The distinction that franchisees are not employees of a franchisor is crucial to the franchise industry’s business model. However, this dynamic may now be at risk in California.

On September 18, 2019, the California Assembly Bill 5 (“AB-5”) was enacted into law, effectively codifying the decision of the Dynamex case with its ABC Test and departing from the prior Borello Test. AB-5 will fundamentally alter the employer-employee relationship across multiple industries in California and will impact franchise businesses in the state of California by considering franchisees as employees of franchise brands.

Hiring entities will now be required to meet the “ABC test” to distinguish an independent contractor from an employee. Under the test, businesses must prove that the hired worker is (a) free from the company’s control, (b) performing work that is outside the usual course of the company’s business, and (c) customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. A worker that does not meet all three conditions will be classified as an employee of the company.

Although geared towards independent contractors and individual workers of the gig economy for companies like Uber or Lyft, through AB-5, franchisors could become liable for franchisees’ expenses of the business. Meaning that the franchisor would be compelled to be involved with the business, responsible for paying the franchisee’s employees and ultimately even be required to take control of the business as franchisees become classified as employees.

The IFA is seeking an exemption to say that, unless the franchisor is exerting control beyond what is necessary to protect the mark, there is no employment relationship. In fact, many professions have already been excluded from the bill such as accountants, architects, doctors, engineers, lawyers, insurance agents, among others. The legislature also created a special exception for journalists, allowing them to write 35 articles annually before they would be considered employees. Already Vox Media has responded by terminating hundreds of its freelance journalists.

As a response to AB-5, the app-based companies created “Protect App-Based Drivers & Services”, an organization with financial support from Uber, Lyft, Instacart, and Doordash and is looking to launch a 2020 ballot referendum to exempt ride-hailing apps from the rules of AB-5.

Already rideshare drivers have started to test these theories in court.  Most recently, an Uber driver on behalf of a putative class of Uber drivers filed suit in the Northern District of California, seeking both monetary damages and an injunction to stop Uber from continuing to classify drivers as independent contractors.  The lawsuit specifically relies on passage of AB-5.  Indeed,  the plaintiff pointed to the fact that Uber had applied for an exception to AB-5 as evidence that even Uber believed the regulations as currently drafted would apply to it.  In this instance, the Court denied the motion for preliminary injunctive relief, but denied Uber’s motion to dismiss most of the claims asserted and allowed those to proceed (opinion can be found here).  Uber has said it will continue classifying drivers as contractors in 2020 because it believes its drivers are not employees under the ABC test.  We will continue to keep an eye on the outcome of this case.

How AB-5 with impact the franchise business model is still uncertain as each model is different, but it can be expected for employment-based lawsuits to be brought under AB-5. Franchisors need to have their counsel examine their franchise model to ensure that they are in compliance with AB-5.

The IFA and many franchise companies have already joined together in a coalition letter to the California Legislature in a hope to of an amendment that would protect franchise businesses in California. The letter can be found here.