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New California Law Ab-5 May Change Franchising Irreparably

On Behalf of | Aug 27, 2019 | Firm News

California has passed legislation that could have a serious impact on franchising in that state and elsewhere. California Bill AB-5 changes the definition of an independent contractor to cover more workers. If passed, Uber drivers, Amazon delivery drivers, and even franchisees could be considered employees of the parent companies.


The Act, AB-5, comes after a landmark case in California in which workers of Dynamex, a document delivery company, sued to obtain the benefits of being employees of the company. In April, 2019, the Supreme Court in Dynamex Operations West vs Superior Court found that the drivers for Dynamex were actually employees of the company and had been misclassified as independent contractors. The workers for Dynamex brought the action over 10 years ago claiming that they were required to wear company uniforms, display the company logo, but did not have the benefits of being an employee and receiving minimum wages and overtime pay. The court established the “ABC” test for determining employees versus independent contractors. To be considered an independent contractor and not an employee under the test you must meet the three criteria. Part A requires that the worker is free from the control of the hiring entity, both contractually and in actual practice. Part B requires that the worker perform work that is outside of the hiring entity’s typical business. Part C requires that the worker be engaged independently in the same trade, occupation or business as the work performed. Lastly, the worker must be in business for him or herself.


Although AB-5 on its face seems to address workers such as Uber drivers and other large corporations that are using the tag of “independent contractor” to avoid paying workers the benefits to which they are entitled. However, the law can also be applied to large franchisors who have franchisees in California. By holding those large corporations as employers of their franchisees, California will collect substantial new employment taxes that were never previously collectible. The entire concept of franchising is structured so that independent business owners can open a business under an established brand or trademark and learn the business and piggy-back their operations on the successful system of the franchisor. Control by a franchisor over the franchisee and system is an important facet of franchising. However, under the ABC test and AB-5, it is possible that these independent franchise owners could be considered employees of their franchisor. This is unlikely to be desired by the franchisee or franchisor. This would make franchising in California highly undesirable.


The International Franchise Association, or IFA, has sent notices out to all members advising of this new legislation and the concerns to the franchise industry. The IFA is asking that its members reach out to the California Assembly and Senate, educate themselves on the Bill and take action against it. The IFA has concluded that the Bill is highly detrimental to the franchise industry and could, in fact, destroy the model.


California AB-5, although structured to protect Dynamex, Uber and Amazon drivers and provide them with the benefits that employees receive by law, the law could have a wide-reaching impact on franchising in California. Imagine the impact that the law would have on franchisor’s like McDonald’s in which they could be deemed to be liable to pay the employee benefits to every McDonald’s franchisee in California. This could have a huge detrimental impact on the franchisor. Even worse, imagine the smaller franchisor with a substantial number of franchisees in California now required to pay employee benefits to each franchisee in the state. If this concept then spreads to other states around the country, and it is already being proposed in other states, it is possible that this would end franchising. The entire benefit of franchising is that a company can expand its brand and system through independently owned and operated businesses around the country. This would no longer be feasible and would completely defeat the purpose of franchising.  Of course, until there is litigation and courts clarifying how this law is interpreted, no one knows the impact that this law will have on franchising in California and elsewhere in the United States.