The Good, the Bad, the Uncertain: Developments In Franchisor Liability

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          The legal debate over imposing vicarious liability of franchisors – or making franchisors liable for the acts of their franchisees and franchisees’ employees – has flared up this year, thanks in large part to a recent court decision and policy directives emanating from the Office of the General Counsel of the National Labor Relations Board.

          The franchise model assumes that franchisees merely license franchise trademarks, copyrights and other intellectual property from franchisors, and that the franchisee is not the agent of the franchisor.  While franchisors may insist that the franchisee follow quality control, marketing and product consistency standards that affect the franchisor’s trademarks, franchisors typically contractually disclaim any right to control day-to-day hiring, firing and supervision of employees.  But that does not prevent parties who assert claims against franchisees from also alleging that the franchisor should be liable as well, based on principles of agency.  The claimant alleges that the franchisee and its employees are agents of the franchisor, and thus the franchisor is liable as well.

          First, the good news for franchisors:  In late August, the California Supreme Court held that Domino’s Pizza LLC was not liable for the acts of a franchisee whose manager had allegedly harassed an employee.  The court’s decision was based largely on the terms of the franchise agreement between Domino’s and its franchisee.  The court did note, however, that a franchisor “will be liable if it has retained or assumed the right of general control over the relevant day-to-day operations at its franchised locations … and cannot escape liability in such case merely because it failed or declined to establish a policy with respect to that particular conduct.”

         Next, the bad news: in July, the Office of the General Counsel to the National Labor Relations Board announced that it would authorize complaints alleging that McDonald’s USA LLC is a “joint employer” of the employees of its franchisees.   The Office of the General Counsel found merit in charges that McDonald’s and its franchisees had violated the rights of employees “as a result of activities surrounding employee protests.”

          The NLRB release announcing the decision did not set forth the grounds as to why McDonald’s was deemed to be a joint employer, but the NLRB Office of the General Counsel has signaled, in another pending case, that it seeks to change the standard for determining when “joint employer” status is applicable.   Under the existing standard, which has been in place for 30 years, a finding of joint employer status is appropriate when two or more parties “share or codetermine those matters governing the essential terms and conditions of employment.” The International Franchise Association and other trade groups have filed a brief in the pending case, opposing the attempt by the NLRB Office of the General Counsel to re-define joint employer status so as to include situations where one party indirectly controls the other.

        While a revision to the definition of joint employer would affect many industries, it would have a massive impact on the franchise industry, whose business model is predicated in large part on the distinction between franchisor and franchisee.

Additional Insured Endorsements: Beware!

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Many franchise agreements require that the franchisee name the franchisor as an “additional insured” on the franchisee’s liability insurance policies.  Similar requirements are included in many distribution agreements.  The purpose of this coverage is to protect the “additional insured” from claims relating to the operations of the party purchasing the policy, as well as the purchasing party itself.

It is easy to forget, however, that insurance policies are contracts that must be carefully reviewed to confirm that the insurer is obligated to provide coverage and defend a lawsuit as the parties intended.  A recent case heard by the Illinois Appellate Court illustrates the difficulties in assuring that proper additional insured protection has been obtained.

An individual suffered injuries while lighting a cigarette behind a gas station. He sued  the gas station owner and Shell Oil, which had granted a franchise to the gas station owner to use Shell Oil’s marks.  The franchise agreement required the gas station owner to name Shell Oil as an additional insured on its liability policies.

The applicable policy endorsements, however, contained limiting language.  The first endorsement applied to Shell Oil “only with respect to their liability as grantor of a franchise to you.” The second provided that Shell Oil was an additional insured, but “only with respect to liability arising out of your operations and premises owned by or rented by you.” In the end, the Illinois court found that notwithstanding their ambiguity, the endorsements created a duty for the insurer to defend Shell Oil. 

In working with clients, we increasingly see insurers claiming they cannot provide satisfactory additional insured endorsements, for a multitude of reasons. With a little persistence, however, these objections may be overcome.  A couple reminders:

  • Merely being listed as an additional insured on a certificate of insurance does not guarantee insurance coverage.  To be afforded coverage as an additional insured, a party must be named in an endorsement to the policy, and not just on a certificate of insurance.
  • The endorsement and policy should be reviewed to confirm that (a) the party is properly named in the endorsement and (b) coverage definitions and limitations do not serve to defeat the intention of the parties, which is to protect the additional insured against claims related to the operations of the franchisee or distributor.