Franchise Law Alert

A Recent Second Circuit Decision Rejects Franchisees’ Claims that Franchisor’s Deductions from Revenue Violated State Minimum Wage and Anti-Kickback Laws, but Leaves the Door Open for Franchisor-Franchisee Relationships to be Classified as Franchisor-Employee Relationships.

The U.S. Court of Appeals for the Second Circuit recently held that a franchisor did not violate Connecticut’s Minimum Wage Act or Anti-Kickback law by deducting fees from its franchisees’ revenues, even if the franchisees should have been classified as employees.  Mujo v. Jani-King International Inc., __ F.4th __ (2nd Cir. 2021).  Last week the full Court declined the franchisees’ request for panel rehearing or rehearing en banc.

Jani-King is a cleaning service franchisor. Under its system, it assigns customers to franchisees which, in turn, are free to accept, reject or trade such customers with other franchisees. The customers pay Jani-King directly. It then deducts fees, including royalty and advertisement fees, before paying the balance to franchisees. 

The franchisees brought claims against Jani-King for violation of statutory minimum wage laws and for unjust enrichment. They claimed that Jani-King misclassified them as independent contractors rather than employees.  They contended that Jani-King’s deductions from customer revenue violated state law prohibiting such deductions and disallowing employers from charging employees fees as a condition of employment. 

The 2nd Circuit affirmed the District Court’s dismissal of all claims against Jani-King.  The Court found that, “even assuming that the [franchisees] are employees who receive wages subject to … the Act, their wages under the franchise agreement are the funds that remain after Jani-King deducts its fees under the franchise agreement.”  The Court also upheld dismissal of the unjust enrichment claim, explaining that, even if Appellants were employees, they may also be franchisees.  As franchisees, they received value under a franchise agreement in exchange for the deducted franchisee fees.  The court emphasized the public policy of freedom of contract -- even if the contract may reflect “bargains unwisely made.”

The 2nd Circuit noted that the franchisees’ position would effectively bar certain types of franchised businesses by making them economically non-viable, contravening the state’s “comprehensive regulatory scheme for franchising.” Implausibly, franchisors could be precluded from collecting most, if not all, franchise fees in any franchise relationship where it first collects customer revenue prior to paying the franchisees.

Mujo v. Jani-King Int’l, Inc. offers guidance about properly structuring a franchise, while avoiding the ultimate issue of whether a franchise agreement created an employment relationship. In addressing employee classification, franchising parties must consider many factors including controls exercised by the franchisor, the franchise systems’ organization and franchise fees.  They must then properly structure, memorialize and implement the franchise relationship to ensure compliance with applicable franchise and employment laws on both state and federal levels.

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