Court Watch

The appellate court, reviewing de novo the denial of Plackis's motions for judgment, sought to determine whether Plackis was an “employer” under the FLSA using the “economic reality test.” Under that test, the court evaluates whether the alleged “employer”: 1) possessed the power to hire and fire the employee; 2) supervised and controlled employee work schedules or conditions of employment; 3) determined the rate and method of payment; and 4) maintained employment records. Not all elements need be established in every case, however. The dominant theme of the cases using the economic reality test is “who has operating control over employees within the company.” As such, an employee may have more than one “employer” for FLSA purposes.

Orozco acknowledged that Plackis did not maintain his employee records but he asserted that Plackis did have influence over the other aspects of his job by virtue of his power to influence the franchisee's actions and, therefore, should be found to be a joint employer.

As the franchisor, Plackis met and communicated with the Entjers concerning their operation. The meetings and communications concerned, among other things, how to improve the profitability of the franchise, including reviewing the work schedules of the shop's employees. Following at least one such meeting, the Entjers adjusted employee hours and wages. Orozco implied that since Plackis provided operating suggestions to the Entjers, changed the menus, contracted with the shop's vendors and directed various advertising plans, he must have also had control over the shop's employment policies. While the magistrate judge apparently bought this argument, the appellate court did not. It pointed out that seeking to assist franchisees is what is expected of a franchisor. There was no evidence that Plackis ordered the personnel or wage changes but, rather, they were within the discretion of the Entjers.

The Franchise Agreement governing the operation of the Entjers' shop stated that the franchisee had to comply with the policies and procedures specified by the franchisor for the selection, supervision or training of personnel, a common franchise agreement term. The magistrate judge, in denying Plackis's motion for judgment also relied on this provision to show that Plackis had sufficient control over the franchisee's employment policies to warrant holding Plackis liable under the FLSA. Again, the appellate court disagreed, stating: “We fail to see how this innocuous statement suggests that Plackis hired or fired employees, supervised or controlled employee work schedules or employment conditions, or determined Orozco's rate and method of payment.”

While stating that it was not suggesting that franchisors can never qualify as an employer under the FLSA, the court found that there was insufficient evidence to satisfy the economic reality test, only vague inferences based on the proximity of franchisor-franchisee meetings to the complained of actions. Therefore, judgment was granted for Plackis.

This case seems to be at variance with the increasing trend to find a franchisor liable for employment-related actions and inactions by its franchisees. It is interesting that the test in this case was called the “economic reality test,” since reality seems to be absent in the growing number of court and administrative decisions finding franchisors liable for various aspects of the employer-employee relationship. For example, on July 29, 2014, the National Labor Relations Board's General Counsel found that McDonald's may have violated the rights of its franchisees' employees as a “joint employer” and could face significant liability for wage and hour and union-related claims. Such rulings, and others like it, threaten the franchise model, a key method of business expansion. While it cannot be argued that workers should not be treated fairly, a little “economic reality” may be needed before the entire framework of franchising is jeopardized.

Second Circuit Upholds Auto Dealer Termination Without Opportunity To Cure

In Giuffre Hyundai, Ltd. v. Hyundai Motor America, 2014 WL 2870507 (2d Cir. June 25, 2014), the Second Circuit Court of Appeals had occasion to rule on the circumstances under which a state dealer protection law must bow to the clear language of the franchise agreement. The issue there was whether the dealer law would be interpreted to require that the franchisee be permitted to cure before its dealership or franchise agreement could be terminated, despite language in the franchise agreement that gave the manufacturer the right to terminate immediately for certain breaches. The dealer was sued by the state Attorney General for engaging in fraudulent and deceptive business practices, such as strong-arm sales practices and unethical conduct. An injunction was issued against the dealer, finding that it had engaged in fraudulent and deceptive practices.

The franchise agreement gave the franchisor/manufacturer the ability to immediately terminate the dealership if the franchisee was convicted of any violation of law that affected the operation of the franchise, including any misrepresentations or unfair trade practices. However, the New York Vehicle and Traffic law gave the dealer the opportunity to challenge a termination on the grounds it lacked “due cause,” which depended on a finding that there was a material breach of a reasonable and necessary provision of a franchise if the breach is not cured within a reasonable time after notice. There was no provision in the dealership law permitting a franchisor to issue a notice without an opportunity to cure. The dealer argued that the termination was illegal because it was not given an opportunity to cure, and therefore the termination was without due cause. The District Court determined that the termination was lawful because the New York statute did not trump the common law that permitted a contracting party to terminate a contract if an opportunity to cure would be useless or if the breach “undermines the entire contractual relationship such that it cannot be cured.”

On appeal, the dealer argued that it had an absolute right to cure under the applicable statute. Not true, answered the appellate court. It applied the presumption that a statute would be deemed to override common law (of which the Legislators were presumably aware) only if the language of the statute clearly indicated that it would trump common law. It relied on several district court opinions dealing with the 7-Eleven franchise system that upheld terminations without the opportunity to cure in situations involving fraud going to the essence of the contract, even though the agreement required that the franchisee be given an opportunity to cure. See, 7-Eleven Inc. v. Khan, 977 F.Supp.2d 214,230 (E.D.N.Y. 2013); Southland Corp. v. Froelich, 41 F.Supp.2d 227, 246-48 (E.D.N.Y. 1999). The court also looked to basic contract law that permits a party to terminate a contract immediately when the malfeasance is incurable and when the cure is unfeasible. It also did not give much weight to a cure provision in a franchise contract (there was none here), since it is presumed that the parties intended that the breach would be of a type that could be cured. It applied the same reasoning to the intent of the legislators.

It was not difficult for the court to find that the breach was incurable. The determination that the dealer had engaged in fraudulent conduct was something that could not be cured. The franchise agreement clearly provided for immediate termination if there was such a finding. Obviously the finding could only be “cured” if a successful appeal were taken, which was not done. If the agreement provided that the franchise could be terminated if the franchisee engaged in the same conduct, it is possible that the franchisee might be able to argue that it should be given an opportunity to correct its conduct, since it was not dependent on a conviction that was not appealed or unsuccessfully appealed. However, if the franchisor could prove that this indeed impaired its good will or reputation, a court could find that there can be no cure.

The importance of this decision is that it appears to be the first circuit or appellate decision upholding the principle set forth in the lower courts: that basic contract law, regardless of a statute or contract provision, determines if an immediate termination will be allowed. Despite the legal way the issue is framed, it all comes down to basic common sense ' a cure provision will only come into play if the breach is one that can be cured.

Charles G. Miller, a member of this newsletter's Board of Editors, is shareholder and director of Bartko, Zankel, Bunzel & Miller in San Francisco. Darryl A. Hart is an attorney with the firm. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.

Appellate Court Finds Franchisor is not Employer For FLSA Purposes

The rapidly-increasing trend to try to access the perceived deep pockets of franchisors for employment-related claims against their franchisees suffered a setback in the case of Orozco v. Plackis, Bus. Franchise Guide (CCH) '15,316 (U.S. Ct. of Appeals, 5th Cir., July 3, 2014). Plackis was the owner of the corporation that was the franchisor of Craig O's Pizza and Pasteria shops. Orozco was a cook at a location owned by a franchisee corporation formed by Sandra and Arnold Entjer. After Orozco's wages were reduced by the Entjers in an effort to stem the decreasing profitability of their restaurant, Orozco resigned and brought an action against the Entjers for violation of the Fair Labor Standards Act (FLSA) alleging failure to pay overtime and the required minimum wage. After settling with the Entjers, Orozco added Plackis as a defendant claiming that he was also legally an employer of Orozco under the FLSA. The FLSA defines an employer as “any person acting directly or indirectly in the interest of an employer in relation to an employee.” 28 U.S.C. '203(d). Plackis was named personally since, if a person is found to have operating control over employees within a company, he or she can be personally liable for the FLSA violations of the company ' even, apparently, if he is not an owner of the offending entity.

After a jury trial presided over by a magistrate judge, the jury found for Orozco and against Plackis. Following the verdict, various motions by Plackis for judgment as a matter of law were denied by the magistrate judge. Plackis appealed.

The appellate court, reviewing de novo the denial of Plackis's motions for judgment, sought to determine whether Plackis was an “employer” under the FLSA using the “economic reality test.” Under that test, the court evaluates whether the alleged “employer”: 1) possessed the power to hire and fire the employee; 2) supervised and controlled employee work schedules or conditions of employment; 3) determined the rate and method of payment; and 4) maintained employment records. Not all elements need be established in every case, however. The dominant theme of the cases using the economic reality test is “who has operating control over employees within the company.” As such, an employee may have more than one “employer” for FLSA purposes.

Orozco acknowledged that Plackis did not maintain his employee records but he asserted that Plackis did have influence over the other aspects of his job by virtue of his power to influence the franchisee's actions and, therefore, should be found to be a joint employer.

As the franchisor, Plackis met and communicated with the Entjers concerning their operation. The meetings and communications concerned, among other things, how to improve the profitability of the franchise, including reviewing the work schedules of the shop's employees. Following at least one such meeting, the Entjers adjusted employee hours and wages. Orozco implied that since Plackis provided operating suggestions to the Entjers, changed the menus, contracted with the shop's vendors and directed various advertising plans, he must have also had control over the shop's employment policies. While the magistrate judge apparently bought this argument, the appellate court did not. It pointed out that seeking to assist franchisees is what is expected of a franchisor. There was no evidence that Plackis ordered the personnel or wage changes but, rather, they were within the discretion of the Entjers.

The Franchise Agreement governing the operation of the Entjers' shop stated that the franchisee had to comply with the policies and procedures specified by the franchisor for the selection, supervision or training of personnel, a common franchise agreement term. The magistrate judge, in denying Plackis's motion for judgment also relied on this provision to show that Plackis had sufficient control over the franchisee's employment policies to warrant holding Plackis liable under the FLSA. Again, the appellate court disagreed, stating: “We fail to see how this innocuous statement suggests that Plackis hired or fired employees, supervised or controlled employee work schedules or employment conditions, or determined Orozco's rate and method of payment.”

While stating that it was not suggesting that franchisors can never qualify as an employer under the FLSA, the court found that there was insufficient evidence to satisfy the economic reality test, only vague inferences based on the proximity of franchisor-franchisee meetings to the complained of actions. Therefore, judgment was granted for Plackis.

This case seems to be at variance with the increasing trend to find a franchisor liable for employment-related actions and inactions by its franchisees. It is interesting that the test in this case was called the “economic reality test,” since reality seems to be absent in the growing number of court and administrative decisions finding franchisors liable for various aspects of the employer-employee relationship. For example, on July 29, 2014, the National Labor Relations Board's General Counsel found that McDonald's may have violated the rights of its franchisees' employees as a “joint employer” and could face significant liability for wage and hour and union-related claims. Such rulings, and others like it, threaten the franchise model, a key method of business expansion. While it cannot be argued that workers should not be treated fairly, a little “economic reality” may be needed before the entire framework of franchising is jeopardized.

Second Circuit Upholds Auto Dealer Termination Without Opportunity To Cure

In Giuffre Hyundai, Ltd. v. Hyundai Motor America, 2014 WL 2870507 (2d Cir. June 25, 2014), the Second Circuit Court of Appeals had occasion to rule on the circumstances under which a state dealer protection law must bow to the clear language of the franchise agreement. The issue there was whether the dealer law would be interpreted to require that the franchisee be permitted to cure before its dealership or franchise agreement could be terminated, despite language in the franchise agreement that gave the manufacturer the right to terminate immediately for certain breaches. The dealer was sued by the state Attorney General for engaging in fraudulent and deceptive business practices, such as strong-arm sales practices and unethical conduct. An injunction was issued against the dealer, finding that it had engaged in fraudulent and deceptive practices.

The franchise agreement gave the franchisor/manufacturer the ability to immediately terminate the dealership if the franchisee was convicted of any violation of law that affected the operation of the franchise, including any misrepresentations or unfair trade practices. However, the New York Vehicle and Traffic law gave the dealer the opportunity to challenge a termination on the grounds it lacked “due cause,” which depended on a finding that there was a material breach of a reasonable and necessary provision of a franchise if the breach is not cured within a reasonable time after notice. There was no provision in the dealership law permitting a franchisor to issue a notice without an opportunity to cure. The dealer argued that the termination was illegal because it was not given an opportunity to cure, and therefore the termination was without due cause. The District Court determined that the termination was lawful because the New York statute did not trump the common law that permitted a contracting party to terminate a contract if an opportunity to cure would be useless or if the breach “undermines the entire contractual relationship such that it cannot be cured.”

On appeal, the dealer argued that it had an absolute right to cure under the applicable statute. Not true, answered the appellate court. It applied the presumption that a statute would be deemed to override common law (of which the Legislators were presumably aware) only if the language of the statute clearly indicated that it would trump common law. It relied on several district court opinions dealing with the 7-Eleven franchise system that upheld terminations without the opportunity to cure in situations involving fraud going to the essence of the contract, even though the agreement required that the franchisee be given an opportunity to cure. See, 7-Eleven Inc. v. Khan, 977 F.Supp.2d 214,230 (E.D.N.Y. 2013); Southland Corp. v. Froelich, 41 F.Supp.2d 227, 246-48 (E.D.N.Y. 1999). The court also looked to basic contract law that permits a party to terminate a contract immediately when the malfeasance is incurable and when the cure is unfeasible. It also did not give much weight to a cure provision in a franchise contract (there was none here), since it is presumed that the parties intended that the breach would be of a type that could be cured. It applied the same reasoning to the intent of the legislators.

It was not difficult for the court to find that the breach was incurable. The determination that the dealer had engaged in fraudulent conduct was something that could not be cured. The franchise agreement clearly provided for immediate termination if there was such a finding. Obviously the finding could only be “cured” if a successful appeal were taken, which was not done. If the agreement provided that the franchise could be terminated if the franchisee engaged in the same conduct, it is possible that the franchisee might be able to argue that it should be given an opportunity to correct its conduct, since it was not dependent on a conviction that was not appealed or unsuccessfully appealed. However, if the franchisor could prove that this indeed impaired its good will or reputation, a court could find that there can be no cure.

The importance of this decision is that it appears to be the first circuit or appellate decision upholding the principle set forth in the lower courts: that basic contract law, regardless of a statute or contract provision, determines if an immediate termination will be allowed. Despite the legal way the issue is framed, it all comes down to basic common sense ' a cure provision will only come into play if the breach is one that can be cured.

Charles G. Miller, a member of this newsletter's Board of Editors, is shareholder and director of Bartko, Zankel, Bunzel & Miller in San Francisco. Darryl A. Hart is an attorney with the firm. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.