Master Franchisees Beware

Last but not least, master franchisees should review the ways in which they encourage unit franchisees to expand their businesses. The contracts between these parties typically allow the latter to drum up business on their own – one sign of an independent operation – but in many cases master franchisees do all the prospecting for new customers, in effect telling unit franchisees that they have clients wanting service and that the limits on unit franchisee income depend only on how many territories the unit franchisees can afford to buy up and service.

Regulators say this practice amounts to nothing more than an employer providing leads to its employees – as, for instance, an insurance agency might supply leads to its agents. In most cases, regulators say, unit franchisees actually provide services only to clients of the master franchisee, no matter what the agreement between the parties says.
 
A big challenge in reviewing these contractual and practical arrangements is that not all agencies in a given state test for franchisor-franchisee relationships in the same way, irrespective of the provisions of state law. Indeed, many agencies look for different signs of the relationship and rule accordingly, the result being that one agency may deem a particular relationship to be that of a franchisor and franchisee where another sees an employer-employee relationship. To make matters worse, because case law holds that such rulings by one state agency are not binding on others, this can leave companies in a kind of legal limbo.
 
Even more ominously, in several states including California, franchisors of all kinds now face the threat of litigation from the plaintiff’s bar under new provisions of state law allowing plaintiff’s attorneys to bring suit against private businesses for violations of employment law – in the past the job of state regulatory agencies only. The incentive in these new provisions of state law is that the penalties for such violations may flow not to the state, as in the past, but to the attorneys themselves.
 
Clearly, franchise operations in the industries under scrutiny face threats on several fronts, and they must step carefully if they are to thrive. This will not be easy, given the traditional informality of business arrangements among many operators in the industries now under scrutiny, among them their tendency to hire unskilled, often illegal immigrant laborers who do not speak English and know nothing of American franchise and labor law. But the alternative is worse.

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