Massachusetts Supreme Judicial Court Finds Independent Contractor Test Applicable To Franchisees
The Massachusetts Supreme Judicial Court (“SJC”) recently held that the three-prong test used to determine independent contractor status under Massachusetts law applies to relationships between franchisors and franchisees.
The SJC’s decision, Patel v. 7-Eleven, Inc., was issued in response to a certified question brought before the court: whether the three-prong test under the Massachusetts independent contractor statute applies to a franchisee/franchisor relationship where the franchisor is obligated to comply with the Federal Trade Commission’s (“FTC”) Franchise Rule.
The SJC’s conclusion that the three-prong test does apply to franchisees and does not conflict with the FTC Franchise Rule could have important repercussions, as franchisees in Massachusetts may be able to show more readily that they are employees of their franchisors and, consequently, protected by all of the rights and remedies that employee status entails.
The Patel case centered on whether the Massachusetts independent contractor statute impermissibly conflicted with the FTC Franchise Rule.
The plaintiffs in the case were individuals who entered into franchise agreements with the defendant, 7-Eleven Inc., to operate 7-Eleven branded convenience stores in Massachusetts. The franchise agreements describe the plaintiffs as independent contractors, providing that they do not receive a salary but instead draw pay from their stores’ gross profits after paying the fees required by the franchise agreement to 7-Eleven.
The plaintiffs filed a complaint in Massachusetts Superior Court, alleging that they are, in fact, 7-Eleven employees and that they have been misclassified by 7-Eleven as independent contractors in violation of the Massachusetts independent contractor statute, as well as the Massachusetts Wage Act and the state minimum wage law.
The case was removed to the U.S. District Court for the District of Massachusetts. A District Court judge entered summary judgment in favor of 7-Eleven, concluding that the independent contractor statute does not apply to franchisee/franchisor relationships because there is an “inherent conflict” between the statute and the FTC Franchise Rule. The plaintiffs appealed, and the District Court certified for the SJC the question of whether there is a conflict between the language of the independent contractor statute and the FTC Franchise Rule.
Independent Contractor Statute
The independent contractor statute, M.G.L. c. 149, §148B, establishes the standard for determining whether an individual is an independent contractor or an employee under the Massachusetts Wage Act, M.G.L. c. 149, §148, and the state minimum wage law, M.G.L. c. 151, §§1, 7.
The independent contractor statute uses a three-prong test (commonly known as the “ABC test”) to make this determination. Under the ABC test, an individual providing services for an employer will be considered an employee unless: 1) the individual is free from control and direction in connection with the performance of the service, both under his or her contract for the performance of service and in fact; (2) the service is performed outside the usual course of the business of the employer; 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.
There are heavy penalties for employers that misclassify employees as independent contractors. Employees who prove they have been misclassified are entitled to treble (i.e., triple) damages for any lost wages and other benefits, as well as the costs of any litigation and reasonable attorneys’ fees.
FTC Franchise Rule
The FTC Franchise Rule does not directly concern employee status. Instead, it addresses the disclosures that franchisors must make to franchisees regarding potential franchise agreements. The Franchise Rule makes a franchisor’s failure to provide certain specified presale disclosures to a prospective franchisee an unfair or deceptive act or practice in violation of the Federal Trade Commission Act, 15 U.S.C. §45(a)(1).
These disclosure requirements apply to franchisors and define a “franchise” as a continuing commercial relationship under which the franchisor “will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.” The disclosure obligations are triggered when a prospective franchisor either exerts a significant degree of control over the franchisee’s method of operation or chooses to provide significant assistance in the franchisee’s method of operation.
The question certified to the SJC was whether the first prong of the ABC test conflicted with the FTC Franchise Rule, given that the first prong of the ABC test weighs the degree of control the employer exerts over the putative employee, while the Franchise Rule is triggered when the franchisor exercises significant control over a franchisee. In essence, the SJC was asked: (i) whether the similarity between these two requirements would guarantee that franchisees who received disclosures under the Franchise Rule were employees for purposes of the Massachusetts independent contractor statute; and, (ii) if so, whether that would present a conflict between state and federal law such that the independent contractor statute would be preempted to that extent by the federal Franchise Rule.
Under general principles of preemption, such a conflict may be found if it is impossible, as a practical matter, for a party to comply with the requirements of both state and federal law. The SJC, however, determined that there was no such conflict, concluding that a franchisor could comply with the Franchise Rule to make the required disclosures, and that “in situations where a franchisee is deemed an employee under the independent contractor statute, the franchisor can comply with its obligations under the [state] wage statutes.”
In support of its holding, the SJC first noted that the independent contractor statute and the Franchise Rule concern different areas of the law. Although the Franchise Rule requires franchisors to make certain financial disclosures, it does not regulate the substantive terms of the business relationship in the same manner as the independent contractor statute. In particular, the court held that compliance with the disclosure requirements of the Franchise Rule does not mandate that a franchisor exert the type of control over a franchisee that would create an employer/employee relationship between the parties under the independent contractor statute.
The SJC also rejected 7-Eleven’s argument that application of the ABC test would result in every franchisee being classified as an employee of the franchisor thereby effectively ending the practice of franchising in the Commonwealth. The court differentiated between the types of control described in the first prong of the ABC test and in the Franchise Rule, stating that “the franchisor’s election to exercise ‘a significant degree of control over the franchisee’s method of operation’ does not render every franchisee an employee under the first prong of the ABC test; the two tests are not the same.” The court also noted that the application of the ABC test in the franchise context in other states with similar independent contractor statutes has not resulted in every franchisee being classified as an employee in those states, nor has it ended the practice of franchising in general, as 7-Eleven predicted.
Finally, the SJC addressed the concern that the classification of some franchisees as employees would preclude the paying of franchise fees as a prohibited assignment of an employee’s future wages to an employer. The court stated that even in a situation in which a franchisee was classified as an employee, a franchise fee could still be assessed as a cost of doing business deductible from gross revenue rather than from wages.
Implications For Employers
The Patel decision is favorable for Massachusetts franchisors insofar as it affirms that franchisees will not necessarily be deemed employees. Nonetheless, franchisors should take great care, and seek legal advice, in structuring their business relationships with franchisees, as the consequences under the Massachusetts independent contractor statute for misclassifying employees are severe.
* * *
Please feel free to reach out if you have any questions about the Patel decision or franchisor/independent contractor issues generally.