Court Watch

In Awuah, et al. v. Coverall North America, Inc., 460 Mass. 484 (Aug. 31, 2011), the court was called upon to respond to various questions concerning the franchisor's practice of charging back its franchisees for accounts that were uncollectable and for various insurance costs normally borne by an employer. The court also addressed whether franchise fees and royalties were collectable from employees who were found to have been misclassified as franchisees. In this article, we refer to the plaintiffs as “franchisees,” even though they were found to be legally employees.

The parties did not contest the employee classification in the instant case. Rather, they argued whether employers and employees could by contract allocate certain costs and fees between them. The first issue related to the policy of Coverall to “advance” payment to the franchisee based on amounts billed to customers but to deduct from amounts paid later the amount of accounts that proved to be uncollectible. The court held that under the Massachusetts Wage Act, wages must be paid within a statutorily specified time. By engaging in what was characterized as “accounts receivable financing,” Coverall deferred the actual payment of wages for several months until the amount of any uncollectible accounts was determined. This violated the timely payment provision of the Wage Act. Even if the original payments were considered “wages,” deducting bad debts at a later time was improper under that law.

The next issue was whether Coverall could have its franchisees pick up the tab for the workers' compensation insurance since the Wage Act allowed insurance premiums to be deducted from wages. The court held that the Wage Act intended that only premiums for employee policies, such as health insurance, could be deducted ' not insurance premiums pertaining to policies that the law required employers to carry.

Since the district court invited the Massachusetts court to provide any other advice about Massachusetts law that it felt was relevant, the Supreme Judicial Court elected to address whether the initial franchise fee and royalties payable by Coverall franchisees were valid charges. The court held that since it is against Massachusetts public policy to require an employee to pay for his job or kick back wages to his employer, payment of the concerned fees was prohibited and could be collected as damages by the franchisees.

In an interesting footnote to the opinion, the court acknowledged that the franchise agreement did not fit neatly into the mold of an employment contract. The franchise agreement provided that Coverall would set prices and bill and collect from customers. As such, the court acknowledged that costs and charges other than wages were included in the totals billed to cleaning customers, such as management costs, administrative fees, and so forth. It was rather at a loss about how to deal with those charges, since the issue at hand was wages. As such, it elected not to deal with that troublesome issue; it decided only to deal with the certified questions, plus the issue of franchise fees and royalties which it took up on its own motion. In all likelihood, given the extensive nature of this litigation, we will probably have one or more future decisions on this tricky issue.

Use of Regional Franchisees Shields Franchisor from Employment Law Issues

Another recent case involving a janitorial franchise raised a variation of the franchisee vs. employee issue. In Jan-Pro Franchising International, Inc. v. Depianti, Bus. Fran. Guide (CCH) '14,643 (Georgia Ct. of Appeals, June 23, 2011), a summary judgment in favor of franchisees finding they were “employees” under Massachusetts law was reversed.

Jan-Pro developed its trademarked system but implemented it by granting regional franchises, which then granted subfranchises directly to unit franchisees who performed the actual cleaning services. The Georgia court applied Massachusetts law in finding that the elements discussed in Awuah were not present in the instant case because the operative contract was between the franchisee and the subfranchisor, who in turn performed the various supervisory and administrative services that led to the Awuah result.

Boilerplate Severability Provision May Create Ambiguity in Arbitration Clause

In another Coverall decision, a federal district court in Los Angeles took pause at the way the franchise agreement was worded in holding off ordering an arbitrator to decide issues of arbitrability. Laguna v. Coverall North America, Bus. Fran. Guide (CCH) '14,656 (U.S.D.C., S.D. CA., July 26, 2011).

After the U.S. Supreme Court issued its decision in AT&T Mobility LLC v. Concepcion, __ U.S. __, 131 S.Ct. 1740, __ L.Ed.2d __ (2011), Coverall moved to compel individual arbitrations. Plaintiffs sought leave to conduct discovery on the enforceability of the arbitration provisions. Coverall argued that issues as to enforceability must be decided by the arbitrator (and thus no discovery should be allowed in the judicial proceeding), since the parties had agreed to be bound by the Commercial Arbitration Rules of the American Arbitration Association, which gave the arbitrator the authority to determine the validity of the arbitration agreement.

Unfortunately for Coverall, the franchise agreement contained a standard severability clause which provided, in essence, that if a court determined that any provision in the agreement was unenforceable, it would not affect the enforceability of the remaining provisions of the agreement. Such clauses are boilerplate in most contracts, but the ambiguity in this one was used by the magistrate judge to question whether the ability of the court to strike a provision in the agreement (the arbitration clause) left unanswered whether the court or the arbitrator was to rule on the validity of the arbitration provision. Because the authority of an arbitrator to decide issues of validity of the arbitration agreement must be clear, the severability clause raised an ambiguity for the district judge to resolve.

This case is a warning to drafters to take note of boilerplate provisions. Where the court is likely to go on this issue is anyone's guess. Coverall has several possible arguments. The company will likely argue that the severability clause should be interpreted as simply saying that if the parties, without objection, asked the court to decide the issue of enforceability or validity of the arbitration clause, then the court can decide it, but the severability clause was not intended to give the court the power to decide enforceability without more. Coverall also could argue that the severability provision is a general provision governing the contract overall and that the arbitration provisions are specifically related to arbitration issues and, thus, come within the rule that the specific overrides the general. In an earlier iteration of Awuah v. Coverall North America, Inc., Bus. Fran. Guide (CCH) '14,061 (1st Cir., Jan. 23, 2009), the parties disputed an identical question. The court said that the franchisee's reliance on the severability clause was “too thin” to avoid the arbitration provision.

Charles G. Miller is a shareholder and director, and Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.

Latest Awuah v. Coverall North America Decision Focuses on Collection of Franchise Fees and Royalties

In the most recent decision in a long-running battle between a group of janitorial franchise owners and their franchisor, the Massachusetts Supreme Judicial Court, in response to questions certified to it by the U.S. District Court for the District of Massachusetts, decided several issues arising from an earlier finding that the “franchisees” were, in fact, “employees” under the Massachusetts Wage Act, G.L. c.149, Sec.148 et seq. In Awuah et al. v. Coverall North America, Inc., Bus. Fran. Guide (CCH) '14,349 (U.S.D.C., D. Mass, March 23, 2010), the U.S. District Court decided that while the franchise agreement at issue cast the franchisees as independent contractors, the degree of control maintained by the franchisor, the nature of the services performed by the franchisees and the interdependence of the parties, among other things, caused the parties to have an employer-employee relationship rather than that of a traditional franchisor and franchisee. In an earlier case, the Massachusetts Supreme Judicial Court had held that different Coverall franchisees were employees for unemployment law purposes. Coverall North America, Inc. v. Commissioner of the Division of Unemployment Assistance , 447 Mass. 852, Bus. Fran. Guide (CCH) '13,491 (Dec. 12, 2006). See discussion in Klaus, Swierzewski and Winkelman, “Court Watch” LJN's Franchising Business & Law Alert, Vol. 13, No. 5, Feb. 2007, p. 5 et seq.

Once it was established that the franchisees were employees under Massachusetts law, an action was brought in the U.S. District Court to determine whether various fees and charges that were to be paid and/or deducted from the amounts payable to the franchisees under their franchise agreement were proper given the change in status wrought by the “employee” finding and, if not, which of these fees and charges would be considered as “damages” for purposes of the Massachusetts statute. Awuah et al. v. Coverall North America, Inc., 740 F.Supp. 2d 240, Bus. Fran. Guide (CCH) '14,473 (Sept. 28, 2010). Finding much of the plaintiffs' argument turned on Massachusetts public policy, the district court certified most of the key questions to the Massachusetts court.

In Awuah, et al. v. Coverall North America, Inc., 460 Mass. 484 (Aug. 31, 2011), the court was called upon to respond to various questions concerning the franchisor's practice of charging back its franchisees for accounts that were uncollectable and for various insurance costs normally borne by an employer. The court also addressed whether franchise fees and royalties were collectable from employees who were found to have been misclassified as franchisees. In this article, we refer to the plaintiffs as “franchisees,” even though they were found to be legally employees.

The parties did not contest the employee classification in the instant case. Rather, they argued whether employers and employees could by contract allocate certain costs and fees between them. The first issue related to the policy of Coverall to “advance” payment to the franchisee based on amounts billed to customers but to deduct from amounts paid later the amount of accounts that proved to be uncollectible. The court held that under the Massachusetts Wage Act, wages must be paid within a statutorily specified time. By engaging in what was characterized as “accounts receivable financing,” Coverall deferred the actual payment of wages for several months until the amount of any uncollectible accounts was determined. This violated the timely payment provision of the Wage Act. Even if the original payments were considered “wages,” deducting bad debts at a later time was improper under that law.

The next issue was whether Coverall could have its franchisees pick up the tab for the workers' compensation insurance since the Wage Act allowed insurance premiums to be deducted from wages. The court held that the Wage Act intended that only premiums for employee policies, such as health insurance, could be deducted ' not insurance premiums pertaining to policies that the law required employers to carry.

Since the district court invited the Massachusetts court to provide any other advice about Massachusetts law that it felt was relevant, the Supreme Judicial Court elected to address whether the initial franchise fee and royalties payable by Coverall franchisees were valid charges. The court held that since it is against Massachusetts public policy to require an employee to pay for his job or kick back wages to his employer, payment of the concerned fees was prohibited and could be collected as damages by the franchisees.

In an interesting footnote to the opinion, the court acknowledged that the franchise agreement did not fit neatly into the mold of an employment contract. The franchise agreement provided that Coverall would set prices and bill and collect from customers. As such, the court acknowledged that costs and charges other than wages were included in the totals billed to cleaning customers, such as management costs, administrative fees, and so forth. It was rather at a loss about how to deal with those charges, since the issue at hand was wages. As such, it elected not to deal with that troublesome issue; it decided only to deal with the certified questions, plus the issue of franchise fees and royalties which it took up on its own motion. In all likelihood, given the extensive nature of this litigation, we will probably have one or more future decisions on this tricky issue.

Use of Regional Franchisees Shields Franchisor from Employment Law Issues

Another recent case involving a janitorial franchise raised a variation of the franchisee vs. employee issue. In Jan-Pro Franchising International, Inc. v. Depianti, Bus. Fran. Guide (CCH) '14,643 (Georgia Ct. of Appeals, June 23, 2011), a summary judgment in favor of franchisees finding they were “employees” under Massachusetts law was reversed.

Jan-Pro developed its trademarked system but implemented it by granting regional franchises, which then granted subfranchises directly to unit franchisees who performed the actual cleaning services. The Georgia court applied Massachusetts law in finding that the elements discussed in Awuah were not present in the instant case because the operative contract was between the franchisee and the subfranchisor, who in turn performed the various supervisory and administrative services that led to the Awuah result.

Boilerplate Severability Provision May Create Ambiguity in Arbitration Clause

In another Coverall decision, a federal district court in Los Angeles took pause at the way the franchise agreement was worded in holding off ordering an arbitrator to decide issues of arbitrability. Laguna v. Coverall North America, Bus. Fran. Guide (CCH) '14,656 (U.S.D.C., S.D. CA., July 26, 2011).

After the U.S. Supreme Court issued its decision in AT&T Mobility LLC v. Concepcion , __ U.S. __, 131 S.Ct. 1740, __ L.Ed.2d __ (2011), Coverall moved to compel individual arbitrations. Plaintiffs sought leave to conduct discovery on the enforceability of the arbitration provisions. Coverall argued that issues as to enforceability must be decided by the arbitrator (and thus no discovery should be allowed in the judicial proceeding), since the parties had agreed to be bound by the Commercial Arbitration Rules of the American Arbitration Association, which gave the arbitrator the authority to determine the validity of the arbitration agreement.

Unfortunately for Coverall, the franchise agreement contained a standard severability clause which provided, in essence, that if a court determined that any provision in the agreement was unenforceable, it would not affect the enforceability of the remaining provisions of the agreement. Such clauses are boilerplate in most contracts, but the ambiguity in this one was used by the magistrate judge to question whether the ability of the court to strike a provision in the agreement (the arbitration clause) left unanswered whether the court or the arbitrator was to rule on the validity of the arbitration provision. Because the authority of an arbitrator to decide issues of validity of the arbitration agreement must be clear, the severability clause raised an ambiguity for the district judge to resolve.

This case is a warning to drafters to take note of boilerplate provisions. Where the court is likely to go on this issue is anyone's guess. Coverall has several possible arguments. The company will likely argue that the severability clause should be interpreted as simply saying that if the parties, without objection, asked the court to decide the issue of enforceability or validity of the arbitration clause, then the court can decide it, but the severability clause was not intended to give the court the power to decide enforceability without more. Coverall also could argue that the severability provision is a general provision governing the contract overall and that the arbitration provisions are specifically related to arbitration issues and, thus, come within the rule that the specific overrides the general. In an earlier iteration of Awuah v. Coverall North America, Inc., Bus. Fran. Guide (CCH) '14,061 (1st Cir., Jan. 23, 2009), the parties disputed an identical question. The court said that the franchisee's reliance on the severability clause was “too thin” to avoid the arbitration provision.

Charles G. Miller is a shareholder and director, and Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.