Franchisors often resist franchisee requests for loosening controls in order to make the franchisee's loan eligible for SBA financing.
Thanks to several recent Court decisions, a franchisor's case for maintaining certain kinds of control over the franchisee just got a lot weaker.
Recent cases involving employment discrimination have held that too much control, which creates ineligible "affiliation" under the SBA rules and regulations, can also make franchisors liable for claims by the franchisee's employees. (Keep reading to see the nose ring case)
Franchising has historically succeeded as a business model due, in large measure, to the support the franchisee gets from the franchisor in exchange for fees and a commitment by the franchisee to preserve and protect the franchisor's system and its attributes, including especially franchisor's trade marks, trade names.
The franchisee typically agrees to be trained in the franchise system and to comply with the franchise agreement rules and procedures.
Generally, franchisors want to ensure franchisees adhere to the look and feel of its system. Small business loan applicants frequently choose franchising or similar arrangements such as licensing or distributorships as a business model and seek SBA financing for their operations.
Affiliation issues found in franchise, license and certain dealer or distributorship agreements can render the small business ineligible for SBA financing. Affiliation is found where the franchisor exercises so much control over the franchisee and the franchised business that the small business no longer has the independent right to profit from its efforts or bear the risk of loss commensurate withy ownership.
Recent court cases provide franchisee-borrowers applying for SBA loans with better ammunition for getting franchisors to back off from some controls and enable franchisees to negotiate modifications to the franchise agreement to avoid affiliation and make the agreement eligible.
Actions such as step-in rights, where the franchisor can take over the franchisee's job if the franchisee is performing inadequately (Hayes v. Enmon Enterprises, LLC d/b/a Jani-King, 2011 U.S. dist. LEXIS 66736 (S .D.. Miss.) or where the franchisor runs all payroll through its central system (Myers v. Garfield, 679 F. Supp. 2d 598 (E.D. Pa. 2010) have made franchisors liable as joint employers with the franchisee.
Factors courts are looking at to determine whether a franchisor can be held to be a joint employer include all of the following: authority to hire and fire employees, promulgate work rules and assignments and set conditions of employment, including benefits, compensation and hours; day-to-day supervision of employees including discipline; and control of employee records, including payroll, insurance, taxes and the like.
Courts say that no one single factor is dispositive in determining whether a franchisor is a joint employer.
Now, for the nose ring case -----
An employee of a fast-food franchise was fired by the franchisee for wearing a nose ring that she said was religiously required but that violated the franchisor's no-facial-jewelry policy. She filed a claim with the Equal Employment Opportunity Commission.
The EEOC, on her behalf, sued the franchisee ---- and the franchisor. In denying the franchisor's motion to be let out of the case, the court said there was enough evidence to find that the franchisor's were a joint employer with the franchisee, especially since only the franchisor had the authority to waive the no-facial-jewelry policy that was enforced by the franchisee against the employee.
The controls that give rise to a franchisor's liability as a "joint-employer" of the franchisee's employees provide a franchisee and its SBA Lender with additional leverage to negotiate fixes to a franchise agreement that is not on the SBA franchise registry to render it eligible for SBA financing.
For more information regarding franchise eligibility matters, please contact Lynn at [email protected] or call (215) 542-7070.
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There are so many great avenues for discussion regarding this article.
How does a Franchisor establish the right balance of controls on the franchisee to help mitigate liability risk?
Too much and your liable as a 'joint employer'. Too little and you're defeating the purpose of the franchisor/franchisee relationship and may put find yourself fighting other issues.
Not only that, but as Lynn may attest, each state may have differing rules and regulations on this. It can create a tough balancing act for the franchisor.
But I feel there are ways to develop a good balance and work around this.
Sheppard, I think the general issue Lynn is pointing out is that franchisors have an implicit negotiation going on with the SBA that they didn't have before.
The SBA is tightening up on the control issues.
This would make an interesting negotiation exercise.
Certainly would. I agree that that her main issue was dealing with SBA loans and franchisor control.
However, I do feel that the over-arching theme opens up to a broader spectrum of discussions.
It is certainly something that every franchisor needs to be addressing,
Very interesting. And yes, I guess from your insurance point of view mitigation of risk is huge. Too much control may pierce the franchisor veil and lead unintentionally to more and not less expected risk.
Brian Cole's article is also relevant:
https://www.franchise-info.ca/cooperative_relations/2012/07/what-changes-in-franchise-contracts-is-the-sba-demanding.html