Court Watch

As part of the purchase, McDonald's executed an assignment agreement, authorizing the assignment of the former franchisee's agreements to Husain. Husain believed that, as part of the purchase, McDonald's had agreed that it would extend the terms of the franchises with fewer than five years remaining for an additional 20 years, although this was not expressly provided for in writing.

Shortly after the assignment, McDonald's sent a proposal to Husain offering an extension of the lease of one of the franchises in exchange for a promise to upgrade the location. Husain stated that he accepted the proposal and returned it to McDonald's; McDonald's never received the acceptance.

In 2007, Husain had financial difficulties, and McDonald's informed him that he was not qualified “for growth or rewrite.” Nonetheless, Husain obtained a refinancing loan, approved by McDonald's, using the franchise agreements as security. In 2008, McDonald's informed Husain of several improvements that needed to be made at one of the locations (the Novato franchise) that had an expiring agreement. Husain eventually made the improvements, but not in the manner or timing McDonald's wanted. In December 2008, McDonald's denied Husain a new 20-year term for the Novato franchise. Husain filed suit, and both parties moved for injunctive relief relative to the continued operation or termination of three of Husain's franchises, including the Novato franchise. The court held an extensive evidentiary hearing.

Husain testified that he had been advised that the three franchises would be renewed, and that he would not have purchased the franchises and invested $10.5 million in them if he knew the term would be so short. McDonald's maintained the position that circumstances had changed in the three years since the purchase, and Husain now was not qualified for renewal.

In interpreting whether the assignment agreement required renewal, the court found it would be “extraordinary, harsh and unjust” if Husain was expected to make such a large investment in purchasing franchises that would expire within five years. It also noted that if McDonald's did not plan to renew the franchises, it could have made that clear in the agreement. Further, the court did not agree with McDonald's that the circumstances had significantly changed. Therefore, on the likelihood-of-success factor for injunctive relief, the court believed that Husain was more likely to succeed on the merits.

In addition, the court declared that the balance of harms tipped “strongly in Husain's favor.” The court noted that Husain would suffer significant financial difficulties if the franchises were terminated, and his ability to remain in business would be threatened by the loss of the three franchises because of the synergies across all of his locations. In contrast, the court found that the potential harm to McDonald's was not nearly as significant. Although the court recognized that unauthorized use of trademarks can be grounds for injunctive relief, it did not believe that Husain was a current threat to McDonald's goodwill or trademarks. Therefore, the court denied McDonald's motion and granted Husain's motion for a preliminary injunction, allowing him to continue operating the three franchises pending a trial on the merits.

Franchisor Not Jointly Liable for Labor Claims Brought By Franchise
Employee

Since the federal court opinion in Awuah v. Coverall North America, Inc. was released, an issue at the top of mind for those in the franchise industry is whether a franchisee can be characterized as an employee of the franchisor. A recent case in which a franchisee's employee named the franchisor in a lawsuit under a joint employer theory now serves to remind franchisors that they must also tread carefully in considering their dealings with employees of their franchisees.

In Reese v. Coastal Restoration and Cleaning Services, Inc. d/b/a SERVPRO of Pearl River/Hancock & SW Harrison Counties et al., Bus. Franchise Guide (CCH) ' 14,523 (Dec. 15, 2010), Leigh Reese brought suit against his employer, Coastal, and he also named SERVPRO, the franchisor, as a party to the suit under a joint-employer theory. When Reese was originally hired by Coastal, he worked as a non-exempt employee paid on an hourly basis. Reese subsequently obtained a number of pay increases, and he eventually was promoted to a salaried management position. As part of his new role, Reese was required to assume management duties in addition to his former workload; according to Reese, he regularly worked more than 40 hours a week during the course of his employment.

In October 2009, Reese contacted the U.S. Department of Labor, Wage and Hour Division (“DOL”) regarding Coastal's failure to provide him with overtime pay. He argued that he was still a non-exempt employee and should be paid for overtime work. In the course of the DOL's investigation, Coastal became aware of the complaint, and it subsequently informed Reese that he would be paid an hourly rate on a going-forward basis. Reese filed suit against Coastal for violation of the Fair Labor Standards Act (“FLSA”), and named SERVPRO as an additional defendant in the case on a joint-employer theory under the FLSA.

The provisions of the FLSA apply only if an entity is actually an employer of an individual, and joint employers can be found jointly and severally liable for damages for failure to comply with the FLSA. In this case, the court applied a four-factor “economic reality test” to determine whether SERVPRO could be considered the joint employer of Reese. The factors considered were the ability of SERVPRO to: 1) hire and fire the employee; 2) supervise and control the employee's work schedule or conditions of employment; 3) determine the rate and method of payment for the hours worked; and 4) maintain employment records of the employee.

Hiring and Firing. Pursuant to the terms of the franchise agreement between SERVPRO and Coastal, Coastal was required to conduct background checks on employees and inform SERVPRO of certain results. In practice, Coastal obtained an authorization form from each of its employees, including Reese, that authorized Coastal to conduct the background check and to provide the results to SERVPRO. Reese used this practice to argue that SERVPRO had the power to control hiring and firing of Coastal employees. The court dismissed this argument and instead found that SERVPRO could not be inferred to have the power to hire and fire Coastal employees solely based on its ability to require background checks and to obtain the results. The court found the issue to be one of the “quality control standards SERVPRO requires as a condition to granting a franchise for the use of its system, trade name, service marks, [and] trademarks.”

Control of Schedule and Working Conditions. Reese also pointed to the terms of the franchise agreement that required Coastal to meet SERVPRO's standards, including with respect to equipment, supplies, uniforms, and computer hardware and software, and he argued that these terms allowed SERVPRO to control the conditions of his employment. To this point, the court found that the requirement of the franchisee to meet system standards does not mean that SERVPRO supervised the franchisee's employees or controlled their working conditions. The court failed to find evidence that SERVPRO had the power to influence daily operations of the business or Reese's work schedule or other conditions of employment.

Payment and Employee Records. Finally, Reese noted Coastal's obligations to maintain accounting procedures in accordance with SERVPRO's standards, and to provide accurate records to SERVPRO of gross sales. He claimed these amounted to giving SERVPRO the ability to control what Coastal paid Reese, and he added that SERVPRO maintained employment records for Coastal's employees. The court found that nothing in the franchise agreement empowered SERVPRO to control what Reese was paid. The provisions of the franchise agreement cited by Reese relating to accounting procedures and gross sales simply allow the franchisor to “assess the viability of the franchise,” “compute the royalties and fees due to it,” and “ensure the future value of its trademark, proprietary system information, and quality associated with the SERVPRO brand name.” The court did not find any evidence that SERVPRO had maintained any employee records, or used information maintained to control the daily management of Coastal or its employees.

Also interestingly, the court seemed to give weight to the no third-party beneficiary clause of the franchise agreement, providing that agreement should not be construed to provide any rights to any third party or entity. The court found no evidence of an employment relationship between SERVPRO and Reese, and it granted summary judgment to SERVPRO.

Franchisors and their counsel should carefully consider the test used by the court to ascertain whether a franchisee's employee could also be considered an employee of the franchisor. In this case, the facts led the court to find that no employment relationship existed. However, franchisors should review their franchise agreements and current practices to consider whether they maintain the ability to control, or have actual control, over employees of franchisees in the system.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3263.

Preliminary Injunction Prevents McDonald's Franchisee Termination

As always, a recent case reminds us that franchisors should carefully watch their representations to franchisees at the time of contracting. Although not expressly provided for in any written agreement, a California court recently decided that a franchisee of several McDonald's restaurants was reasonably likely to succeed on the merits of his claim that the franchisor had agreed to renew three franchises with fewer than five years remaining on the agreements when it approved of the franchisee's purchase of the restaurants from another franchisee. Husain v. McDonald's Corp., Bus. Franchise Guide (CCH) ' 14,530 (Cal. Super. Ct. Dec. 20, 2010).

Husain has been a McDonald's franchisee since the early 1980s. In 2005, he owned McDonald's locations in the San Francisco area, and he entered into an agreement with another franchisee to purchase seven more. A McDonald's franchise agreement typically has a 20-year term, but some of the agreements for these seven franchises had a less than a five-year term remaining at the time that they were purchased by Husain.

As part of the purchase, McDonald's executed an assignment agreement, authorizing the assignment of the former franchisee's agreements to Husain. Husain believed that, as part of the purchase, McDonald's had agreed that it would extend the terms of the franchises with fewer than five years remaining for an additional 20 years, although this was not expressly provided for in writing.

Shortly after the assignment, McDonald's sent a proposal to Husain offering an extension of the lease of one of the franchises in exchange for a promise to upgrade the location. Husain stated that he accepted the proposal and returned it to McDonald's; McDonald's never received the acceptance.

In 2007, Husain had financial difficulties, and McDonald's informed him that he was not qualified “for growth or rewrite.” Nonetheless, Husain obtained a refinancing loan, approved by McDonald's, using the franchise agreements as security. In 2008, McDonald's informed Husain of several improvements that needed to be made at one of the locations (the Novato franchise) that had an expiring agreement. Husain eventually made the improvements, but not in the manner or timing McDonald's wanted. In December 2008, McDonald's denied Husain a new 20-year term for the Novato franchise. Husain filed suit, and both parties moved for injunctive relief relative to the continued operation or termination of three of Husain's franchises, including the Novato franchise. The court held an extensive evidentiary hearing.

Husain testified that he had been advised that the three franchises would be renewed, and that he would not have purchased the franchises and invested $10.5 million in them if he knew the term would be so short. McDonald's maintained the position that circumstances had changed in the three years since the purchase, and Husain now was not qualified for renewal.

In interpreting whether the assignment agreement required renewal, the court found it would be “extraordinary, harsh and unjust” if Husain was expected to make such a large investment in purchasing franchises that would expire within five years. It also noted that if McDonald's did not plan to renew the franchises, it could have made that clear in the agreement. Further, the court did not agree with McDonald's that the circumstances had significantly changed. Therefore, on the likelihood-of-success factor for injunctive relief, the court believed that Husain was more likely to succeed on the merits.

In addition, the court declared that the balance of harms tipped “strongly in Husain's favor.” The court noted that Husain would suffer significant financial difficulties if the franchises were terminated, and his ability to remain in business would be threatened by the loss of the three franchises because of the synergies across all of his locations. In contrast, the court found that the potential harm to McDonald's was not nearly as significant. Although the court recognized that unauthorized use of trademarks can be grounds for injunctive relief, it did not believe that Husain was a current threat to McDonald's goodwill or trademarks. Therefore, the court denied McDonald's motion and granted Husain's motion for a preliminary injunction, allowing him to continue operating the three franchises pending a trial on the merits.

Franchisor Not Jointly Liable for Labor Claims Brought By Franchise
Employee

Since the federal court opinion in Awuah v. Coverall North America, Inc. was released, an issue at the top of mind for those in the franchise industry is whether a franchisee can be characterized as an employee of the franchisor. A recent case in which a franchisee's employee named the franchisor in a lawsuit under a joint employer theory now serves to remind franchisors that they must also tread carefully in considering their dealings with employees of their franchisees.

In Reese v. Coastal Restoration and Cleaning Services, Inc. d/b/a SERVPRO of Pearl River/Hancock & SW Harrison Counties et al., Bus. Franchise Guide (CCH) ' 14,523 (Dec. 15, 2010), Leigh Reese brought suit against his employer, Coastal, and he also named SERVPRO, the franchisor, as a party to the suit under a joint-employer theory. When Reese was originally hired by Coastal, he worked as a non-exempt employee paid on an hourly basis. Reese subsequently obtained a number of pay increases, and he eventually was promoted to a salaried management position. As part of his new role, Reese was required to assume management duties in addition to his former workload; according to Reese, he regularly worked more than 40 hours a week during the course of his employment.

In October 2009, Reese contacted the U.S. Department of Labor, Wage and Hour Division (“DOL”) regarding Coastal's failure to provide him with overtime pay. He argued that he was still a non-exempt employee and should be paid for overtime work. In the course of the DOL's investigation, Coastal became aware of the complaint, and it subsequently informed Reese that he would be paid an hourly rate on a going-forward basis. Reese filed suit against Coastal for violation of the Fair Labor Standards Act (“FLSA”), and named SERVPRO as an additional defendant in the case on a joint-employer theory under the FLSA.

The provisions of the FLSA apply only if an entity is actually an employer of an individual, and joint employers can be found jointly and severally liable for damages for failure to comply with the FLSA. In this case, the court applied a four-factor “economic reality test” to determine whether SERVPRO could be considered the joint employer of Reese. The factors considered were the ability of SERVPRO to: 1) hire and fire the employee; 2) supervise and control the employee's work schedule or conditions of employment; 3) determine the rate and method of payment for the hours worked; and 4) maintain employment records of the employee.

Hiring and Firing. Pursuant to the terms of the franchise agreement between SERVPRO and Coastal, Coastal was required to conduct background checks on employees and inform SERVPRO of certain results. In practice, Coastal obtained an authorization form from each of its employees, including Reese, that authorized Coastal to conduct the background check and to provide the results to SERVPRO. Reese used this practice to argue that SERVPRO had the power to control hiring and firing of Coastal employees. The court dismissed this argument and instead found that SERVPRO could not be inferred to have the power to hire and fire Coastal employees solely based on its ability to require background checks and to obtain the results. The court found the issue to be one of the “quality control standards SERVPRO requires as a condition to granting a franchise for the use of its system, trade name, service marks, [and] trademarks.”

Control of Schedule and Working Conditions. Reese also pointed to the terms of the franchise agreement that required Coastal to meet SERVPRO's standards, including with respect to equipment, supplies, uniforms, and computer hardware and software, and he argued that these terms allowed SERVPRO to control the conditions of his employment. To this point, the court found that the requirement of the franchisee to meet system standards does not mean that SERVPRO supervised the franchisee's employees or controlled their working conditions. The court failed to find evidence that SERVPRO had the power to influence daily operations of the business or Reese's work schedule or other conditions of employment.

Payment and Employee Records. Finally, Reese noted Coastal's obligations to maintain accounting procedures in accordance with SERVPRO's standards, and to provide accurate records to SERVPRO of gross sales. He claimed these amounted to giving SERVPRO the ability to control what Coastal paid Reese, and he added that SERVPRO maintained employment records for Coastal's employees. The court found that nothing in the franchise agreement empowered SERVPRO to control what Reese was paid. The provisions of the franchise agreement cited by Reese relating to accounting procedures and gross sales simply allow the franchisor to “assess the viability of the franchise,” “compute the royalties and fees due to it,” and “ensure the future value of its trademark, proprietary system information, and quality associated with the SERVPRO brand name.” The court did not find any evidence that SERVPRO had maintained any employee records, or used information maintained to control the daily management of Coastal or its employees.

Also interestingly, the court seemed to give weight to the no third-party beneficiary clause of the franchise agreement, providing that agreement should not be construed to provide any rights to any third party or entity. The court found no evidence of an employment relationship between SERVPRO and Reese, and it granted summary judgment to SERVPRO.

Franchisors and their counsel should carefully consider the test used by the court to ascertain whether a franchisee's employee could also be considered an employee of the franchisor. In this case, the facts led the court to find that no employment relationship existed. However, franchisors should review their franchise agreements and current practices to consider whether they maintain the ability to control, or have actual control, over employees of franchisees in the system.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3263.