Court Watch

The federal Fair Labor Standards Act (FLSA), 29 U.S.C. ”201-219 et. seq. , allows employees to sue their employers for various employment-related causes of action. While the FLSA applies only to “employers,” the Supreme Court has noted that the FLSA's definition of an “employee” has been characterized as “the broadest definition that has ever been included in any one act.” U.S. v. Rosenwasser, 323 U.S. 360 (1945). Consequently, it is not surprising that courts in two recent cases have ruled that actions brought, pursuant to the FLSA, by franchisees and franchisee employees, sufficiently alleged that franchisors were “employers” to withstand motions to dismiss under Federal Rule of Civil Procedure 12(b)(6).

Naik v. 7-Eleven Inc.

In Naik v. 7 Eleven Inc., Bus. Franchise Guide (CCH) '15, 332 (D.N.J. 2014), four franchisees of franchisor 7-Eleven Inc. contended that, despite being designated by the operative franchise agreement as “franchisees” and “independent contractors,” the economic reality of the relationship was that they were employees of 7-Eleven and, therefore, entitled to the protections of the FLSA; thus, they argued, they were authorized to assert claims for unpaid wages, minimum wages and overtime wages per this statute.

In denying 7-Eleven's motion to dismiss, the court in Naik applied the six-factor test set forth by the Third Circuit in Martin v. Selker Bros. Inc., 949 F.2d 1286, 1293 (3d Cir. 1991), for determining whether an individual is an employee under the FLSA. The six factors are:

1. The degree of the alleged employer's right to control the manner in which the work is to be performed;
2. The alleged employee's opportunity for profit or loss depending upon his managerial skill;
3. The alleged employee's investment in equipment or materials required for his task, or his employment of helpers;
4. Whether the service rendered requires a special skill;
5. The degree of permanence of the working relationship;
6. Whether the service rendered is an integral part of the alleged employer's business.

In considering the first factor, the Naik court found that the plaintiff franchisees had alleged sufficient facts to show that this factor justified categorizing the plaintiffs as employees. The alleged facts which this court found adequate to support the franchisees' claim that 7-Eleven exercised an employer's right of control was that 7-Eleven did the following:

• Regulated vendors and supplied product pricing, advertising and promotional items;
• Processed plaintiffs' payroll via 7-Eleven's internal payroll system;
• Required plaintiffs to wear uniforms in store and at off-site events;
• Subjected plaintiffs to intense daily oversight, including installation of a security system to record plaintiffs' conduct;
• Controlled the volume of plaintiffs' televisions, air-conditioning and heat in their stores;
• Prevented plaintiffs from owning active business interests in other business entities;
• Controlled all bookkeeping and accounting, and required plaintiffs to get approval before withdrawing money;
• Controlled maintenance of the equipment in plaintiffs' stores and controlled marketing efforts and advertisements; and
• Imposed fines on plaintiffs as a means of controlling their activities.

With regard to the second factor of the plaintiffs' opportunity for profit or loss, the court found that this factor was neutral because, while the franchise agreement presented sufficient opportunities for profit and loss, the plaintiffs had also presented allegations that 7-Eleven's conduct undercut those opportunities through pervasive control.

As to the third factor of the plaintiffs' investment in equipment, the court found that it weighed in favor of finding the plaintiffs to be independent contractors, rather than employees. In particular, the court relied on the allegations of the complaint that the plaintiffs paid 7-Eleven franchise fees in a range of $100,000 – $150,000 and had made substantial franchise specific investments within each store.

The court similarly found that the fourth factor ' whether the plaintiffs possessed special skills ' also weighed in favor of classifying them as independent contractors rather than employees. In so ruling, the court observed that the complaint contained factual allegations that the plaintiffs were the in-store operators of their franchises, purchased their store inventory and hired their employees.

With regard to the fifth factor of the degree of permanence of the working relationship, the court found that it weighed in favor of classifying the plaintiffs as employees. The court noted that the franchise agreement contained an initial four-year lease term and two options to extend the lease for an additional 10 years.

With respect to the sixth factor of the plaintiffs' service being integral to 7-Eleven's business, the court found that the allegations of the complaint that 7-Eleven would not be able to operate its businesses in the manner that it did but for the plaintiffs, coupled with the franchise agreement, were sufficient to weigh this factor in favor of classifying the plaintiffs as employees.

After applying the six-factor test, as set forth above, the Naik court then applied the “economic reality” test as well. The court held that it “must review the circumstances of the whole activity and 'whether, as a matter of economic reality, the individuals are dependent upon the business to which they render service.'” The plaintiffs alleged that, despite the language in the franchise agreements stating that they were independent contractors, the economic reality of the relationship was that 7-Eleven controlled all aspects of the plaintiffs' business. 7-Eleven responded that many of the plaintiffs' allegations of “control” ' such as, regulation of vendors, equipment maintenance, product supply, uniforms and standardized store environments ' were quality control measures employed to ensure uniformity among its franchisees. The court found, however, that the plaintiffs' allegations were beyond mere uniformity measures and impacted the plaintiffs' opportunities for profit and loss and the discretion to run their franchise units. The court thus concluded that the plaintiffs had alleged facts “that depict an economic reality of dependence on Defendant [7-Eleven]” such that the plaintiffs had sufficiently “ alleged an economic reality indicating an employer-employee relationship.” Consequently, the court denied 7-Eleven's motion to dismiss the plaintiffs' FLSA claims.

Olvera v. Bareburger Group LLC

In Olvera v. Bareburger-Group LLC, Bus. Franchise Guide (CCH) '15,345 (S.D. N.Y. 2014), the plaintiffs were employed as porters, dishwashers, food preparers and cooks at three “organic fast food restaurants” owned by certain franchisees who operated the restaurants pursuant to franchise agreements with two corporate entities ' Bareburger Group LLC and Bareburger Inc. The plaintiffs' action alleged that both the franchisees and the Bareburger franchisor had violated the FLSA by failing to pay minimum wage, overtime and spread-of-hours compensation. The Bareburger franchisors moved to dismiss the action as to them, asserting that the complaint had failed to plausibly plead that the franchisors were “joint employers” for purposes of the FLSA.

In denying the franchisors' motion, the court in Olivera first reviewed the definition of an “employer” provided in the FLSA, which is “any person acting directly or indirectly in the interest of an employer in relation to an employee.” The court observed that the Supreme Court in Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318, 326 (1992), had emphasized that this is an expansive definition with “striking breadth.” The court further clarified that an individual may simultaneously have multiple “employers” for the purposes of the FLSA.

Much like the court in Naik, the Olivera court invoked the “economic reality” test as the primary determinant of whether an employer-employee relationship exists for purposes of the FLSA. The court observed that the relevant analysis “should be grounded in 'economic reality rather than technical concepts.'”

The court found that in assessing economic reality, the Second Circuit has articulated two tests for determining whether an employment relationship exists for the purposes of the FLSA, one relating to formal control, the other to functional control.

The formal control test, set forth in Carter v. Dutchess Community College, 735 F.2d 8, 12 (2d Cir. 1984), asks whether the alleged employer:

1. Had the power to hire and fire the employees;
2. Supervised and controlled employee work schedules or conditions of employment;
3. Determined the rate and method of payment; and
4. Maintained employment records.

The functional-control test, set forth in Zheng v. Liberty Apparel Co., 355 F.3d 61, 71-72 (2d Cir. 2003), identified the following as pertinent, although not exclusive factors:

1. Whether the alleged employer's premises and equipment were used for the plaintiff's work;
2. Whether the subcontractors had a business that could or did shift as a unit from one putative joint employer to another;
3. The extent to which plaintiffs performed a discrete line-job that was integral to the alleged employers' process of production;
4. Whether responsibility under the contracts could pass from one subcontractor to another without material changes;
5. The degree to which the alleged employers or their agents supervised plaintiffs' work; and;
6. Whether plaintiffs worked exclusively or predominantly for the alleged employers.

In reviewing the complaint, the court in Olivera found that the plaintiffs had pleaded sufficient facts that would satisfy either the formal- or functional-control test. In this regard, the court held that either test was met by the complaint's allegations that the franchisors had done the following:

1. Guided franchisees on how to hire and train employees;
2. Set and enforced requirements for the operation of franchises;
3. Monitored employee performance;
4. Specified the method and procedures used by their employees to prepare customer orders;
5. Exercised control, directly or indirectly, over the work of employees;
6. Required franchisees to “employ recordkeeping” of operations including “systems for tracking hours and wages and for retaining payroll records”; and
7. Exercised control over their franchisees' timekeeping and payroll practices.

The court concluded that when these pled facts were taken as true, they stated a plausible claim that the franchisor defendants were the plaintiffs' joint employers under the FLSA.

Michael W. Tyler is a partner with Kilpatrick Townsend & Stockton LLP, residing in its Atlanta office where he leads the firm's Franchise Litigation Practice. He can be contacted at 404-815-6474 or at [email protected].

The federal Fair Labor Standards Act (FLSA), 29 U.S.C. ”201-219 et. seq. , allows employees to sue their employers for various employment-related causes of action. While the FLSA applies only to “employers,” the Supreme Court has noted that the FLSA's definition of an “employee” has been characterized as “the broadest definition that has ever been included in any one act.” U.S. v. Rosenwasser, 323 U.S. 360 (1945). Consequently, it is not surprising that courts in two recent cases have ruled that actions brought, pursuant to the FLSA, by franchisees and franchisee employees, sufficiently alleged that franchisors were “employers” to withstand motions to dismiss under Federal Rule of Civil Procedure 12(b)(6).

Naik v. 7-Eleven Inc.

In Naik v. 7 Eleven Inc., Bus. Franchise Guide (CCH) '15, 332 (D.N.J. 2014), four franchisees of franchisor 7-Eleven Inc. contended that, despite being designated by the operative franchise agreement as “franchisees” and “independent contractors,” the economic reality of the relationship was that they were employees of 7-Eleven and, therefore, entitled to the protections of the FLSA; thus, they argued, they were authorized to assert claims for unpaid wages, minimum wages and overtime wages per this statute.

In denying 7-Eleven's motion to dismiss, the court in Naik applied the six-factor test set forth by the Third Circuit in Martin v. Selker Bros. Inc., 949 F.2d 1286, 1293 (3d Cir. 1991), for determining whether an individual is an employee under the FLSA. The six factors are:

1. The degree of the alleged employer's right to control the manner in which the work is to be performed;
2. The alleged employee's opportunity for profit or loss depending upon his managerial skill;
3. The alleged employee's investment in equipment or materials required for his task, or his employment of helpers;
4. Whether the service rendered requires a special skill;
5. The degree of permanence of the working relationship;
6. Whether the service rendered is an integral part of the alleged employer's business.

In considering the first factor, the Naik court found that the plaintiff franchisees had alleged sufficient facts to show that this factor justified categorizing the plaintiffs as employees. The alleged facts which this court found adequate to support the franchisees' claim that 7-Eleven exercised an employer's right of control was that 7-Eleven did the following:

• Regulated vendors and supplied product pricing, advertising and promotional items;
• Processed plaintiffs' payroll via 7-Eleven's internal payroll system;
• Required plaintiffs to wear uniforms in store and at off-site events;
• Subjected plaintiffs to intense daily oversight, including installation of a security system to record plaintiffs' conduct;
• Controlled the volume of plaintiffs' televisions, air-conditioning and heat in their stores;
• Prevented plaintiffs from owning active business interests in other business entities;
• Controlled all bookkeeping and accounting, and required plaintiffs to get approval before withdrawing money;
• Controlled maintenance of the equipment in plaintiffs' stores and controlled marketing efforts and advertisements; and
• Imposed fines on plaintiffs as a means of controlling their activities.

With regard to the second factor of the plaintiffs' opportunity for profit or loss, the court found that this factor was neutral because, while the franchise agreement presented sufficient opportunities for profit and loss, the plaintiffs had also presented allegations that 7-Eleven's conduct undercut those opportunities through pervasive control.

As to the third factor of the plaintiffs' investment in equipment, the court found that it weighed in favor of finding the plaintiffs to be independent contractors, rather than employees. In particular, the court relied on the allegations of the complaint that the plaintiffs paid 7-Eleven franchise fees in a range of $100,000 – $150,000 and had made substantial franchise specific investments within each store.

The court similarly found that the fourth factor ' whether the plaintiffs possessed special skills ' also weighed in favor of classifying them as independent contractors rather than employees. In so ruling, the court observed that the complaint contained factual allegations that the plaintiffs were the in-store operators of their franchises, purchased their store inventory and hired their employees.

With regard to the fifth factor of the degree of permanence of the working relationship, the court found that it weighed in favor of classifying the plaintiffs as employees. The court noted that the franchise agreement contained an initial four-year lease term and two options to extend the lease for an additional 10 years.

With respect to the sixth factor of the plaintiffs' service being integral to 7-Eleven's business, the court found that the allegations of the complaint that 7-Eleven would not be able to operate its businesses in the manner that it did but for the plaintiffs, coupled with the franchise agreement, were sufficient to weigh this factor in favor of classifying the plaintiffs as employees.

After applying the six-factor test, as set forth above, the Naik court then applied the “economic reality” test as well. The court held that it “must review the circumstances of the whole activity and 'whether, as a matter of economic reality, the individuals are dependent upon the business to which they render service.'” The plaintiffs alleged that, despite the language in the franchise agreements stating that they were independent contractors, the economic reality of the relationship was that 7-Eleven controlled all aspects of the plaintiffs' business. 7-Eleven responded that many of the plaintiffs' allegations of “control” ' such as, regulation of vendors, equipment maintenance, product supply, uniforms and standardized store environments ' were quality control measures employed to ensure uniformity among its franchisees. The court found, however, that the plaintiffs' allegations were beyond mere uniformity measures and impacted the plaintiffs' opportunities for profit and loss and the discretion to run their franchise units. The court thus concluded that the plaintiffs had alleged facts “that depict an economic reality of dependence on Defendant [7-Eleven]” such that the plaintiffs had sufficiently “ alleged an economic reality indicating an employer-employee relationship.” Consequently, the court denied 7-Eleven's motion to dismiss the plaintiffs' FLSA claims.

Olvera v. Bareburger Group LLC

In Olvera v. Bareburger-Group LLC, Bus. Franchise Guide (CCH) '15,345 (S.D. N.Y. 2014), the plaintiffs were employed as porters, dishwashers, food preparers and cooks at three “organic fast food restaurants” owned by certain franchisees who operated the restaurants pursuant to franchise agreements with two corporate entities ' Bareburger Group LLC and Bareburger Inc. The plaintiffs' action alleged that both the franchisees and the Bareburger franchisor had violated the FLSA by failing to pay minimum wage, overtime and spread-of-hours compensation. The Bareburger franchisors moved to dismiss the action as to them, asserting that the complaint had failed to plausibly plead that the franchisors were “joint employers” for purposes of the FLSA.

In denying the franchisors' motion, the court in Olivera first reviewed the definition of an “employer” provided in the FLSA, which is “any person acting directly or indirectly in the interest of an employer in relation to an employee.” The court observed that the Supreme Court in Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318, 326 (1992), had emphasized that this is an expansive definition with “striking breadth.” The court further clarified that an individual may simultaneously have multiple “employers” for the purposes of the FLSA.

Much like the court in Naik, the Olivera court invoked the “economic reality” test as the primary determinant of whether an employer-employee relationship exists for purposes of the FLSA. The court observed that the relevant analysis “should be grounded in 'economic reality rather than technical concepts.'”

The court found that in assessing economic reality, the Second Circuit has articulated two tests for determining whether an employment relationship exists for the purposes of the FLSA, one relating to formal control, the other to functional control.

The formal control test, set forth in Carter v. Dutchess Community College, 735 F.2d 8, 12 (2d Cir. 1984), asks whether the alleged employer:

1. Had the power to hire and fire the employees;
2. Supervised and controlled employee work schedules or conditions of employment;
3. Determined the rate and method of payment; and
4. Maintained employment records.

The functional-control test, set forth in Zheng v. Liberty Apparel Co., 355 F.3d 61, 71-72 (2d Cir. 2003), identified the following as pertinent, although not exclusive factors:

1. Whether the alleged employer's premises and equipment were used for the plaintiff's work;
2. Whether the subcontractors had a business that could or did shift as a unit from one putative joint employer to another;
3. The extent to which plaintiffs performed a discrete line-job that was integral to the alleged employers' process of production;
4. Whether responsibility under the contracts could pass from one subcontractor to another without material changes;
5. The degree to which the alleged employers or their agents supervised plaintiffs' work; and;
6. Whether plaintiffs worked exclusively or predominantly for the alleged employers.

In reviewing the complaint, the court in Olivera found that the plaintiffs had pleaded sufficient facts that would satisfy either the formal- or functional-control test. In this regard, the court held that either test was met by the complaint's allegations that the franchisors had done the following:

1. Guided franchisees on how to hire and train employees;
2. Set and enforced requirements for the operation of franchises;
3. Monitored employee performance;
4. Specified the method and procedures used by their employees to prepare customer orders;
5. Exercised control, directly or indirectly, over the work of employees;
6. Required franchisees to “employ recordkeeping” of operations including “systems for tracking hours and wages and for retaining payroll records”; and
7. Exercised control over their franchisees' timekeeping and payroll practices.

The court concluded that when these pled facts were taken as true, they stated a plausible claim that the franchisor defendants were the plaintiffs' joint employers under the FLSA.

Michael W. Tyler is a partner with Kilpatrick Townsend & Stockton LLP, residing in its Atlanta office where he leads the firm's Franchise Litigation Practice. He can be contacted at 404-815-6474 or at [email protected].