A franchisor may find itself between a rock and a hard place when the U.S. Department of Labor (DOL) comes calling; particularly when the call concerns franchisee compliance under the federal Fair Labor Standards Act (FLSA). On the one hand, a franchisor can refuse to cooperate. Though such refusal risks an aggressive response by the DOL, including costly litigation and increased damages claims. On the other hand, a franchisor can agree to cooperate. However, such cooperation is not without its own risks. Among other things, such cooperation may spur on “joint employer” claims under the FLSA (and other laws) against the franchisor.

A recent agreement between the DOL and Subway, franchisor to nearly 27,000 franchised Subway sandwich restaurants, underscores the dilemma.  The DOL began investigating wage and hour violations by Subway franchisees several years ago. Subway and its franchisees are legally-distinct entities; the franchisees being the direct employers of the day-to-day employees making the sandwiches and running Subway franchisee restaurants.  Nevertheless, beginning in 2012, the DOL sought the collaboration of Subway, as franchisor, in the DOL’s investigations of the franchisees. Subway agreed. The result was a voluntary compliance agreement this past July whereby Subway and the DOL will (1) provide “compliance assistance and training materials” for franchisees; (2) develop “compliance support for franchisees through data-sharing and technology”; (3) host “meetings to share information, evaluate compliance trends, and solve problems”; (4) communicate to franchisees “about responsibilities to comply with the investigative process”; and (5) emphasize to franchisees the “consequences for FLSA noncompliance.” If this sounds like a happy ending, several other major national fast food chains did not think so and declined similar invitations by the DOL. This was despite reports that the DOL made assurances to Subway that the voluntary agreement would not affect Subway’s status (either way) as a joint employer under the FLSA. However, the DOL gave no written assurances that it would not assert joint employer claims against Subway in the future. In fact, the DOL included language that made clear the voluntary agreement would “not waive any of SUBWAY’s liability” under the FLSA. The DOL further refused to provide any assurances to Subway or others that collaboration between franchisors and franchisees would not play into a joint employer finding under other statutes, such as the National Labor Relations Act (NLRA).

Understanding the law behind joint employer status is critical to understanding the dilemma franchisors may face as in the case of Subway. A franchise typically is set up so that the franchisor is a separate entity, legally-distinct from its independently-owned franchisees. The franchisees are the employers of the franchisee employees, and no such employment relationship is formed between those employees and the franchisor. Thus, the franchisees should be (in theory) solely responsible for the pay and hours of their employees and any resulting liability for violations under the FLSA. However, if a franchisor controls franchisee wage and hour practices—such as overseeing FLSA compliance—the franchisor could be deemed a “joint employer” subject to liability for an FLSA violation. The risk of this result is great given the DOL’s recent, expansive interpretation of joint employer status under the FLSA. In January 2016, the DOL issued an Administrator’s Interpretation on the subject. In its guidance, the DOL provides examples of both “vertical” and “horizontal” joint employer relationships. The latter horizontal relationship, which is most relevant to franchisors, is formed where an employee is deemed to be employed by two “technically separate but related or overlapping employers.” The DOL identifies a series of factors to consider, no one being fully dispositive, that play into a horizontal joint employer relationship finding. Such factors include, without limitation: (1) whether the potential joint employers share control over operations such as payroll, scheduling, and overhead costs; (2) whether the potential joint employers share supervisory authority over employees; (3) whether the potential joint employers share customers; and (4) whether there are any agreements between the potential joint employers. As you can see, the foregoing list of factors may cut in favor of a joint employer finding in the franchisor-franchisee context where the franchisor becomes overly involved with its franchisees regarding wage and hour practices.

Critically, the risks caused by wage and hour collaboration is not limited to FLSA coverage and liability. Such collaboration could result in joint employer status being asserted under other laws, such as the Family and Medical Leave Act or the NLRA. 

In light of the foregoing joint employer considerations, the voluntary agreement with the DOL and Subway’s level of involvement with its franchisees should be cause for concern. For instance, Subway is charged with disseminating wage and hour compliance materials to franchisees and managers, among others. Subway further agrees to “building alerts into the payroll and scheduling platform” it provides to its franchisees to warn of FLSA violations. Additional duties include Subway (1) providing all governmental disclosures, such as financial disclosures to the Federal Trade Commission, additionally to the DOL; (2) committing to quarterly meetings with DOL officials to improve franchisee compliance; (3) advising franchisees of the DOL’s investigatory rights; and (4) warning franchisees that they must comply with the FLSA as provided by their franchise agreements or risk being dropped. That is an awful lot of involvement in wage and hour practices by a franchisor claiming no joint employer relationship with its franchisees.           

How this will all play out for Subway is yet to be seen. However, it certainly increases the likelihood that the DOL will intensify its pursuit of franchisees through their franchisors. Franchisors should be wary next time the DOL calls asking for mere “cooperation” with franchisee compliance.