California AB5 employee contractor

Perhaps you’ve heard about the California Legislature’s efforts to target misclassification of employees in the gig economy.

While the law passed in September 2019 had obvious impacts on companies like Uber and Lyft, it can also significantly affect franchisors. AB 5 increases the likelihood that a franchisee or franchisee’s employees will be viewed as employees of the franchisor, which dramatically increases the franchisor’s obligations to them.

Read on to learn how legislation in California may effect you.

Background

In 2018, the California Supreme court decided the case Dynamex Operations West, Inc. v. Superior Court of Los Angeles (Dynamex), which dealt with the misclassification of employees in a delivery services business. The court decided introduced a new test for determining if a person is an employee or independent contractor. The “ABC” test states that a worker is an employee unless the employer proves three things:

“(A) that the worker is free from the control and direction of the hiring entity 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 the work performed.”

This test made it much more difficult for employers to show that their workers are independent contractors.

Gig economy california

AB 5

While the court case used the ABC test only in association with wage orders, the new California law applies the ABC test to unemployment insurance and the California labor code. This means that if a worker is an “employee” under these laws, the employer has significant new responsibilities related to working conditions, wages, contracts, inventions, terminations of employment, workplace safety, and rehabilitation!

Risks for Franchisors

Some types of franchisors may have difficulty showing all of the elements for the ABC test. For example, control is a consistent issue in franchising and is the focus of the A prong of the test. The franchisor needs to have control over the brand and yet cannot exercise too much control over the performance of the work.

Different types of franchise system models are more likely to fail the ABC test. An attorney can help evaluate a franchisor’s model for the risks unique to each system.

Here are some general considerations for California franchisors under AB 5:

  • Who contracts with customers, bills them, and collects the fees?
  • What business activities does a franchisor do for franchisees?
  • How the operating manuals are drafted — is the franchisor exercising unnecessary control?
  • Are franchisees required to be legal entities?
  • What does the franchise agreement say about employment?

After thinking through some of these questions, franchisors can adjust their business practices, agreements, and manuals to more clearly show that they are not the employer of their franchisees or their franchisee’s employees.