News Briefs

IFA Files Amicus Briefs in Two Major Franchise Cases

In the last month, the International Franchising Association (“IFA”) filed amicus briefs in two cases, indicating the importance of recent litigation to the franchising industry.

On June 3, IFA filed a brief (Friendly's Restaurants Franchise, LLC and Fantastic Sams Franchise Corp. were co-filers) with the Massachusetts Supreme Judicial Court in Awuah v. Coverall North America, Inc. Cleaning franchisor Coverall is appealing a decision from 2010 in which the U.S. District Court for the District of Massachusetts held that, based on Massachusetts' employment statutes, the franchisees of Coverall North America were actually employees of the franchisor who had been misclassified as independent contractors. Judge William G. Young found that franchisees met one of the three elements of the state's classification as employees of the franchisor, and he famously criticized the concept of franchising with this comment: “Describing franchising as a business in itself, as Coverall seeks to do, sounds vaguely like a description for a modified Ponzi scheme ' a company that does not earn money from the sale of goods and services, but from taking in more money from unwitting franchisees to make payments to previous franchisees.”

Not surprisingly, IFA is challenging Judge Young's decision. “Wrongfully defining franchisees as employees of the franchisors instead of as business owners, as the federal district court's ruling does, threatens the viability of franchising as a business model in Massachusetts,” said IFA President and CEO Steve Caldeira. He added that IFA supports legislation in Massachusetts that would change how the independent contractor test is applied to franchising.

Speaking with FBLA in June 2010, attorney Shannon Liss-Riordan, who represented the plaintiffs in Awuah v. Coverall North America, said the scope of the ruling was smaller than members of the franchise industry fear, and it was not a broadside aimed at the entire industry. “The decision is significant for the franchising industry because it demonstrates that the mere use of the 'franchise' label does not protect a company from being subject to employment and wage-and-hour laws if its franchisees meet the state law test for being employees rather than independent contractors. In this case, we have alleged that, rather than providing a true entrepreneurial opportunity for its franchisees, Coverall essentially sold them low-paying jobs,” she said.

In an unrelated matter, on June 1, IFA filed an amicus brief urging the U.S. Supreme Court to review and overturn the Iowa Supreme Court's ruling in 2010 to allow the state to tax out-of-state franchisors that do not have a physical presence in the state. The court held that the state of Iowa has the authority to impose its corporate income tax on franchisors based solely on the use of infrastructure and other state services by franchisees located in the state. The court agreed with Iowa's argument that those services enabled KFC's intellectual property to flourish, thus creating an economic nexus to justify a tax on the royalty paid to KFC by its Iowa franchisees.

IFA disagrees. “The current state of the law, with states split on the right to impose income taxes on out-of-state franchisors, creates tremendous uncertainty about franchisors' past and future tax obligations. This uncertainty is especially problematic for multi-state franchise systems with long-term contracts that cannot be modified to respond to fundamental changes in tax obligations,” IFA wrote in its petition. “KFC Corp. is an appropriate candidate for this Court to resolve the mixed answers and at-odds approaches offered by the sixteen states that have addressed the physical presence/economic nexus issue outside of the franchise context. Granting the petition also provides an opportunity to reaffirm the Court's decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and protect the long settled expectations of the thousands of franchisors and franchisees who have carefully arranged their economic lives in reliance on it.”

IFA Files Amicus Briefs in Two Major Franchise Cases

In the last month, the International Franchising Association (“IFA”) filed amicus briefs in two cases, indicating the importance of recent litigation to the franchising industry.

On June 3, IFA filed a brief (Friendly's Restaurants Franchise, LLC and Fantastic Sams Franchise Corp. were co-filers) with the Massachusetts Supreme Judicial Court in Awuah v. Coverall North America, Inc. Cleaning franchisor Coverall is appealing a decision from 2010 in which the U.S. District Court for the District of Massachusetts held that, based on Massachusetts' employment statutes, the franchisees of Coverall North America were actually employees of the franchisor who had been misclassified as independent contractors. Judge William G. Young found that franchisees met one of the three elements of the state's classification as employees of the franchisor, and he famously criticized the concept of franchising with this comment: “Describing franchising as a business in itself, as Coverall seeks to do, sounds vaguely like a description for a modified Ponzi scheme ' a company that does not earn money from the sale of goods and services, but from taking in more money from unwitting franchisees to make payments to previous franchisees.”

Not surprisingly, IFA is challenging Judge Young's decision. “Wrongfully defining franchisees as employees of the franchisors instead of as business owners, as the federal district court's ruling does, threatens the viability of franchising as a business model in Massachusetts,” said IFA President and CEO Steve Caldeira. He added that IFA supports legislation in Massachusetts that would change how the independent contractor test is applied to franchising.

Speaking with FBLA in June 2010, attorney Shannon Liss-Riordan, who represented the plaintiffs in Awuah v. Coverall North America, said the scope of the ruling was smaller than members of the franchise industry fear, and it was not a broadside aimed at the entire industry. “The decision is significant for the franchising industry because it demonstrates that the mere use of the 'franchise' label does not protect a company from being subject to employment and wage-and-hour laws if its franchisees meet the state law test for being employees rather than independent contractors. In this case, we have alleged that, rather than providing a true entrepreneurial opportunity for its franchisees, Coverall essentially sold them low-paying jobs,” she said.

In an unrelated matter, on June 1, IFA filed an amicus brief urging the U.S. Supreme Court to review and overturn the Iowa Supreme Court's ruling in 2010 to allow the state to tax out-of-state franchisors that do not have a physical presence in the state. The court held that the state of Iowa has the authority to impose its corporate income tax on franchisors based solely on the use of infrastructure and other state services by franchisees located in the state. The court agreed with Iowa's argument that those services enabled KFC's intellectual property to flourish, thus creating an economic nexus to justify a tax on the royalty paid to KFC by its Iowa franchisees.

IFA disagrees. “The current state of the law, with states split on the right to impose income taxes on out-of-state franchisors, creates tremendous uncertainty about franchisors' past and future tax obligations. This uncertainty is especially problematic for multi-state franchise systems with long-term contracts that cannot be modified to respond to fundamental changes in tax obligations,” IFA wrote in its petition. “KFC Corp. is an appropriate candidate for this Court to resolve the mixed answers and at-odds approaches offered by the sixteen states that have addressed the physical presence/economic nexus issue outside of the franchise context. Granting the petition also provides an opportunity to reaffirm the Court's decision in Quill Corp. v. North Dakota , 504 U.S. 298 (1992) and protect the long settled expectations of the thousands of franchisors and franchisees who have carefully arranged their economic lives in reliance on it.”