Franchising And California At A Crossroads: The Dynamics Of Dynamex And The ABC Test

In 2018, the Supreme Court of California turned much of the established law regarding worker classification on its head with its decision in Dynamex Operations West Inc. v. Superior Court.1 Dynamex addressed a single, narrow question: whether certain workers were appropriately classified as independent contractors or were instead properly classified as employees for purposes of the state's wage and hour laws. In the wake of Dynamex, however, some have urged courts to expand the scope of the case beyond the narrow confines of independent contractor/employee classification to instead broadly redefine the law of joint employment and vicarious liability generally. If courts take up this invitation, it may sound the death knell for the franchise model of business operation in California, imposing joint liability on franchisors with little to no control over the day-to-day activities of their franchisees or of those franchisees' employees.

For legal, practical, and policy reasons, it is hoped that courts will decline to expand Dynamex, keep the case cabined to its facts and the narrow question presented in it, and instead rely on the well-developed body of state law setting forth standards for establishing joint employment status and vicarious liability in the franchise context. Moreover, as the state legislature entertains proposals to purportedly codify the Dynamex decision, it should expressly clarify that the bill is intended to address the standard for determining only whether a worker is an employee or an independent contractor, and not intended to address joint employment status broadly or change the status of franchise relationships.

Background

In Dynamex, the court adopted the so-called "ABC test" for determining whether an individual worker was properly classified as an employee or an independent contractor for purposes of the California's Industrial Welfare Commission's wage orders. By any measure, the ABC test is a far broader standard than that applied by California courts previously, and its application results in many more workers being classified as "employees" rather than contractors.

Courts subsequent to Dynamex have aggressively applied the ABC test. Most recently, in 2019, the federal Ninth Circuit Court of Appeals in Vazquez v. Jan-Pro Franchising International, Inc.,2 held that Dynamex and the ABC test provide the appropriate standard for determining whether franchise workers were properly classified as independent contractors or instead were employees of a national master franchisor (as distinct from the regional franchisees with which they contracted) for purposes of state wage and hour law. In doing so, the court dismissed prior California Supreme Court case law recognizing the "special features" of franchising relevant to conducting a vicarious liability analysis. The Ninth Circuit remanded the case to the lower court for an application of the ABC test to the facts presented, but in doing so, stopped just short of expressly concluding that the franchisee workers could be deemed employees of the national franchisor, which could then be held liable for wage and hour violations allegedly committed by its franchisees.

The question now presented to the Ninth Circuit: Are Dynamex and Vazquez "misclassification" cases such that use of the ABC test should be limited to the question of whether a worker is properly classified as an employee or an independent contractor? Or are they broader "employer" cases, meaning that the ABC test is the appropriate standard for determining employer status and joint liability generally under California's wage orders even in the absence of any claimed misclassification, and irrespective of the business model at issue? The court is squarely presented with that question in the pending case of Salazar v. McDonalds Corp.3

If the Salazar court determines that Dynamex and its progeny are applicable only to the narrower question of whether an individual is an employee or an independent contractor, the impact on franchisors may be lessened—in most franchise models, the question of whether an individual is an employee or independent contractor will rarely be at issue. If, however, the Ninth Circuit concludes that the ABC test is broadly applicable in determining employer wage and hour liability or joint employer status generally—irrespective of any claimed "misclassification" as independent contractors—the franchise model of business operation will be dramatically compromised, as franchisors will find themselves potentially liable for labor law violations by franchisee employees over which they exert little or no control. Simply put, how broadly courts in California choose to read Dynamex is likely to have profound consequences for franchising within the state and its economy writ large.

It is against this backdrop that the California legislature considers A.B. 5, legislation that purports to codify the Dynamex decision. Should the bill be enacted as presently written, it could conceivably expand liability for franchisee employees to franchisors throughout the state, potentially destroying the viability of the franchise model. To date, public discussion of A.B. 5 has focused on the misclassification of employees as independent contractors, and the need to protect workers in the "gig" economy. The potential broader implications of the bill apart from the independent contractor issue have drawn little scrutiny and less discussion. It is possible that the legislature does not intend A.B. 5 to reach beyond issues of independent contractor misclassification to joint employer status more broadly. It that is so, legislators should amend A.B. 5 to make that point expressly clear.

This report begins with a discussion of issues specific to the franchising model of business. It then examines pre-Dynamex case law in California analyzing employer status under state law, including specifically in the franchise context. From there, it analyzes the holdings of Dynamex and its application in Vazquez, and the question left open and now pending before the Ninth Circuit in Salazar. Finally, it analyzes A.B. 5, and the potential devastating impact the bill could have on the franchise model in California.

The Business of Franchising

At the outset, the economic impact of franchising in California should not be understated. Over 75,800 franchises employ almost 729,000 people in the state, generating $28.8 billion in payroll and almost $70 million in output. These jobs and money are at risk if the franchising model is hopelessly compromised or otherwise made unworkable, whether by court-made law or legislative fiat.

By way of brief background, franchising is a method of marketing goods and services that depends upon the existence of the franchisor's control over a trademark, other intellectual property, or some other commercially desirable interest sufficient to induce franchisees to pay to participate in the franchisor's system by distributing goods or services under the franchisor's trademark or name.4 It is typical in franchising that a franchisor will license, among other things, the use of its name, its products or services, and its reputation to its franchisees. It is commonplace—and in fact explicitly required under federal trademark law—for a franchisor to impose quality, consistency, and operational standards on its franchisees. These standards allow franchisors to maintain the uniformity and quality of product and service offerings and, in doing so, to protect their trade names, trademarks and service marks (collectively the "Marks"), the goodwill associated with those Marks, and most importantly, the protection of the consumer.

The Lanham Act, the federal law regulating trademarks, service marks, and unfair competition, mandates that owners of trademarks must "maintain[] sufficient control of the licensee's use of the mark to assure the nature and quality of goods or services that the licensee distributes under the mark."5 Moreover, because the Lanham Act provides that a trademark can be deemed "abandoned" when "any course of conduct of the owner . . . causes the mark . . . to lose its significance,"6 franchisors have a strong incentive to control the nature and quality of the good or services sold by their franchisees. As a result, franchisors are compelled to establish and monitor brand standards and provide global oversight with regard to their franchisees.

Given these facts, most franchise agreements will routinely include contractual provisions governing many aspects of business operation, some in great detail, but have little-to-no bearing on a franchisor's "control" of its franchisees' employees. Such provisions, commonly found in franchisor/franchisee agreements, include brand standards manuals and guidance; training requirements or suggestions; broad contours for the conduct of business administration, including required hours of operation, trade dress provisions ensuring the visual consistency of brand décor, design, color, and signage; staffing guidance; sample manuals and policies; safety and security standards; and proprietary software for business operation.7 Finally, franchise agreements will often include language expressly characterizing the relationship of both businesses, and setting forth which responsibilities each party assumes or retains.8

The discussion of franchising and the typical features likely to be found in most if not all franchise agreements is not simply an academic point. Rather, it is important to set out that, by definition and legal requirement, franchisors are bound to exert a certain level of control over their franchisees' operations and procedures (as distinguished from day-to-day control over franchisees' employees). As California law has increasingly sought to impose liability on one entity by virtue of its "control" over another entity's employees, this point becomes critical. At times the California Supreme Court has...