August 30, 2014

California Supreme Court Limits Franchisor Liability

Seller Beware: Consumer Protection Insights for Industry

In a closely watched case, the California Supreme Court provided significant protection to franchisors from liability for lawsuits based on the actions of their franchisees. In clarifying the standard for franchisor liability -- an issue that has been increasingly troubling for franchisors -- the Court ruled in Patterson v. Domino's Pizza, LLC that a franchisor was not liable for the acts of a franchisee's employees where the franchisor did not have day-to-day control over the operations leading to the claim.

In Domino's, the Court determined that the franchisor was not liable for alleged sexual harassment by a manager at one of its franchised locations. In reversing the Court of Appeal, a divided Supreme Court considered the evidence presented on the relationship between franchisor and franchisee -- focusing on the franchise agreement as well as the interactions between Domino's personnel, including a franchise consultant, and the franchisee and his employees. Despite the strict standards that Domino's instituted and "vigorously enforced" regarding its trademarks and brand image, as well as the procedures for operating the franchised locations and making and delivering pizzas, the Court held that it was the franchisee and not Domino's that made the day-to-day decisions regarding employment at the store, such as hiring, supervising, and disciplining employees. Accordingly, Domino's could not be held liable for the acts of the franchisee's employees under either the Fair Employment and Housing Act (FEHA) or the doctrine of respondeat superior.

The news prior to Thursday's opinion had not been quite so positive for franchisors. Last month the Office of the General Counsel of the National Labor Relations Board (NLRB) authorized complaints for alleged violations of the National Labor Relations Act against McDonald's (the franchisor) for working conditions of employees at franchised locations. And just last week, the California legislature passed Senate Bill 610, which, among other things, addresses when franchisors can terminate a franchise agreement should the Governor sign the bill into law. While organized labor and other activists advocate for changes in the landscape of franchisor liability, the guidance from the Domino's decision provides a helpful roadmap to franchisors operating in California.

In clarifying the standard for franchisor liability, however, the Domino's court did make clear that a franchisor may be held liable in similar circumstances if it maintains "the right of general control" over the day-to-day operations at the franchised location. (The dissent believed this to be a question for the trier of fact but the majority, like the trial judge, believed it could be decided on summary judgment.) Although the Domino's decision is limited to the employee context, it nevertheless is likely to be cited in other contexts and provides useful guidance to franchisors looking to strike the appropriate balance, for their franchise systems, between control and potential liability.

Given the current legislative and regulatory climate, franchisors should be vigilant about the amount of control they exercise over their franchisees, especially with respect to the actions of their franchise consultants. Courts clearly will look not only at the documents evidencing the relationship but also the course of dealing between franchisor and franchisee in determining whether an action of a franchisee is appropriately attributable to the franchisor.

© Arnold & Porter Kaye Scholer LLP 2014 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

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