The Massachusetts Supreme Judicial Court Upholds 7-Eleven Franchise System in Denying Franchisees’ Challenge to Their Independent Contractor Status

Introduction

On September 5, 2024, the Massachusetts Supreme Judicial Court (“SJC”) answered a second certified question in Patel, et al. v. 7-Eleven, Inc., et al. (“Patel II”), a long-running case where 7-Eleven franchisees claimed they are misclassified independent contractors and should be deemed employees.  This time, in a resounding victory for 7-Eleven, the SJC held that the franchisee-plaintiffs failed to meet their threshold burden under the Massachusetts Independent Contractor Law (“ICL”) of proving that, as 7-Eleven franchisees, they were individuals performing service for the franchisor-defendant 7-Eleven.  Because the court ruled that 7-Eleven franchisees were not “providing services” to 7-Eleven in the operation of their franchised convenience stores, the ICL and the rigorous three-prong “ABC test” did not apply.

In our Legal Update on March 29, 2022, available here, we discussed the SJC’s first decision in Patel v. 7-Eleven, Inc., 489 Mass. 356 (2022) (“Patel I”), previewing the threshold question now answered by the SJC in Patel II.  While some saw the holding in Patel I—that the FTC franchise rule did not preempt application of the ICL to a franchise relationship—as a boon for potential franchisee misclassification claims, we noted that the SJC carefully limited the scope of the ruling.  Most significantly, Patel I confirmed that the classification question is a fact-intensive inquiry with the threshold question being whether a franchisee-worker who disavows independent contractor status and claims to be a misclassified employee actually is an “individual performing any service” for the franchisor.  In Patel II, the SJC answered that question, “no.” Patel II, No. SJC-13485, 2024 WL 4046630, at *2 (Mass. Sep. 5, 2024).  The franchisee-plaintiffs did not establish that by operating as franchisees they actually provided service to 7-Eleven and instead were determined to be operating their own independent business.

The Patel II decision represents not only a win for 7-Eleven but also for other legitimate franchise relationships and potentially other businesses that utilize independent contractor business models.

Case Background

Understanding Patel I lends to a better understanding of Patel II.  In Patel I, the SJC addressed whether the FTC Franchise Rule, which requires certain control over franchisees by franchisors, preempted the application of the three-prong “ABC” test under the ICL.  While Patel I held that the FTC Franchise Rule did not preempt application of the ICL, it noted the independent contractor classification question was fact-determinative and began with the threshold question whether the individual franchisee claiming to be a misclassified employee actually “perform[s] any service” for the franchisor. Patel I, 489 Mass. at 370.  On this threshold question, the SJC observed that the franchisee (or alleged employee) bears the burden of proof.  Id. at 361.  If the franchisee meets this threshold burden, then the burden shifts to the franchisor (or alleged employer) to meet all three prongs of the ABC test.  Id.  Patel I recognized where franchisees truly operate independent businesses they are not providing services to the franchisor and, thus, the ICL’s three-prong test would not apply. Id. As the SJC recognized in Patel I, nothing in the ICL prohibits legitimate franchise relationships not created to evade obligations under the wage statutes. Id. at 370.

After Patel I, the trial court entered summary judgment in favor of 7-Eleven, finding that the three-prong ICL test did not apply because the plaintiffs could not establish they were “performing any service” for their putative employer, 7-Eleven. Patel v. 7-Eleven, Inc., 618 F. Supp. 3d 42, 49 (D. Mass. 2022). On appeal, the First Circuit certified a second question to the SJC, this time specifically asking whether, by operating their franchises pursuant to the 7-Eleven franchise agreement, the 7-Eleven franchisees were providing service to 7-Eleven:

"Do [the plaintiffs] 'perform[] any service' for 7-Eleven within the meaning of [the independent contractor statute], where, as here, they perform various contractual obligations under the Franchise Agreement and 7-Eleven receives a percentage of the franchise's gross profits?"

Patel v. 7-Eleven, Inc., 81 F.4th 73, 76 (1st Cir. 2023).  The SJC answered that question “no.”  Patel II, 2024 WL 4046630, at *2.  While affirming "[t]he purpose of the independent contractor statute is 'to protect workers by classifying them as employees” the SJC held that the relationship between 7-Eleven as a franchisor and the plaintiffs as franchisees, “which generally are typical of franchise relationships, do not indicate that the plaintiffs are in fact employees….”  Id.  Addressing squarely the elements of the 7-Eleven franchise system, the SJC held that the plaintiff-franchisees are not providing service to 7-Eleven but rather are operating their own independent businesses.

Patel II Recognizes and Protects Legitimate Franchise Relationships.

Patel II now confirms that in the franchisor-franchisee context where the franchisee is actually operating an independent business, the ICL simply does not apply.  Noting the “character of a franchise relationship and its intersection with federal law,” the SJC ruled that simply operating a franchised business does not satisfy the ICL’s threshold requirement that the putative employee be “providing services” to the franchisor.  Patel II, 2024 WL 4046630, at *2.  The SJC focused on the characteristics of a true franchise relationship where instead of the franchisee developing a new brand and business format the franchisee elects to operate their own independent business using the franchisor’s trademark, good will, and business format.  Id.  In particular, the SJC said:

Specifically, “[a] franchise is a business format typically characterized by the franchisee’s operation of an independent business pursuant to a license to use the franchisor’s” intellectual property, such as its service mark, trademark, trade dress, or trade name. . .  Thus, rather than operate a store under their own name or developing their own goodwill with the consuming public, franchisees choose to operate their stores using the franchisor’s brand, presumably having concluded that the benefits of doing so outweigh the franchise fee and other conditions associated with the brand’s use. 

Patel II, 2024 WL 4046630, at *5 (internal citation excluded).  In other words, “in exchange for the right to use the franchisor’s brand,” the franchisee agrees to comply with certain conditions, including a certain level of franchisor control and the payment of compensation to the franchisor.  While franchisor “control” is often argued to be indicative of misclassification, the Patel II court acknowledged that federal law provides a franchisor’s failure “to control and supervise the use of its brand” may result in a determination that the franchisor has abandoned its intellectual property. Id.

While characterization of the relationship as a franchise is not determinative, the fact that the 7-Eleven franchisees entered into franchise agreements and specifically chose to operate a 7-Eleven branded convenience store using the 7-Eleven trademarks and system capitalizing on the “good will and associated market power” of the 7-Eleven brand was important. Id. at *7. Indeed, the SJC observed that “[t]his business decision by the franchisees” informs whether “the circumstances indicate that they are, in fact, employees,” such that classification of them as employees serves the purpose of the independent contractor statute.” Id. at *2 (quoting Depianti v. Jan-Pro Franchising Int’l, Inc., 465 Mass. 607, 620 (2013)).

The SJC also rejected plaintiffs’ argument that they are providing services to the franchisor simply because franchisees are required to operate the franchised business in conformity with the franchisor’s business standards.  Specifically, the SJC said:

If, as contended by the plaintiffs, operating the convenience stores in compliance with these obligations were considered "performing any service," all typical franchise relationships would be presumptive employment relationships.  We reject such an unreasonable construction.

Patel II¸ 2024 WL 4046630, at *9. The SJC added that “[s]uch a sweeping classification of independent owners of franchises as presumptive employees of the franchisor does not further the ‘main objective to be accomplished’ by the” ICL.  Id.

The SJC held similarly that (i) simply because 7-Eleven benefits from the sale of products or services by franchisees does not mean that the franchisees are providing services to 7-Eleven; and (ii) it does not matter whether 7-Eleven charges a flat fee or royalty to the franchisee.  Id. at *7.  Ultimately, the question is not the services provided by 7-Eleven as franchisor or the requirement that the franchisees “operate their stores in compliance with certain quality, marketing, and operational standards set by 7-Eleven” but whether the franchisee is performing a service to 7-Eleven.  Id. at *9.  Again, the court focused on the decision by the franchisees to operate their convenience store businesses using the 7-Eleven business format “rather than operate a convenience store under their own name and goodwill. . . .” Id.  While the franchisee is using the franchisor’s brand and system, in the end, the SJC held that the franchisee is still operating an independent business for its own benefit and thus the circumstances simply did not “indicate that [the plaintiffs] are, in fact, employees” of 7-Eleven. Id. at *10.

In Patel II, the SJC also addressed (and distinguished) the so-called janitorial cases (e.g., 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 (2006)), which some courts have cited as confirming that the ICL’s three prong test applies to franchises. See, e.g., Vasquez v. Jan-Pro Franchising Int’l, Inc., 939 F.3d 1050, 1051 (9th Cir. 2019).  Per the SJC, the Coverall franchisees were not truly operating independent business.  “Unlike the typical franchise relationship described supra, pursuant to which the franchisee operates its own independent business using the franchisor’s brand, the record in Coverall showed that the franchisee provided the janitorial labor for the franchisor’s customer accounts and was paid by the franchisor for doing so.” Patel II¸ 2024 WL 4046630, at *6.  While the Coverall cases were decided based on the application of the ICL’s ABC prongs, 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 the franchisor.  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 that those franchisees were not operating true independent businesses but rather were simply being paid for the cleaning services they were providing to Coverall.  Awuah, 707 F. Supp. 2d at 84; Coverall N.A., Inc., 447 Mass. at 859.

Franchisors Should Be Ready to Show That Franchisees Truly Operate Independent Businesses.

As Patel II makes clear, simply labeling the relationship a franchise does not protect the relationship from a misclassification challenge.  To avoid or defeat claims of misclassification, a franchise system must be a true franchise whereby franchisees are operating independent businesses.  This means that franchisors should review and assess the structure of their business format, as well as their franchise agreements, operations manuals and policies, to make sure that the franchisee is operating an independent business.  In this regard, the specific terms of the franchise agreement and relationship are important, especially the franchisee’s authority and responsibility to manage and control customer relationships, pricing, profits, and more.  Franchisors should also 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.  All should make clear that when franchisees decide to enter into the franchise system and use the franchisor’s brand and business format, they are entering into a commercial relationship pursuant to which they will establish and operate their own business—one that does not entail the franchisee “performing service” to the franchisor.

Patel I and II Offer Useful Guidance Beyond the Franchisor-Franchisee Relationship.

As we observed in our Legal Update regarding Patel I, the threshold “service” question is an important question – one that is not unique to franchise relationships.  A decision from the Massachusetts Appeals Court earlier this year underscores this point.  In Weiss v. Loomis, Sayles & Co., Inc., 104 Mass. App. Ct. 1 (2024), the court affirmed a jury verdict in favor of an alleged employer in an independent contractor misclassification case where the alleged employee, a software engineer, provided service to the alleged employer, an investment firm, through a business entity that he created and owned. Weiss, 104 Mass. App. Ct. at 2.  The Appeals Court framed the issue as follows:

Where individuals provide services directly to the employer, the application of the [ICL] statute is relatively straightforward: they are presumptively considered employees unless the employer – carrying the burden of proof – proves that [the] three separate [ABC] prongs are all satisfied.  However, the situation becomes murkier where the individual provides services to the employer through an intermediary entity.  In such circumstances, the individual may not have standing to pursue a misclassification claim, because the statute was not intended to bar legitimate business-to-business relationships.

Weiss, 104 Mass. App. Ct. at 2-3 (internal quotation marks and citations omitted).

While Weiss and Patel II are different, the question of who provides service, and under what circumstances, is front and center in both decisions.  In Patel II, the franchisees claiming to be employees did not provide service to 7-Eleven simply by operating their convenience store businesses.  In Weiss, the would-be employee provided service through one or more third party business entities.  In fact, in Weiss, the plaintiff arguably did not provide any service to the alleged employer.  Rather, the third-party business entities provided service to the alleged employer and the plaintiff was simply an instrument for providing the service.  In both cases, the appellate courts acknowledged the importance of the threshold “service” inquiry.  They did not treat application of the ICL’s ABC test as a foregone conclusion.  Accordingly, when framing or structuring an independent contractor relationship or defending a claim under the ICL, businesses are well-served to conduct a strategic evaluation of all the circumstances, such as who or what is providing service and to whom or what the service is being provided.  And documenting these points in a contract may be advisable.  As Patel II and other decisions show, the structure of the actual relationship matters.

John Skelton is a partner and co-chair of Seyfarth’s Franchise and Distribution Practice Group. Anthony Califano is a partner in the firm’s Labor and Employment department.  Alex Reganata is an associate in the firm’s Labor and Employment department.