Franchise Liability: Punishment for the Control Freak

One reason that the franchise method of doing business appeals to so many is that, if used correctly, both parties operate with some freedom.  A franchisor usually can expand its brands and system at a lower capital cost than by company-owned growth, and can teach its business methods but is independent.  A franchisee, meanwhile, gains a template for operations, but makes many management decisions and reaps the gains of unit growth.  The typical franchise agreement affirms that the two are independent contractors, and not employees or agents.  The franchisor’s protection from liability to the franchisee’s employees, customers, and vendors is an important benefit traditionally enjoyed from this independent contractor relationship. But, as a California Court of Appeals in a recent case reminds us, these protections may be lost, regardless of the language in the franchise agreement, if the franchisor “assumes substantial control over the franchisee’s local operation, its management-employee relations or employee discipline.”  The moral of the story is, “Don’t overdo it.”

Most franchisors spend a lot of time, trouble, and resources to build their brand.  Franchisees are usually bound by contract to re-create trade dress, menus, decor, and all of the other elements that help build the brand. One unit in the system should look much like any other, since all operate under the same trademark.  The customer, the thinking goes, should know exactly what to expect at any unit in the system.  This means that the typical franchise agreement between the franchise and the franchisee business owner says that the franchisee is an independent contractor.  Because the franchisee has put its own capital into the business, and is relying on its own management skills and sweat equity in making many business decisions, it is not an employee or agent of the franchise work.

In Patterson v. Domino’s Pizza, LLC (Sup. Ct. 56-2009-00347668-CU-OE-SIM, 6/27/12), an employee of a Domino’s pizza franchisee sued Domino’s Pizza corporate headquarters, as her employer, seeking to hold the corporate entity vicariously liable for a sexual assault by one of the franchisee’s store managers.   The lower court granted summary judgment in favor of Domino’s, holding that it could not be liable because the franchisee was not its agent according to the terms of the contract.  The California Court of Appeal reversed the summary judgment, finding that the other terms of the contract gave the franchisor such broad controls over all aspects of the franchisee’s business that it could have liability.

The case illustrates the dangers of trying to control too much of a franchisee’s business operations:  “Where a franchise agreement gives the franchisor the right to complete or substantial control over the franchisee, an agency relationship exists…Consequently, a franchisee may be found to be an agent of the franchisor even where the franchise agreement states it is an independent contractor.” The court acknowledged that a franchisor has an interest in protecting its reputation.

It drew a distinction between controlling process, and controlling product.  The opinion suggested that a franchisor has a legitimate interest in controlling the trademarks, products, and the quality of its services – what the customer sees.  In the Domino’s agreement, though, Domino’s had the right to control every aspect of the business, including, among other things, employee training, dress code, discipline, hiring, and firing – all secondary to the ultimate product of the restaurant.  Pizza quality and good customer service, it implied, were legitimate objects of protection for Domino’s corporate reputation; behind the scenes should have been left to the franchisee’s discretion.  The court looked to sections of the franchise contract governing almost every aspect of operations of the franchise.  It looked not only to specific language in the franchise agreement stating that the franchisee was an independent contractor, but at the “totality of the circumstances to determine who actually exercises the ultimate control.”

Because Domino’s was found to be the supervisor, it had potential strict liability for the manager’s sexual assault on the employee. The summary judgment was reversed, and the plaintiff could proceed to give evidence of control.

Not all states would reach the same result, but this and the Coverall cases in Massachusetts (finding an employment relationship in a janitorial franchise where the franchisor executed customer contracts) suggest that a franchisor needs to take a hard look at what provisions it really needs to have and enforce to maintain its reputation.  If a method of business operation does not affect the product and its system, it should be careful to allow the franchisee discretion in business operations.