Last year roughly 653,000 businesses left California for greener and more business-friendly pastures. More recently, California voters soundly rejected the Proposition 22 ballot initiative, which would have classified app-based drivers as employees instead of independent contractors. This was a direct response to the hotly contested state law known as AB-5, which attempts to codify the “ABC Test,” articulated by the California Supreme Court in the 2018 case of Dynamex Operations West, Inc. v. Superior Court of Los Angeles. AB-5 attempts to re-classify virtually all independent contractors as employees by its application of what is known as the “ABC Test”.

Now the entire franchise industry is in the crosshairs of AB-5, which threatens untold damage to this vital sector of the state economy. The franchise model supports more than 82,600 independently owned and franchised businesses, more than 700,000 jobs, and more than $82.9 billion in economic output in California. International Franchise Association CEO Robert Cresanti has said AB-5 “could prove disastrous to thousands of livelihoods,” who are “being threatened by a California law that was never intended to impact franchises at all.”

Application of AB-5 to franchised businesses will have the likely effect of making franchisees – along with those whom they employ – actual employees of the franchisor. Operators will no longer be independent business owners. This change potentially exposes both franchisors and franchisees to a barrage of litigation, including workplace liability claims.

The franchise business model creates a prosperous commercial relationship between franchisors and franchisees, who share the common goals of success and survival. Franchisees have no desire to relinquish the degree of independence and autonomy which the franchise model provides. We believe AB-5’s unnatural distortion of the franchise relationship into a supposed “employment” relationship is among the gravest threats the law poses.

California franchisors and franchisees alike have found common cause in taking up the battle against AB-5. Independent franchisee organizations, like the DD Independent Franchise Owners, give franchisees the power of collective advocacy. In that vein, several prominent franchisee associations have sued the State of California with the stated aim of rendering the portion of AB-5 known as the “ABC Test” from being erroneously applied to the franchise business model. On November 17, 2020, behind the representation of our firm, Marks & Klein, and other esteemed franchise law groups, DDIFO joined the Asian American Hotel Owners Association, Supercuts Franchisee Association and the IFA in filing suit in the United States District Court for the Southern District of California.

The ABC Test as adopted by AB-5 presumptively considers all workers to be employees, and permits workers to be classified as independent contractors only if the hiring business demonstrates that the worker in question satisfies each of three conditions:

(a) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact;

(b) that the worker performs work that is outside the usual course of the hiring entity’s business; and,

(c) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

The AB-5 Lawsuit asserts that this test and its presumption of employee status flies directly in the face of franchisees’ inherent rights under federal law – known as the FTC Franchise Rule – which creates the framework for and governs the franchise business model nationwide. The Franchise Rule explicitly defines a “franchise” as a continuing commercial relationship and not an employment relationship, logically treating them as mutually exclusive. California’s application of the ABC Test is irreconcilable with the federal legal framework which regulates franchising.

The requirement of prong (a) above, that workers be shown to be entirely free from the control of the hiring entity, threatens to undermine the federally approved model and converts all franchise relationships into employment relationships.

Although by definition all franchisees are granted the right to operate a business identified with the franchisor’s trademark, prong (b) prohibits proper classification as an independent contractor unless work is performed outside the usual course of the hiring entity’s business. Thus, a franchisee’s business operations naturally associated with the franchisor’s trademark render franchisees as “employees” under the ABC Test.

There is a clear and inherent conflict between the ABC Test and the franchise business model. It is illogical and contrary to federal law that qualifying as a franchisee under the Franchise Rule necessarily makes one become an employee. We believe such an application of the ABC Test would completely eviscerate the franchise business model. More ominously, we believe it would render those regulated by the FTC Rule with potential criminal liability for failing to classify franchisees as employees.

The seemingly unintended threat posed to California franchisees by the ABC Test cannot be overstated. The franchisee associations now pursuing litigation are carrying the mantle in an effort to halt an impending commercial disaster in California. The mission is not theirs alone, as California’s entire franchise industry and the thousands of citizens whose livelihoods depend upon it are on the line as well. •

Justin M. Klein is a founding partner of Marks & Klein LLP, a nationally recognized franchise focused law firm with offices in New Jersey, New York City, Chicago and Boca Raton. Mark Fishbein practices business litigation in the firm’s Chicago office.