Perhaps Being A Franchisor is Better than being an Employer

January 25th, 2012

David Cahn

On January 3, 2012, the National Labor Relations Board (NLRB) issued a decision in D. R. Horton, Inc. and Michael Cuda, NLRB Case 12–CA–25764, that provides a powerful incentive to expand business in the U.S. methods through franchising or other methods that do not involve hiring employees. It ruled that requiring employees to sign arbitration agreements that prevent them from joining a class action lawsuit or class arbitration over employment-related issues (like overtime pay) violates the National Labor Relations Act (NLRA). This decision applies to all private employers, regardless of whether their employees are unionized or not.
Specifically, the NLRB ruled that “employers may not compel employees to waive their NLRA right to collectively pursue litigation of employment claims in all forums, arbitral and judicial.” The NLRB did not forbid agreements that require employees to arbitrate workplace disputes, but rather held that such agreements must provide a method for employees to assert class or collective claims in arbitration or through the courts.
This decision came in a case in which an employee attempted to bring a class action arbitration accusing his employer of misclassifying certain supervisors as exempt from the Fair Labor Standards Act’s overtime pay requirements. The employer refused to arbitrate on a class basis, citing a provision in the employee’s employment agreement that barred arbitration of class claims. The employee then filed an unfair labor practices claim with the NLRB, alleging that the agreement violated his rights under the NLRA. The NLRB found the employee’s claim had merit, and that “the NLRA protects employees’ ability to join together to pursue workplace grievances, including through litigation.”
The NLRB also held that, under these circumstances, its decision did not conflict with the Federal Arbitration Act (“FAA”). The NLRB distinguished last year’s Supreme Court issued a decision upholding the use of class arbitration waivers in consumer contracts, on the basis that the employer’s mandatory class action “waiver interferes with substantive statutory rights under the NLRA, and the intent of the FAA was to leave substantive [legal] rights undisturbed.” The NLRB’s basis for interpreting the FAA was a line of U.S. Supreme Court decisions, in particular Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 24 (1991).
Nevertheless, given that the NLRB’s decision has wide application to all employment relationships, and it conflicts with the Supreme Court’s many recent pro-arbitration and anti-class action rulings, this decision will likely be challenged in the courts and may wind up being addressed by the Supreme Court.
In the meantime, however, this decision is another reminder that growing a business through debt or equity financing for “company-owned” locations comes with many legal risks, not the least of which is employment liability. Franchising might be an alternative worth considering for many businesses.
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Franchising and its Growth Alternatives

January 19th, 2012

David Cahn

Compliance costs and ongoing challenges of obtaining financing for new businesses have led many companies seeking growth to search for alternatives to franchising. These efforts, while quite understandable, have legal and practical implications. To understand whether they are worth the effort involved, it is important to analyze the nature of your business and its growth objectives by attempting to answer these types of questions:

1. Does your business primarily involve the sales of products you supply, the sale of products to be created by others using your methods, or the provision of services?

2. Does your business benefit from close association with a related enterprise? Examples are energy auditing, which is complementary to mechanical and renovation contractors, and the selling of fractional interests in real estate as part of a real estate brokerage business.

3. Will your business incur substantial upfront costs in the opening of new locations, either directly in the purchase of materials and inventory or indirectly in the time spent by staff in supporting the new operator?

4. Are your business methods a more compelling business asset than your brand name?

5. To what degree is poor service quality in one location likely to jeopardize the ongoing fortunes in other locations?

6. What is your ability to finance growth through profits from existing operations?

7. What is your appetite for risk in growth? Company-owned locations can be more profitable than franchises, but also substantially riskier for many reasons, including employment risk (for a recent example, see this National Labor Relations Board decision).

Your answers to these questions and others will help lead to the desired method of growth and, in turn, the steps required to comply with applicable laws and that safeguard your company’s interests. The answer could be granting a franchise for someone else to develop and own a truly new, independent business, i.e., licensing someone else to operate using your brand, under methods you prescribe and in exchange for fees paid to you. Alternatively, you might recruit local representatives who have successful related businesses to sell your product or service as a relatively small part of their ongoing operations. You might use profits from existing operations to finance part of the costs of opening new locations, while recruiting “local talent” who will finance the other part of the cost and operate those locations (as “partners”). Or perhaps you will offer stock in your company and recruit talented salespeople or managers who will make no cash investment, but who also will have more limited ability to control and profit from local operations over time.

Each such solution (and there may be more than one) requires different legal services and provide different challenges. As growth counselors, the attorneys of Whiteford Taylor & Preston L.L.P. have the skills to assist with any of these endeavors. Contact David L. Cahn to discuss your growth strategy.

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