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.