisors want to bear the cost of insuring that vicarious risk, or will they decide to operate the franchised business themselves? Stay tuned.
1 Saladworks, LLC v. Workers' Comp. Appeal Bd. (Gaudioso & Uninsured Emp’rs. Guar. Fund), 135 A.3d 1016 (Pa. 2016).
2 In its 2015 decision in Browning-Ferris, the NLRB expanded the definition of “joint employer” to include direct or indirect control of the conditions of employment. BFI Newby Island Recyclery, 2015 NLRB LEXIS 672, *8 (N.L.R.B. Aug. 27, 2015). However, the NLRB rejected a recent push by the General Counsel to further expand the scope of the definition of “joint employer” in Nutritionality, Inc. d/b/a Freshii. National Labor Relations Board, Advice Memorandum, Nutritionality, Inc. d/b/a Freshii, Cases 13-CA-134294, 13-CA-138293, and 13-CA-142297, 177-1650-0100 (Apr. 28, 2015), available at https://www.nlrb.gov/cases-decisions/advice-memos?issuance_date=2015.
3 David Weil published his groundbreaking book, The Fissured Workplace: Why Work Became So Bad for Many and What Can Be Done to Improve It, in February 2014. Weil has argued that labor outsourcing has replaced the traditional employer-employee relationship with a complex network of contractors, subcontractors, franchisors and franchisees. Weil believes this shift has resulted in lower wages, fewer benefits and insufficient safety standards in the name of flexibility and efficiency. In 2012, Weil looked at the fast food and hotel industries, specifically comparing those run by franchisees versus the corporations themselves and found that franchisees have more wage and hour infractions than the corporations. Although Weil has stated many times that he is not against franchises and merely wants to make sure that they are following wage and hour laws, franchisees have faced increased scrutiny during his leadership of the Wage and Hour Division.
4 Earlier this year, the International Franchise Association and the U.S. Chamber of Commerce expressed similar concerns in Main Street in Jeopardy: The Expanding Joint Employer Threat to Small Businesses (June 21, 2016), available at https://www.uschamber.com/report/main-street-jeopardy-the-expanding-joint-employer-threat-small-businesses.
5 The NLRB began examining the relationship that McDonald’s has with its franchisees in 2012, specifically considering whether McDonald’s should ultimately be held responsible for the actions of its franchisees. See McDonald’s USA, LLC, a Joint Emp’r, et al. & Fast Food Workers Comm. & Service Emps. Int’l Union, CTW, CLC, et al. Cases 02–CA–093893, et al. 04–CA–125567, et al. 13–CA–106490, et al. 20–CA–132103, et al. 25–CA–114819, et al. 31–CA–127447, et al.
6 In June 2014, Seattle’s City Council voted to raise the minimum wage in increments, aiming to have full participation in a $15 minimum wage for businesses with at least 500 employees by 2017. Like New York, Seattle opted to treat franchised businesses like larger companies, meaning that franchisees had to phase in the minimum wage on the same schedule as larger companies. Smaller companies get more time to raise the minimum wage, not having to reach $15 until 2021. The International Franchise Association (IFA) immediately challenged the law, filing for a preliminary injunction. The U.S. Court of Appeals for the Ninth Circuit affirmed the district court’s denial of a preliminary injunction, upholding the finding that the IFA did not show a likelihood of success on its Dormant Commerce Clause, Equal Protection, First Amendment, Lanham Act and Washington constitutional law claims. Int'l Franchise Ass'n v. City of Seattle, 803 F.3d 389 (9th Cir. 2015), cert. denied, 2016 U.S. LEXIS 3040 (U.S. May 2, 2016).
7 Gaudioso v. G21 LLC d/b/a Saladworks, 2014 PAWCLR (LRP) LEXIS 169, at *15 (Pa. Workers’ Comp. App. Bd. 2014)
8 Section 302(a), 77 P.S. § 461, provides:
A contractor who subcontracts all or any part of a contract and his insurer shall be liable for the payment of compensation to the employees of the subcontractor unless the subcontractor primarily liable for the payment of such compensation has secured its payment as provided for in this act. Any contractor or his insurer who shall become liable hereunder for such compensation may recover the amount thereof paid and any necessary expenses from the subcontractor primarily liable therefor.
9 Saladworks, LLC v. Workers’ Comp. Appeal Bd. (Gaudioso & Uninsured Emp’rs. Guar. Fund), 124 A.3d 790, 799 (Pa. Commw. 2014).
10 In the two-sentence order granting the petition for certiorari to the Pennsylvania Supreme Court, the court noted, “The issue, rephrased for clarity, is whether a franchisor may be subject to liability as a statutory employer under Section 302(a) of the Workers' Compensation Act?” Saladworks, LLC v. Workers' Comp. Appeal Bd. (Gaudioso & Uninsured Emp’rs. Guar. Fund), 2016 Pa. LEXIS 945, *1 (Pa. May 3, 2016).
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.