Patel, et al. v. 7-Eleven, Inc., et al – While the Massachusetts’ Independent Contractor Statute May Apply to Franchise Relationships, the SJC’s Decision Actually offers Protection for Franchisors

Introduction

On March 24, 2022, the Massachusetts Supreme Judicial Court (“SJC”) issued a much-anticipated decision in Patel, et al. v. 7-Eleven, Inc., et al. answering a certified question from the United States Court of Appeals for the First Circuit concerning the application of the Massachusetts independent contractor law (“ICL”) to franchise relationships.  The SJC found there is no conflict (and thus no preemption) between the “freedom from control” requirement under Prong A of the ICL and the Federal Trade Commission (“FTC”) Franchise Rule (the “FTC Franchise Rule”) which includes franchisor control as a potential element of a franchise relationship.  

While some may see the SJC’s ruling as a boon for potential franchise misclassification claims, the SJC was careful to limit the scope of the ruling and actually offers useful guidance for franchisors.  First, the SJC confirmed the importance and protection of legitimate franchise relationships. Second, and significantly, it made clear that before any consideration of the ICL’s three prongs, there is a threshold question: a franchisee claiming to be a misclassified employee must first establish that the franchisee is an “individual performing any service” for the franchisor.  Patel v. 7-Eleven, Inc., No. SJC-13166, 2022 WL 869486, at *1 (Mass. Mar. 24, 2022). This is significant because franchisors don’t pay franchisees for services. Rather, franchisees pay franchisors, commonly through an upfront fee and ongoing royalties, for a license to use the franchisor’s trademarks and business format to operate an independent business associated with the franchisor’s brand.  Indeed, as defined under both the FTC Franchise Rule and various state franchise relationship laws, a “franchise” (and thus a franchise relationship) is an ongoing commercial relationship where a franchisee operates an independent “business” associated with the franchisor’s trademark.  Thus, this threshold providing services question should mean that for franchisors with true franchise relationships where franchisees operate independent businesses (as opposed to those designed to evade wage and hour laws) the ICL’s three--prong test simply will not apply.

Case Background and Decision

The Massachusetts ICL establishes a three-pronged “ABC” test to determine whether someone is an employee or an independent contractor. If an individual performs services for the putative employer, the ICL presumes employment status, which the putative employer can overcome by establishing:

1. the individual is free from control and direction in performing services;
2. the service performed is outside of the putative employer’s usual course of business; and
3. the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.

In Patel, several 7-Eleven franchisees allege they are actually employees misclassified as independent contractors.  See Patel v. 7-Eleven, Inc., 8 F.4th 26, 28 (1st Cir. 2021). On cross motions for summary judgment, citing Monell v. Boston Pads, LLC, 471 Mass. 566 (2015), the Federal District Court found that the ICL did not apply to a franchisor / franchisee relationship because “there is an ‘inherent conflict” between Prong A which requires the “worker” be “free from control in connection with the performance of the service” and the FTC Franchise Rule which contemplates a franchisor will “exert or [have] authority to exert a significant degree of control over the franchisee’s method of operation . . . .” Patel v. 7-Eleven, Inc., 485 F. Supp. 3d 299, 309 (D. Mass. 2020).  Plaintiffs appealed.  Focusing on that conflict, the First Circuit certified the following question:  “[w]hether the three-prong test for independent contractor status set forth in [G. L. c. 149, § 148B,] applies to the relationship between a franchisor and its franchisee, where the franchisor must also comply with the FTC Franchise Rule [16 C.F.R. § 436.1, et seq.].”  Patel, 8 F.4th at 29.  The Court of Appeals recognized the broader policy implications at stake, noting, in its certified question: there are “unique policy interests at stake,” the resolution of which impacts “untold sectors of workers and business owners across the Commonwealth.” Id. The SJC also saw the significant policy implications and took the opportunity to offer additional guidance which actually offers significant protections for franchisors. Patel, 2022 WL 869486 at *9. 

On the conflict question, the SJC noted the importance of proper classification and how the ICL reflects “the Legislature's broad, remedial intent ‘to protect workers by classifying them as employees, and thereby grant them the benefits and rights of employment, where the circumstances indicate that they are, in fact, employees.’”  Id. at *3 (quoting Depianti v. Jan-Pro Franchising Int'l, Inc., 465 Mass. 607, 620 (2013)).  Excluding franchise relationships from the ICL could potentially “permit employers to evade obligations under the wage statutes merely by labeling what is actually an employment relationship as a "franchise" relationship.” Patel, 2022 WL 869486 at *9.

The SJC ultimately found no conflict because the FTC Franchise Rule “is a pre-sale disclosure rule” that “does not regulate the substantive terms of the franchisor-franchisee relationship.” Id. at *6.  Given the FTC definition of a franchise, the SJC found that “control” is not necessarily the defining element because a franchisor can either exert “a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation”.  It could be just “significant assistance” to the franchisee. 

Even where the franchisor chooses to exercise control over the franchisee's method of operation, however, the SJC found that the FTC Rule disclosure obligations “do not run counter to proper classification of employees and, importantly, does not necessary make the franchisee an employee under Prong A.”  Id. at *6-7.  “Indeed, ‘significant control’ over a franchisee's ‘method of operation’ and ‘control and direction’ of an individual's ‘performance of services’ are not necessarily coextensive,” the SJC reasoned.  Id. at *7 (quoting Goro v. Flowers Foods, Inc., No. 17-CV-2580 TWR (JLB), 2021 WL 4295294 (S.D. Cal. Sept. 21, 2021)).  Similarly, the SJC noted that the “controls required under the Lanham Act, 15 U.S.C. § 1064(5)(A),” also do not preclude compliance with the first prong of the ABC test.  Patel, 2022 WL 869486, at *7 n.16.

Finally, the SJC dismissed both the franchise industry's concern that a literal application of the ICL prongs would render virtually all franchisees employees and any thought of the “apocalyptic end of franchise arrangements.” Id. at *8.  Signaling an opportunity for franchisors to defend the legitimacy of their business models and the resulting franchise relationship, especially through the now clearly applicable threshold providing services question, the SJC noted that “any analysis of whether the ABC test is met must be done on a case-by-case basis”, citing numerous cases where franchise relationships were found to satisfy the three prongs of the ICL.  Id. *8 n.17.  

Patel provides a roadmap for franchisors defending misclassification claims.

The SJC made clear that application of the ICL to franchise relationships would not “result in every franchisee being classified as an employee of the franchisor”. Id. at *9.  This was obviously important given the recognition by the First Circuit that there are “unique policy interests at stake” which impacts “untold sectors of workers and business owners across the Commonwealth.”  Patel, 8 F.4th 29. The SJC’s decision, especially the additional guidance, provides a roadmap for franchisors facing misclassification claims.

Patel recognizes and protects legitimate franchise relationships.

First, Patel confirms that nothing in the ICL prohibits legitimate franchise relationships that have not been created to evade obligations under the wage statutes.  Patel, 2022 WL 869486 at *9.  The SJC quotes a Massachusetts Attorney General Advisory Opinion which expressly states “there are legitimate independent contractors and business-to-business relationships in the Commonwealth [which] . . . are important to the economic wellbeing of the Commonwealth and, provided that they are legitimate and fulfill their legal requirements, they will not be adversely impacted by enforcement of the [ICL].”  Id. (citing Advisory 2008/1 at 5) (emphasis added).  While the Court did not want a blanket exemption leading to putative employers seeking to avoid the ICL simply by labeling relationships as a franchise, the underlying message of the decision is that legitimate franchise relationships are valid and are to be protected.

The SJC’s endorsement of legitimate franchise relationships is important because franchising is a “ubiquitous, lucrative, and thriving business model” which has “existed in this country in one form or another for over 150 years.” Patterson v. Domino's Pizza, LLC, 333 P.3d 723, 725, 733 (Cal. 2014).  Maybe the most common form of franchising is business-format franchising (e.g., restaurants, hotels, gyms, and convenience stores) where the franchisee buys the right to use the franchisor’s trademarks, service marks, trade names, logos, proprietary business format, and methods to establish and operate their own independent business.  See id. at 733 (“Under the business format model, the franchisee pays royalties and fees for the right to sell products or services under the franchisor's name and trademark.”).  As noted, the FTC Franchise Rule embodies the notion that franchisees are not “workers” but rather individuals who want to own and operate their own independent businesses. See 16 C.F.R. § 436.1(h)(1) (franchise is a “continuing commercial relationship or arrangement” where the franchisee obtains “the right to operate a business that is identified or associated with the Franchisor’s trademark”) (emphasis added).  Indeed, a franchisee is “an entrepreneurial individual who is willing to invest his time and money, and to assume the risk of loss, in order to own and profit from his own business.”  Patterson, 60 Cal. 4th at 490 (emphasis added).  Instead of opening a non-branded convenience store, restaurant, hotel, or other retail business, franchisees see the benefit of using the franchisor’s “brand” and business format because it provides the franchised business instant credibility, a customer base, and the “good will” associated with the franchisor’s brand.  The SJC recognizes franchising as a legitimate business model that is to be protected.

Franchisees must prove they are an “individual providing any service” to the Franchisor and not operating an independent business.

Second, and most significantly, the SJC confirmed that before any consideration of the individual ICL prongs, there is a threshold question that should render the ICL inapplicable to legitimate franchise relationships.  As the Court held, “distinguishing between legitimate arrangements and misclassification requires examination of the facts of each case, which begins with a threshold determination whether the putative employee ‘perform[s] any service’ for the alleged employer.” Patel, 2022 WL 869486 at *9 (citing G. L. c. 149, § 148B) (emphasis added).  In the franchisor -/- franchisee context, this threshold determination should turn on whether the franchisee is actually operating an independent business, or the franchise relationship is a subterfuge to outsource workers by classifying them as independent contractors instead of employees. Id. (citing Sebago v. Boston Cab Dispatch, 471 Mass. 321, 329-331 (2015)).

Significantly, the putative employee challenging the nature of the franchise relationship carries the burden of proof on this threshold question.  Also, per the SJC, the franchisee cannot meet that burden merely by showing there is a mutual economic benefit between the franchisor and franchisee which, of course, is the case.  Patel, 2022 WL 869486 at *9.  Similarly, mere compliance with relevant regulatory obligations by the franchisor is also not dispositive of the “performs any service” question.  Id.

This threshold independent business -/- providing services question actually has been central to many cases.  See, e.g., Athol Daily News v. Bd. Of Rev. Of Div. Of Emp. And Training, 439 Mass. 171, 181, 786 N.E.2d 365 (2003) (Court needs to determine “whether the worker is wearing the hat of an employee of the employing company, or is wearing the hat of his own independent enterprise.”); Boston Bicycle Couriers, Inc. v. Deputy Director of the Div. of Employment & Training, 56 Mass.App.Ct. 473, 480, 778 N.E.2d 964 (2002).  See also Sebago, 28 N.E.3d at 1149 (holding that the trial court erred in failing to award summary judgment to defendant taxi garages where the record showed plaintiffs received service from, and did not provide services to, garages); Gallagher v. Cerebral Palsy of Massachusetts, Inc., 86 N.E.3d 496, 501 (Mass. App. Ct. 2017) (“Gallagher did not provide services to CPM and cannot be deemed its employee for the purpose of the Wage Act or the overtime statute.”).  Further, while decided in the context of the ABC prongs, Awuah v. Coverall N.A., Inc., 707 F. Supp. 2d 80 (D. Mass. 2010) and Coverall N.A. Inc. v. Comm’r of Div. of Unemployment Assistance, 447 Mass. 852, 857 N.E.2d 1083 (2006) also turned on this threshold question.  In each case, the courts concluded, based on the actual relationship and business structure, that the franchisees were not operating independent businesses but instead providing cleaning services for their franchisors.  Because Coverall provided the initial equipment and supplies; solicited and contracted directly with customers; set prices; invoiced customers and collected payments; and paid the putative franchisees after deducting fees, the Awuah and Coverall courts concluded those franchisees were not operating true independent businesses but rather were simply being paid for the cleaning services they were providing. Awuah, 707 F. Supp. 2d at 84; Coverall N.A. Inc., 447 Mass. at 859.

Even though the franchisee has the burden of proof on this threshold question, franchisors should be prepared to demonstrate how and why their franchisees are operating independent businesses. Franchisors should take the opportunity to review their presale disclosures, franchise agreements, and operations manuals and policies, to make sure that nothing reflects that franchisees are providing services and instead confirm that the franchisee is operating an independent business.  Franchisors should have a robust presale disclosure and acknowledgment concerning the nature of the relationship, including that the franchisee, by executing the franchise agreement is agreeing to establish and operate an independent business, the success of which depends on, among other things, the franchisee’s individual entrepreneurial ability. The specific terms of the franchise agreement will also be important, especially the franchisee’s authority and responsibility to manage and control customer relationships, pricing, profits, etc. All should demonstrate that when franchisees execute the franchise agreement they are not applying for a job, but rather entering into a commercial relationship pursuant to which they will establish and operate their own business.

Patel also offers useful guidance beyond the franchisor-franchisee relationship.

The threshold question of whether the individual claimant is performing services for the putative employer is not unique and certainly not limited to franchisor-franchisee relationships.  Patel reflects that various business arrangements involving legitimate independent contract relationships may indeed satisfy the ICL.  

Also, while the ICL is intended to protect Massachusetts workers and provides a presumption of employment status once applicability is determined, Patel confirms that the considerations under the ABC prongs are more nuanced than many suggest.  Indeed, because the ABC test involves intricate, fact-specific inquiries, Patel recognizes that businesses establishing proper independent contractor arrangements can prevail under each prong of the ICL’s ABC test.

As an example, the SJC acknowledges that the specific nature of the control being exerted matters, and not all control precludes a finding of an independent contractor relationship.  While “control and direction in connection with the performance of the service” may reflect an employment relationship, the Patel decision confirms such control is distinct from control over a worker’s “method of operation.”  Patel, 2022 WL 869486 at *7.  According to the SJC, these two types of control “are not necessarily coextensive.”  Id.  Patel indicates that a business can exert control over the method of operation, and perhaps in other areas, and still satisfy prong A. Id.

Patel also reflects that neither prong B nor C is an insurmountable obstacle to a finding of a valid independent contractor relationship.  In a lengthy footnote, the SJC acknowledges, without criticism, numerous decisions where franchisors were held to have satisfied prongs B and C. Id. at *8. While those cases involved franchise arrangements, the Court’s rationale and observations should apply to other independent contractor business relationships.  Because “distinguishing between legitimate arrangements and misclassification requires examination of the facts of each case,” id. at *9, Patel reflects that businesses in Massachusetts—even those involving certain elements of control, synergy, and reliance—can establish legitimate independent contractor relationships.

John Skelton is co-chair of Seyfarth’s Franchise and Distribution Practice Group, Anthony  Califano is a partner in the firm’s Labor and Employment department and routinely represents clients concerning employee classification. Keval Kapadia, is an associate and a member of the Franchise Practice Group.