Coverall Precedent Spreads To Other Franchise Cleaning Systems – “Independent Contractors” Found To Be Mere Employees

By William F. Jones

In early June 2012, the United States District Court for Massachusetts issued a summary judgment ruling which expands and applies the precedent in the Coverall employee-independent contractor litigation to yet another large corporate cleaning franchise. 

Jani-King is a large national cleaning franchise system, and it is a competitor of Coverall with similar business operations.  A putative class of plaintiffs (represented by the same plaintiffs’ counsel who participated in the Coverall litigation) filed similar claims against Jani-King alleging misclassification of Jani-King franchisees as independent contractors, rather than employees.

On cross-motions for summary judgment, Chief Judge Mark L. Wolf followed the precedent in Coverall holding that Jani-King’s franchisees were not independent contractors but actually employees under Massachusetts law.  Crucial to the court’s finding was the applicable Massachusetts law which requires an independent contractor to not be conducting the same business as their putative employer.  In the Jani-King case, the court found that Jani-King was engaged in commercial cleaning services, and this was the identical business to which its franchisees were engaged in as well.  Because of this factor, the court, relying on the Coverall precedent, found that the franchisees were employees rather than independent contractors.  The court also appeared to rely on the fact that Jani-King directly handled customer contracting and accounts as well as customer billing for its franchisees as an aspect of why the franchisees were actually employees rather than independent contractors.

Although not entirely unexpected given the similarity between Coverall’s and Jani-King’s businesses, this ruling shows that the impact of the Coverall decision on other franchise systems continues to grow.  Franchise systems should carefully review their business operations to ensure that their business practices do not create unexpected liability for misclassification claims.

Firehouse Subs Gets Burned On Suit For Trademark Infringement

By Bud Culp

Franchisors are well-advised to vigorously protect their brand name, one of a franchisor’s most valuable assets.  However, before filing suit against a franchisee for using a franchisor’s trademark, a franchisor needs to make sure its own intellectual property house is in order, or, as Firehouse Subs recently learned, the lawsuit may backfire.

In Firehouse Restaurant Group, Inc. d/b/a Firehouse Subs v. Scurmont LLC, Case No. 4:09-CV-00618-RBH, Bus. Franchise Guide (CCH) 14,738 (D.S.C. Oct. 17, 2011), Firehouse Subs sued two South Carolina franchisees for trademark infringement for operating two non-franchise restaurants using names incorporating the Firehouse mark.  The franchisees fought fire with fire:  seeking a declaratory judgment that they had not infringed the marks, and filing a counterclaim seeking to cancel Firehouse’s trademark due to its alleged fraud on the U.S. Patent & Trademark Office (USPTO) when Firehouse obtained its mark.  At trial, the jury agreed with the franchisees, finding that the defendants had not infringed Firehouse Subs’ trademarks, and that Firehouse Subs had defrauded the USPTO.  

Firehouse Subs tried to douse the flames, filing a motion for a new trial, or, alternatively, for a new trial.  However, the U.S. District Court for South Carolina upheld the jury verdict.  The court found that the franchisees had presented adequate evidence that Firehouse Subs knew of a restaurant in Florida operating under the name “Firehouse Grill & Pub” at the time it filed its application for its trademark; however, Firehouse had falsely represented to the USPTO that no other party had the right to use the “Firehouse” mark.  Moreover, in light of evidence that Firehouse Subs unsuccessfully sought to obtain a coexistence agreement with the owners of “Firehouse Grill & Pub” (showing that Firehouse Subs was concerned about the possibility of confusion with the Firehouse Subs trademark), the court also affirmed the jury’s award of nearly $250,000 in attorneys’ fees to the franchisees because the jury’s finding of fraud upon the USPTO rendered the case “exceptional” under the Lanham Act.  

Firehouse Subs has appealed the jury’s verdict.

Mandatory Loss Leaders Travel North Of The Border

By William F. Jones

Recent litigation in the United States has examined issues relating to franchise systems imposing price ceilings on items sold by franchisees, even when those ceilings mandate that items are sold at a loss.  In a notable case, National Franchisee Association v. Burger King Corp., the United States District Court for the Southern District of Florida in 2010 affirmed the right of Burger King to impose a $1 price ceiling on its “Buck Double”  cheeseburger, even though the cost to franchisees producing that cheeseburger were higher than $1.  Essentially, the court agreed with Burger King’s argument that enforcing such price ceilings is a reasonable strategy to draw in other customers in to purchase higher price items, essentially acting as a “loss leader” to benefit overall store sales.

This legal precedent for allowing franchisors to enforce maximum, below-cost price ceilings appears to have migrated north of the border.  Recently, an association of Tim Horton’s franchisees filed a class action against the franchisor requirement that franchisees sell lunch item menus for less than cost.  Echoing the holding in the Burger King case, the Canadian court embraced Tim Horton’s arguments that the applicable analysis involves the overall profitability of the franchise store, rather than the individual profitability of a single item.  The court found that it was commercially reasonable for Tim Horton’s to adopt and enforce a strategy on its franchisees to use below cost lunch menu item as a loss leader to bring in customers and create additional profit on other items.

The adoption of the “loss leader” concept in the context of maximum price ceilings in the Canadian courts may demonstrate a trend towards greater franchisor control and discretion and the pricing of specified menu items system-wide.

Update On The Coverall Employee-Independent Contractor Litigation

By William F. Jones

 A major case of interest in the franchise industry continues to wind its way through the federal district court and state courts in Massachusetts.  In Awuah v. Coverall (the “Coverall case”,  the core dispute involves whether Coverall franchisees are actually classified as employees, rather than independent contractors.  More explanation of the core dispute is covered in a prior blog entry, “Franchisees: Independent Contractors or Employees?” by Bud Culp, posted below.

In the Coverall case, presiding federal district court has now entered an order defining the damages that the Coverall franchisees who were misclassified as independent contractors rather than employees will ultimately receive.  The successful plaintiff franchisees are allowed to recover damages against Coverall which include refunds of their initial franchise fees, additional business fees and insurance deductions.  Also, the plaintiff franchisees can recover any unreimbursed chargebacks and interest on late payment of reimbursed chargebacks. 

Most importantly, however, the judge issued an order which trebled the damages assessed against Coverall.  The court took this action under the prior 2007 version of the applicable Massachusetts statute which makes treble damages discretionary.  The judge’s order trebles damages against Coverall for successful plaintiff-franchisees dating back to 2006.

It is important to note that revisions to the Massachusetts statute in 2008 now make the trebling of damages for misclassification mandatory, rather than discretionary.  This change in the law, along with Coverall case precedent, should impress upon franchise systems the importance of properly evaluating any potential exposure they may face on the issue of whether their franchisees can be classified as employees, rather than independent contractors.

Tough Economic Times Increase The Potential For Franchisor Tort Liability Claims

By William F. Jones

The tough economic conditions in our country have had a significant impact on most businesses, but the impact felt by franchise systems has been particularly acute.  The continued slow pace of economic growth has placed, and continues to place, additional pressures on franchisees, particularly food and retail franchisees operating in industries with tight profit margins.
 
These economic realities can manifest themselves in unexpected ways.  One way is an upswing in claims against franchisors for tort liability arising out of the actions or inactions of its franchisees or its franchisees' employees.  Although a franchisor may think of its franchisees as independent businesses that will be responsible for their own tort liability, the plaintiff's bar sees things differently.  

Particularly in tough economic times, a franchisor makes an attractive target for plaintiffs seeking to impose tort liability for the benefit of an injured client.  Plaintiff's counsel suing franchisors for the alleged torts of its franchisees generally fall into three categories.  First, franchisors typically represent the proverbial "deep pocket."  The very success that a franchise system obtains in increasing the strength of its brand and marketing has the converse effect of having it appear to be an attractive "deep pocket" to the plaintiff's bar.  

Second, the economic pressures on a franchisee may make the franchisor the only viable tort target.  Although most franchisees are required to carry insurance coverage, one byproduct of the tough economic times is that many more franchisees are failing to meet this obligation, failing to pay premiums, and going out of business.  This situation may mean that the franchisee is no longer a viable target for a tort suit, leaving the franchisor as the only viable target for plaintiff's counsel.  

Third, plaintiff's counsel often include a franchisor in an attempt to obtain some money for the "hassle factor."  Whereas most franchisors limit the scope of litigation with franchisees through forum selection clauses in the franchise agreement, those venue and governing law provisions have no application to third-party tort claims.  The prospect of being dragged into state court in any number of jurisdictions also places pressure on the franchisor to attempt to offer a nominal settlement to avoid the cost and expense of litigating in a far-away forum.  Plaintiff's counsel often recognizes this reality, and takes advantage.

It is standard practice in a franchise agreement for a franchisor and a franchisee to agree in writing that the franchisee is an independent business operating free from direct control of the franchisor.  Most franchise systems recognize this reality in their operations, and franchise systems see their franchisees as independent businesses.  This perception and the specific terms of the franchise agreement, however, are not the primary considerations of a court assessing whether a franchisor has liability for the torts of a franchisee or the franchisee's employees. 

Most courts do not have extensive experience with franchises and franchise litigation. Consequently, case law tends to focus on traditional concepts of agency law to examine whether a franchisor bears tort liability for the acts of its franchisee.  The courts examining these questions tend to focus on concepts of actual and apparent agency in making their determination.

Actual agency applies the traditional principal-agent doctrine to the franchisor-franchisee relationship.  In essence, courts examine whether the franchisee is merely the "agent" for the franchisor.  As with most traditional analysis of principal and agent concepts, the dispositive factor comes down to control.  The courts examine the extent to which a franchisor exercises the requisite "control" over its franchisee.

Under an "apparent agency" theory, the analysis differs in several important respects.  Courts examine whether or not the franchisee was held out as the agent of the franchisor.  Particular concern is given to what actions the franchisor as the putative principal took to clothe the franchisee as an agent for purposes of the tort victim.  Again, the key consideration in which courts engage is to determine what "control" the franchisor ultimately exercises over the franchisee in its interaction with the tort victim.

The "Control" Test

In addressing potential tort liability of a franchisor for the acts of a franchisee, courts analyze the degree of control that a franchisor exercises over "day-to-day" operations of the particular franchisee.  Analysis includes determining whether a franchisor controls the daily business operation and practices at a franchisee, including hiring and firing employees, supervision of cleanliness and hygiene standards, and implementation of employment and other policies.  It is within these examinations of the actual "control" exercise by a franchisor that a natural tension arises between the franchisee's status as an independent business and the franchisor's legitimate concerns in protecting the integrity of its system.

A franchise agreement typically specifies that the franchisee is an independent and separate business.  The franchise agreement also typically specifies that the franchisee is responsible for both the operations of its business and matters relating to the hiring, firing and supervision of employees.

A closer examination, however, often reveals that a franchisor is not actually as hands-off in practice as the language of the franchise agreement may suggest.  Franchisors have legitimate interest in protecting their unique business system by ensuring that franchisees are in compliance with system requirements.  The whole system of franchising as a business model is that the franchisor creates a business system consisting of licensed marks, brand recognition and operations to ensure consistency among its franchisees throughout the system.  

Although consistency is a legitimate goal of a franchisor, there are traps for the unwary in a franchise system which attempts to control the operation of its franchisee's business too closely.  For example, a franchisor may require franchisees to take certain operational steps to ensure that franchisee businesses across the country are run in a similar fashion.  These methods of business, however, can be construed to be a level of "control" over the franchisee's business which could result in imposing tort liability.  When courts analyze these questions, they do not allow the franchisor to have it both ways.  If a franchisor dictates the precise method by which a franchisee operates it business, this direction may form the basis for establishing the necessary control such that the franchisor is responsible for the franchisee's tort liability.

The Causal Nexus

The analysis by courts of potential franchisor tort liability does not solely relate to a generalized question of the extent to which a franchisor controls its franchisees' businesses.  Courts examining this question often look for a causal nexus between the control exercised by a franchisor and the conduct upon which the plaintiff bases its claimed injury.  Even if a franchisor exercises substantial control over its franchisee's business methods, liability for tort breaks down if the alleged conduct is separate and apart from the areas of the business the franchisor controls closely. 

At a basic level, if a franchisor provides substantial direction and oversight to all franchisees on the manner on which they hire and fire employees, that franchisor may be subject to tort liability for claims arising out of employment issues.  This analysis, however, may have no bearing on a tort claimant whose claim has nothing to do with the hiring and firing practices of the franchisee.  This is an area where defense counsel can take action to protect franchisors from tort liability.  It is crucial that counsel for a franchise drive a wedge between those aspects of the franchise relationship where the franchisor exercises control and the specific conduct of the franchisee which may cause the alleged torts.  Without a causal nexus between control and the alleged injury, franchisors may escape liability for the acts of their franchisees.

Practice Pointers

For general tort liability, the majority of applicable law appears to support arguments from the franchisor which distances franchisors from tort liability for the actions of franchisees or their employees.  If operating in accordance with the franchise agreement, a typical franchise system minimizes potential liability.
The challenge for a franchisor and its lawyers is to find a way to raise this issue in court in an early and effective manner.  Often, issues of control are extremely fact specific, making it difficult for a franchisor to effectively raise its defenses in the preliminary stages of litigation.  This forces the franchisor to endure substantial costs related to its defense prior to dismissal through a motion for summary judgment.

To minimize risk, the franchise system should review as appropriate its insurance requirements on franchisees.  Although insurance requirements may be contained in the franchise agreement, it is crucial for a franchise system to have procedures in place to review the applicable insurance and to ensure that the franchisee has the requisite insurance in place.  Requirements for the franchisees to furnish evidence of insurance, having the franchise system named as an additional insured, or requiring notification directly to the franchisor of notices of non-payment or potential cancellation, are several tools that a franchise system can use to ensure that the franchisee has effective insurance available for potential tort suits.

Lastly, franchise systems should take a good hard look at the elements of control they exercise over their franchisees.  Franchise systems should analyze whether the control actually exercised is consistent with the core business strategy and functions of the franchise system, rather than control which is not necessary to the business model.  To the extent a franchise system can reduce its control over the franchisees and their actions in a way that does not detract from the business model, this change in operation will minimize the ability of the plaintiff's bar to pursue a franchisor for the tort actions of its franchisees or employees.

Franchisees: Independent Contractors or Employees?

By Bud Culp

A series of court rulings in Massachusetts have challenged the assumption that franchisees are independent contractors and not employees.  In the most recent case, the Massachusetts Supreme Judicial Court held that a franchisee for a commercial cleaning service, misclassified by the franchisor as an independent contractor instead of an employee, was entitled to recover damages for franchise fees and insurance premiums deducted from his “wages.”  Awuah v. Coverall North America, Inc., 460 Mass. 484 (August 31, 2011).  

Coverall franchisees enter into a franchise agreement to provide commercial janitorial services to third-party customers.  Coverall contracts directly with the customers to provide cleaning services, bills the customers, and pays the franchisee for services after deducting franchise royalties and insurance payments.  The court found that this procedure improperly deferred payment of wages and that the Coverall system, in effect, required employees to “buy their jobs” in violation of public policy.  Id at 497-98.

While the contract structure of Coverall differs from that used in most franchise relationships, franchisors should analyze their business model to determine whether its franchisees may be considered independent contractors in the states in which they do business.  Franchisors should consider changing a model in which the franchisor, and not the franchisee, bills the customer and collects payment.  Franchisors should also consider granting franchise rights from a different company than the legal entity that operates any company-owned units.  Otherwise, franchisors may inadvertently find their franchisees have been transformed into employees and themselves liable under labor, tax and other laws for workers’ compensation and damages.

Guide to Brands of the IP Frontier

By Charles F. Luce, Jr.

The Bar Lazy J. The Long X. The Flying Crown.  These famous brands still stir images of the Old West. Sizzled on the hides of livestock, the hallmark of a good brand was that it was instantly identifiable and difficult to alter. A good brand says, “This is mine, back off!” 

Brands and brand protection are still important in the New West: the IP Frontier. Just survey your chuck wagon (pantry) or the aisle of any Kroger or Costco, Pardner, and you’ll see what I mean. So here is your guide to the Brands of the IP Frontier.

©

This brand denotes the owner claims copyrights in the material on which it is used. A copyright notice consists of the copyright symbol, followed by the year the claimed work was first published the name of the copyright claimant, e.g., © 2012 Moye White LLP.

Prior to 1989, the failure to use this brand usually caused an otherwise copyrighted work to be lost to public domain. Not so since 1989, when the United States became a full signatory to the Berne Convention. However, since not all countries are Berne Convention members, use of this brand is still a good idea if you don’t want your copyrights to be rustled.

TM

The brand ™ is an unofficial notice that the word(s) and/or design on which it is affixed is considered a trademark. Because ™ is an unofficial brand there are no rules governing its use. By custom the small capital letters ™ are typically used as a superscript or subscript immediately adjacent to the material claimed to be a trademark.

While the use or failure to use ™ carries no legal weight or penalty, it is effective in drawing attention to a claim of common law trademark rights, particularly when the claimed mark might otherwise not be recognized to be considered proprietary, e.g., The Little Bakery™.

SM

This more rarely seen brand, an abbreviation of “service mark,” serves the same function as ™, except most people haven’t a clue what it means.

The correct usage of SM to demonstrate that one knows the difference between a product and a service might warrant a gold star from a trademark professor. But since service marks are subsumed within the definition of “trademark,” and the whole point of IP branding is to provide notice, this wrangler thinks anyone who uses SM is a sissy.

®

This brand connotes that the owner has registered its mark with the United States Patent and Trademark Office. The recovery of damages under the Trademark Act is dependent upon its consistent use. Conversely, using the registered trademark symbol without having an actual trademark registration is consumer fraud and can be the basis for deny­ing an application for registration.

A surprising number of registered trademark owners incur the time and expense to obtain the right to use this legal brand and then never do. Given the powerful legal presumptions accorded to the owner of a United States trademark registration it is the opinion of this IP wrangler that someone who owns a federal trademark registration and fails to use the official registration symbol is plum loco.

Patent Pending

Let’s get one thing straight: patents don’t pend. You either got a patent or you don’t.

Now that we’ve settled that, the Patent Act does allow someone who’s filed a patent application to mark their inventions “patent pending” to indicate that a patent application is pending.
But woe unto the varmint who uses the brand “patent pending” if a patent application isn’t actually pending. The false use of “Patent Pending” is prohibited by federal law.

Reg. U.S. Pat. Off.

This here brand means “Registered United States Patent Office,” and should be followed by a patent number. A U.S. patent allows a patent holder to prevent others from making, using, sell­ing, or leasing inventions covered by the patent. This particular brand is required by the Patent Act to recover damages under the Patent Act.

Them’s the brands of the IP Frontier. Use them properly to protect your intellectual property herd and be respectful when you see them used by others.

Billy Jones to Speak at DRI on Hot Topics in Franchise Law

Moye White attorney, Billy Jones, will be a featured speaker at the Defense Research Institute's Business Litigation and Intellectual Property Seminar in New York, 16-18 May 2012. 

Billy will discuss three recent cases and their practical implications for franchisors and franchisees, including whether franchisees are truly independent contractors; state efforts to apply income tax to franchisee royalties paid to an out-of-state franchisor; and potential franchisor liability for workers' compensation injuries to a franchisee's employees.