Labor Department Rescinds Pro-Franchise Joint-Employment Rule

On July 29, 2021, the U.S. Department of Labor announced it is rescinding a final rule issued just last year (2020 Final Rule) that sought to clarify the standard for finding two separate entities to be “joint employers” under the Fair Labor Standards Act (FLSA). The 2020 Final Rule was a welcome development for franchise businesses because it limited the circumstances under which a franchisor and independent franchisees could be deemed joint employers of franchisees’ employees and expressly clarified that the typical franchise model does not make joint-employer status more likely.

Unfortunately, the Labor Department’s rescission of the 2020 Final Rule and its common sense standard for determining joint employment under the FLSA makes it more likely that a franchisor and franchisee could be deemed joint employers of the independent franchisee’s employees.

The Labor Department’s 2020 Final Rule

The FLSA requires employers to pay their nonexempt employees at least the federal minimum wage for every hour worked and overtime for every hour worked over 40 in a work week, among other things. The Labor Department has long recognized that two or more entities may sometimes “jointly” employ a single employee under the FLSA. Each joint employer is jointly and severally liable for the employee’s wages. Under Labor Department regulations implemented in 1958, multiple entities can be joint employers of an employee if they are “not completely disassociated” with respect to the employee’s employment.

Seeking to interpret the “not completely disassociated” standard, federal courts around the country developed several different multi-factor tests for evaluating joint-employment claims under the FLSA. Some courts ask whether a particular employee is “economically dependent” upon an alleged joint employer, while other courts focus on the relationship between the two alleged joint employers. The result of these differing tests is that companies operating in multiple jurisdictions may face joint-employer liability in one jurisdiction, but not in another, for the same business practices.

In early 2020, the Labor Department updated its 1958 regulations interpreting when multiple entities can be held liable as “joint employers” under the FLSA. Seeking to promote greater uniformity in court decisions and predictability for organizations and employees, the 2020 Final Rule set forth a four-factor balancing test that assesses whether the putative joint employer: (1) hires or fires the employee; (2) supervises and controls the employee’s work schedule or conditions of employment to a substantial degree; (3) determines the employee’s rate and method of payment; and (4) maintains the employee’s employment records. No single factor is dispositive. The 2020 Final Rule clarified that a potential joint employer must actually exercise, directly or indirectly, control over the relevant employee to be jointly liable under the FLSA, and that alleged “economic dependence” on a potential joint employer is not relevant. A boon to both franchisors and franchisees, the 2020 Final Rule further explained that a company’s business model, specifically including franchising, does not make joint-employer status more likely under the FLSA.  

With its focused scope and practical guidance, the 2020 Final Rule, which became effective on March 16, 2020, narrowed the circumstances under which a franchisor could be deemed a joint employer of its independent franchisees’ employees.

Court Battles and Rescission

Shortly after the 2020 Final Rule went into effect, attorneys general from seventeen states and the District of Columbia challenged it in federal court. The states argued that the 2020 Final Rule’s clarified standard was too narrow, the Labor Department impermissibly deviated from prior precedent, and the Labor Department failed to account for important costs incurred by states. In New York v. Scalia, the Southern District of New York agreed and in late 2020 struck down most of the 2020 Final Rule as arbitrary and capricious. The decision is currently on appeal to the Second Circuit Court of Appeals.

Meanwhile, the change of presidential administrations brought new leadership to the Labor Department and, with it, new attacks on the 2020 Final Rule. After first issuing a notice of proposed rulemaking in March 2021, the Labor Department issued a new final rule on July 29, 2021 rescinding the 2020 Final Rule. The Labor Department contended the 2020 Final Rule conflicted with the language of the FLSA and deviated from prior guidance. The rescission will become formally effective on September 28, 2021.

What’s Next?

While the Labor Department is rescinding the 2020 Final Rule, and its clarified four-factor test, it has not announced any new analysis or standard to replace it.  As a result, courts around the country will continue to apply in FLSA cases their various, and not always consistent, multi-factor tests. The lack of a clear standard makes it more likely that a franchisor may be deemed a “joint employer” of its franchisees’ employees and thus jointly liable under the FLSA for its independent franchisees’ actions.

Joint-employment standards continue to evolve, and franchisors and franchisees should keep apprised of ongoing developments in this area to best evaluate the risks of joint-employment claims in their franchise systems.