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Do Franchisors Face Triple Damages If They Fraudulently Induce Franchisees to Come to California?

by on Fraud and Unfair Trade Practices

California Labor Code section 970 states that “[n]o person, or agent or officer thereof, directly, shall influence, persuade, or engage any person to change from one place to another in this State or from any place outside to any place within the State…through or by means of knowingly false representations, whether spoken, written, or advertised in printed form, concerning either: (a) The kind, character or existence of such work…” Does a franchisee come within this statute? What if the franchisee can be categorized as an employee under Dynamex?

Does Anti-Fraud Statute, California Labor Code Section 970, Apply to Franchisees?

The first question is whether Labor Code Section 970 only protects employees. In interpreting, “we start with the statute’s words, assigning them their usual and ordinary meanings, and construing them in context.” Wells v. One2One Learning Found., 39 Cal.4th 1164, 1190 (2006). “If the words themselves are not ambiguous, we presume the Legislature meant what it said, and the statute’s plain meaning governs.” Id.

Section 970 applies to any “person” who moves to the state based on false representations. Being in the labor code, Section 970 has typically been applied to employees. However, the plain language of the statute provides for no such limitation. The issue is ripe for consideration as there is no published case analyzing whether the statute applies to persons who act as independent contractors or franchisees.

The original purpose of Section 970 was to prevent employers from making false promises to induce migrant workers to move. Over time, courts have applied the statute beyond its farm labor origin. As recognized in Munoz v. Kaiser Steal Corp., 156 Cal.App.3d 965, 980 (1984), “nothing in the statute restricts application of the statutory language to any particular class or kind of employment, and we find no justification for restricting application of the statutory provisions to farm labor or other mass hiring situations.” More generally, the public policy behind Section 970 was designed to stop companies from making false promises to induce people to move. See Fittante v. Palm Springs Motors, Inc., 105 Cal. App. 4th 708, 716 (2003). The same public policy should apply to franchisees.

In a recent case, a franchisee made this argument. Negrel v. Drive N Style Franchisor SPV, LLC, et. al., Case No. 8:18-cv-00583-JVS-KES (C.D. Cal. Aug. 27, 2018) (Dkt. No. 30) (denying motion to dismiss in part). There, the franchisor made certain written representations that purportedly caused two French citizens to move to California to start a Drive N Style franchise. The franchisor conceded for purposes of a motion to dismiss that the franchisee fell within its protection. Instead, the franchisor argued that it did not cause the franchisee to move. However, the court found that the franchisee had stated a plausible claim because the “inciting factor” causing the Negrels to move from France to California was the opportunity presented by the Drive N Style franchise and its alleged representations.

Under the Dynamex Test, Franchisees Can Argue That They Are Employees of the Franchisor and Thus Are Protected by Section 970

The franchisee argued in Drive N Style that even if California Labor Code section 970 is construed as only applying to employees, the franchisee was an employee of the franchisor. In light of the California Supreme Court’s recent decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (2018), those arguments can be persuasive.

On April 30, 2018, the California Supreme Court adopted a new misclassification test that starts with the presumption that workers are employees. Dynamex, 4 Cal.5th at 930. Under the Dynamex approach, the burden is on the franchisor to establish that the franchisee is not an employee. Id. at 957. To meet this burden, the franchisor must establish each of the three elements embodied in the ABC test:

  1. That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
  2. That the worker performs work that is outside the usual course of the hiring entity’s business;
  3. That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Id. at 955-956. The absence of any one of the elements in the ABC test represents grounds for finding the franchisee to be an employee. Id.

In Dynamex, the California Supreme Court cited two franchise cases: Awuah v. Coverall N. Am., Inc., 707 F.Supp.2d 80, 82 (D. Mass. 2010) (considering only part B of the ABC standard) and Coverall N. America v. Div. of Unemployment, 857 N.E.2d 1083, 1087 (Mass. 2006) (considering only part C of the ABC standard). Relying on parts B and C of the ABC test, the courts in those two cases found that franchisees in the Coverall franchise system had been incorrectly classified as independent contractors and were instead employees of the franchisor.

Some franchise systems share similarities to the Coverall franchise system. Franchisees can argue that they operate in the same business as the franchisor and provide the same goods or services. They can also argue that they are not engaged in an independently established trade, occupation, or business. Indeed, most franchisees are restricted from running an independent business pertaining to the same industry, good or service. Lastly, franchisees can argue that franchisors, either by their franchise agreement or the operations manual, exhibit significant control over the franchisee’s performance of their work. In the Drive N Style case, for example, the franchisee argued (1) that they were in the same auto reconditioning business as the franchisor; (2) that they did not operate an independent business outside the franchise system; and (3) that the franchise agreement allowed the franchisor to control the franchisee’s performance.

On the other hand, franchisors have argued that they are not in the same business as franchisees as they are merely licensing a concept. Franchisors have also argued that the franchise agreement and operations manual provides a system but that ultimately it’s up to the franchisee to control its own performance. The arguments may depend on both the nature of the franchise documents and how the franchise system is structured.

Further, there is still a significant question as to whether Dynamex’s holding encompasses a franchisor and franchisee relationship. Dynamex involved employees who had been converted to independent contractors in what appeared to be a blatant attempt to skirt employment laws. Id. at 217. The trial court in Dynamex also excluded from class certification drivers who had their own employees, analogous to franchisees who have their own employees. Thus, its precedential impact may be limited and perhaps only applicable where the franchisee is an individual without employees working under the franchisor’s direction.

Labor Code Section 970 presents another interesting wrinkle in how Dynamex may have an effect on California franchisors. Between the expansive language of Labor Code Section 970 and the potentially expansive nature of the Dynamex holding, there is a possibility that franchisees may fall under the protection of Section 970. It goes without saying that franchisors should put even more consideration into making sure their representations to franchisees, who are being caused to move to California, are accurate.

* Originally published in shorter form in the California Lawyers Association, Business Law Section, Franchise Law Committee, Case Report, November 2018

If You Need to Discuss A Potential Fraud Claim, Then It’s Time to Contact a Franchisee Attorney

Franchisors and their brokers may make false representations to entice a possible franchisee to cross state borders and start a franchise. When you’re ready to discuss your fraud claim, we are ready to listen. We will walk through the representations made to you, identify your case’s strengths and weaknesses, and develop a strategy to accomplish your goals. Whether you are in Orange County, San Diego, Riverside, Los Angeles, or elsewhere in California, to discuss your case and how we can help, contact Luther Firm, PC, to schedule a consultation.