On March 24, 2022, the Massachusetts Supreme Judicial Court (SJC) handed down a key ruling that could have a significant impact on franchising across the state. In Patel v. 7-Eleven, Inc., the SJC was asked whether the three-prong test for independent contractor status set forth in Massachusetts’ state-law independent contractor statute applies to the relationship between a franchisor and its franchisee, where the franchisor must also comply with the Federal Trade Commission’s (FTC) Franchise Rule. The SJC held that the independent contractor statue applies to the franchisor-franchisee relationship and is not in conflict with the franchisor’s disclosure obligations set forth in the FTC Franchise Rule. Therefore, the SCJ determined, a franchisee providing services to a franchisor under the terms of a franchise agreement may, in fact, be classified as an “employee” of the franchisor under state wage-and-hour law.

Massachusetts and FTC Rules

The court’s reference to the “independent contractor statute” refers to Massachusetts G. L. c. 149, § 148B. Under this law, “an individual performing any service” for a putative employer “shall be” considered an “employee” for purposes of the wage statutes. An employer may rebut the presumption by satisfying all elements of the well-known “ABC test.” That is, an employer, by a preponderance of the evidence, must demonstrate:

[A] the individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and [B] the service is performed outside the usual course of the business of the employer; and [C] the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.¹

The FTC Franchise Rule refers to 16 C.F.R. § 436.1, et seq. Of importance, this rule does not involve employee misclassification. Instead, “it was adopted in the late 1970s in response to widespread deception in the sale of franchises, including misrepresentations related to the costs to purchase a franchise and the terms and conditions under which a franchise would operate.” The FTC Franchise Rule “considers a franchisor’s failure to provide presale disclosures specified in the rule to a prospective franchisee to be an unfair or deceptive act or practice in violation of section 5 of the Federal Trade Commission Act.” The FTC Franchise Rule “also prohibits a franchisor from making unilateral, material alterations to the terms and conditions of the franchise agreement without providing timely notice to the franchisee.”

The disclosure requirements under the FTC Franchise Rule apply to, among others, “franchisors,” which, under federal regulations, is defined as “any person who grants a franchise and participates in the franchise relationship.” Additionally, a “franchise,” in turn, is defined as a continuing commercial relationship where, among other things, the franchisor “will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.” Therefore, as the Massachusetts high court stated, “under the FTC Franchise Rule, the required disclosures are triggered when a prospective franchisor makes one of two elections—either to exert a significant degree of control over the franchisee’s method of operation or to provide significant assistance in the franchisee’s method of operation.”

History of Instant Lawsuit

In this case, the U.S. District Court for the District of Massachusetts first held in September 2020 that owner/operators of 7-11 franchises were not employees of the national franchisor under state wage-and-hour law.² As the court observed in its decision, “It cannot be the case, as plaintiffs suggest, that, in qualifying as a franchisee pursuant to the FTC’s definition, an individual necessarily becomes an employee. In effect, such a ruling by this Court would eviscerate the franchise business model, rendering those who are regulated by the FTC Franchise Rule criminally liable for failing to classify their franchisees as employees.”

On an appeal brought by the plaintiffs, the U.S. Court of Appeals for the First Circuit last year asked the Massachusetts SJC to decide whether the Commonwealth’s independent contractor law applied to franchising. In reaching its decision, the SJC first evaluated the purported conflict between the ABC test and the FTC Franchise Rule. Specifically, the court evaluated whether there was a conflict between the FTC Franchise Rule and the first prong of the ABC test, which is primarily centered on the level of control one exercises over its workers. According to 7-Eleven, “classifying franchisees as employees under the statute places the entire market for franchise relationships in the Commonwealth at risk.” However, the SJC determined that no conflict exists between the statute and the regulation.

As the court stated, “[t]he FTC Franchise Rule ‘is a pre-sale disclosure rule[,]’” and “[c]ompliance with these disclosure requirements does not mandate that a franchisor exercise any particular degree of control over a franchisee.” Ultimately,

[a] franchisor can comply with the FTC Franchise Rule to make the prescribed disclosures, and in situations where a franchisee is deemed an employee under the independent contractor statute, the franchisor can comply with its obligations under the wage statutes. Compliance with these latter obligations does not render it impossible for a franchisor to comply with the FTC Franchise Rule.

In that light, it bears noting that the SJC’s decision largely adopts the position that the FTC itself put forward in an amicus brief filed with the court: specifically, that compliance with the FTC’s disclosure rules does not conflict with classification of individuals as employees or independent contractors under state wage-and-hour laws. Rather (and not surprisingly, given the current administration’s focus on employee misclassification), the FTC’s position is that franchisees may be employees of their franchisor, the FTC’s Franchise Rule notwithstanding.

Implications

This decision could have a significant impact on businesses across Massachusetts, not only in the franchise context, but beyond the franchise-franchisor relationship. Specifically, the SJC’s decision illustrates the lack of certainty surrounding the application of the independent contractor law, and for businesses that primarily rely upon independent contractor workforce models. However, it also remains to be seen what will happen as this case now heads back to the First Circuit with an answer to the certified question. In holding that the mere fact that a franchisee operates under a franchise agreement does not render the independent contractor statute inapplicable, the SJC went on at some length to note that this does not “render every franchisee an employee” under state law, citing numerous examples where even under the first “control” prong of the ABC test, franchisees were found to not be employees of the franchisor. Finally, insofar as it turns on a state court’s interpretation of state wage-and-hour law, it is not entirely clear how other federal circuits will consider this case if similar issues arise under other comparable state laws.

Changes to Independent Contractor Status in Massachusetts and Beyond

The decision by the Massachusetts SJC is only one of many items impacting independent contractor status in Massachusetts and across the country. Here is an overview of other key changes and developments:

• Pending Lawsuit. In July 2020, Massachusetts Attorney General Maura Healy filed a complaint for declaratory judgment with the Suffolk County Superior Court alleging that rideshare companies have misclassified workers as independent contractors on their platforms. The complaint seeks declaratory relief that the employees are entitled to protections under Massachusetts’ wage-and-hour laws. The lawsuit is currently pending.

• Massachusetts Ballot Initiative. In August 2021, the Massachusetts Coalition for Independent Work filed two versions of a ballot initiative (Petitions) designed to give Massachusetts voters the option of defining the relationship for Massachusetts app-based drivers for Delivery Network Companies (DNC) and Transportation Network Companies (TNC) as one of independent contractors, so long as certain conditions are met. Both Petitions would provide app-based drivers—as independent contractors—with a variety of guaranteed benefits and compensation. The initiative still needs to get more signatures to be able to appear on the Massachusetts ballot in November 2022, but the campaign has months to get those signatures. The SJC is also considering legal challenges to the two Petitions.

• Trump-era Independent Contractor Rule. On March 14, 2022, the U.S. District Court for the Eastern District of Texas held, in a case filed by Littler on behalf of several trade associations, that the Department of Labor’s 2021 delay and ultimate withdrawal of regulations governing independent contractor status under the Fair Labor Standards Act (FLSA) violated the Administrative Procedure Act (APA). As a result, the former administration’s independent contractor rule is now in effect.  On March 30, 2022, the U.S. Senate failed to confirm Dr. David Weil as administrator of the Department’s Wage and Hour Division (WHD).  In the absence of Senate-confirmed leadership, it is unclear whether and how quickly WHD may move to adopt a new and more limited contractor status standard by way of regulation, Administrator’s Interpretation, or otherwise.

• PRO Act. Despite being stalled in the U.S. Senate, the Protecting the Right to Organize (PRO) Act remains a potential legislative threat to employers across the country. As previously reported, the PRO Act seeks to revise the National Labor Relations Act to incorporate the ABC test and reclassify millions of traditional independent contractors as “employees” subject to union representation.

• ​NLRB & The Atlanta Opera, Inc. Most recently, in The Atlanta Opera Inc., 371 NLRB No. 45 (2021), the Board invited interested parties to file briefs addressing whether it should overturn its decision in SuperShuttle DFW, Inc., 367 NLRB No. 75 (2019) and reconsider its standard for determining the independent contractor status of workers. Littler filed an amicus on behalf of a number of trade associations urging the Board to maintain the SuperShuttle standard.

In short, so-called “employee misclassification” and independent contractor status is likely to continue to be of great concern to employers at both the federal and state levels. Littler’s Workplace Policy Institute will keep readers apprised of current developments.