Regulatory Unburdening?: An End to Uncertainty--but What Lies Ahead?

Regulatory Unburdening?: An End to Uncertainty--but What Lies Ahead?

Headline: "Donald Trump's Cabinet Selections Signal Deregulation Moves Are Coming"
--Wall Street Journal, Dec. 9, 2016, p. 1

Uncertainty is the bane of business. Although the regulatory environment of the past few years seemed bent on attacking the franchise business model (the NLRB's joint employer decision, the DOL's new overtime rule, and steep minimum wage hikes, to name just three), the early drama and politics of the incoming administration seem to be creating a new kind of uncertainty. At least, as the headline above indicates, the prevailing feeling is that the legislative/regulatory environment is about to move in a more favorable direction for business in general and franchising in particular.

"Uncertainty is always uncomfortable. What we don't know is the scariest," says Zane Tankel, CEO and chair of Apple-Metro, which operates 36 Applebee's and two Pizza Studios in and around New York City--including the world's largest Applebee's, in Times Square. "What we do know is that Andy Puzder being Secretary of Labor will be friendly. He certainly knows the restaurant business."

"There will be somebody running the department that's met a payroll. I think that will help," says John Metz, a multi-unit franchisee and franchisor of Hurricane Grill & Wings.

Keith Miller, a Subway franchisee in Northern California and chair of the Coalition of Franchisee Associations, said he was in a good mood on Election Day--not because of who won or lost, but because no matter how it turned out, at least things would be more certain. "As a policy wonk I knew what I'd be dealing with," he says.

Michael Lotito, a franchise attorney who co-chairs the Workplace Policy Institute at Littler Mendelson and is labor counsel to the IFA, echoed their concerns about having to make decisions, such as setting next year's budget or adding units, when the ground rules are changing. "Business uncertainty will continue," he says. "The trend line is positive, but the timeline is not at all clear."

As 2017 begins and the Republican-controlled Congress and new president settle in, we look at some of the thorniest legislative and regulatory threats on the minds of franchisees and franchisors.

Minimum wage

"I'm not opposed to raising wages, but how you do it is more what I'm worried about," says Gary Robins, a Supercuts franchisee with 51 salons and 400 employees. Raising the minimum wage significantly in one fell swoop, from the federal minimum of $7.25 to $15 an hour, for example, is what raises the ire of employers, who suddenly find their labor costs more than doubling at the turn of the calendar.

The push for large hikes to minimum wages across the country "will be more detrimental than people think," he says. "There's no way to do that." Robins favors a phased-in approach as a more sensible route to addressing income inequality, while allowing employers a longer window to adjust without having to lay off workers. Massachusetts, for example, phased in its 2017 minimum wage of $11/hour over three years, boosting it to $9 in 2015 and $10 in 2016.

"A higher minimum wage is technology's best friend," says Tankel. "As wages go up, people just replace that wage with technology." In fact, as it has become increasingly clear, the more the minimum wage rises for unskilled, entry-level workers, the more businesses will turn to technology. Examples include online ordering, in-store kiosks, and tabletop ordering with tablets--even hamburger-making machines.

In New York over the past year, faced with a wage hike for tipped workers to $7.50/hour as of December 31 (increasing to $10/hour by the end of 2018), Tankel was forced to reduce his workforce from more than 3,500 to about 3,000. He tried to do it through attrition, but there were layoffs. "It breaks my heart to get rid of anybody. We're very people-oriented," he says.

"What's happening is that labor is being taken out of practically everything we do," says Metz. "Jobs are getting eliminated. Hopefully we will find new jobs." As a franchisee, Metz has 40 Denny's with 2 more in construction, 1 Dairy Queen, and 1 Marriott Residence Inn; and as a franchisor about 75 Hurricane Grill & Wings (6 corporate), plus his new fast casual brand, Hurricane BTW.

Metz says the variation in minimum wages across the U.S. for tipped workers is a particular problem for restaurant operators. "I'm in favor of a federal minimum wage. If they want to move it up, do it on the federal level, not on a state or local level. Why? Because I'm in the full-service restaurant business. With a federal minimum wage, I preserve my tip credit. With a state minimum wage above the federal level, I lose that." Metz has a simple solution: abolish tipping and raise the minimum wage for servers. "I'm a big fan of raising the minimum wage--if we avoid tipping," he says.

Will NLRB be trumped?

One of last year's hottest topics in franchising was the possible fallout from the NLRB's August 2015 Browning-Ferris decision, which adopted a new--and unsettling--standard for determining whether or not a company is a joint employer, and by extension whether a franchisor can be held liable for the actions of its franchisees. Flying in the face of nearly four decades of practice, the decision generated fear and uncertainty with its potentially devastating effect on the franchise business model, which had been settled since the adoption of the FTC Franchise Rule in 1979.

While franchisors were concerned they might be sued for a single franchisee's bad behavior, a concern for franchisees was that their franchisor would pull back on the of support it been providing for fear of joint liability lawsuits.

"We have not yet seen any significant change in our franchisor's behavior. They have not backed off on their training and level of support," says Supercuts' Robins. However, he adds, "They have in fact changed the franchise agreement to protect themselves, but I'm fine with that. The have not pulled their head into their shell. In fact, they have stepped up to work through these joint employment issues."

Robins, an active CFA member through the Supercuts Franchisee Association, is among many who agree that franchise agreements have become overbalanced toward franchisors and that it's time for the pendulum to swing back.

"We've now added an indemnity clause to our franchise agreement," says Metz, wearing his franchisor's hat. "This means our franchisees indemnify me if I have a loss on account of their practices. We had a blanket indemnity before, just like Denny's does. We made it clearer in the new franchise agreement."

In fact, some franchisors have been bad actors, exerting too much control over their franchisees, opening all of franchising to increased scrutiny by regulators and elected officials.

"Industries get defined not by their best operators, but by their worst," says Lotito, who keeps an eagle eye on this issue as it wends it way through the appeals process. He says to watch for how quickly the composition of the NLRB changes under the Trump administration. If the nomination process goes smoothly and nominees are approved in a timely manner, a newly constituted board will issue decisions relatively quickly to walk back the joint employment decision.

"On the other hand, if the nomination process bogs down, it will let the current board engage in a great deal of mischief," he adds, perhaps until spring or summer when a legal decision is expected to come down.

In his view, it's likely that franchising will not have to deal with indirect control issues. If that happens, he says, "That would be considered a huge victory for franchising." Until then, it's wise to seek expert counsel on all compliance issues, in-house or from a third party.

If you're considering a third-party PEO to hire that expertise, he adds, be sure to perform deep due diligence on them: who is their counsel, the HR personnel in the field, how many they are responsible for, how responsive they are, their turnover rate, and be sure to speak with those already in the PEO network.

So what's next? Sixteen months after Browning-Ferris, much of the hysteria seems to have been overblown. While calmer observers suggest it was a one-off decision and that future rulings will be decided on a case-by-case basis, many in the franchising community continue to be concerned and are following the issue intently as it evolves.

Says Metz, "I think it was a really lousy ruling, but it looks like it will stand, unless someone in the Trump administration wants to strike it down." Under the new administration, says the CFA's Miller, "It's likely that joint employer will go away."

Stay tuned.

State and local laws

The biggest compliance hurdle for multi-state and national franchisees--or even those with statewide operations--may simply be keeping abreast of changes in the law. Even cities, from Seattle to New York, are writing their own rules.

"Be very mindful of what's happening not only in your states, but also in your cities," cautions Lotito. "They are going to engage in additional legislative activity that will continue to make compliance more difficult." This is critical not only in terms of compliance, but also when considering growing your franchise organization.

"Opening a new location, expansion, or growth is always a measured risk," says Robins. "What's affected our growth expansion strategy is the environment. Where we open is now a factor. Five years ago it wasn't. Is the opportunity here, in this area, worth the headache? We're bringing in those factors into measuring the risk." For example, he's become more cautious about expanding in Philadelphia, citing factors such as increased expense, rules, predictive scheduling, and paid time off.

Predictive scheduling

Predictive scheduling is picking up steam nationwide, says Robins. "What one city does affects others." Referring to Seattle, San Francisco, and other cities where the type of business or number of employees determines the applicability of a law, he's calling these "50/500" rules; that is, localities where the law is applied unevenly based on the total number of employees a company has.

"I don't like when the rules are applied unequally," he says. Just ask any franchisee in Seattle, where the City Council has repeatedly burdened franchisees with requirements that don't apply to non-franchised businesses.

"I'm subject to rules my competitors are not, that the guy across the street I'm competing with is not subject to," he says. For example, with minimum wage, he says, "If it goes up for everyone I'm good with that."

"We're under assault by the government--federal, state, and local," says Tankel, noting that the restaurant industry just came off its worst year since the Great Recession. In New York, he says, among half a dozen bills being introduced in the City Council, one would require employers in the city to inform employees of their schedules two weeks in advance--and pay them a bonus if there are changes in the schedule or in their number of hours worked.

"How in the world do you schedule when you don't know if it's going to snow?" says Tankel, citing the potential absurdity of having to pay a penalty to everyone who's scheduled to work at his more than three dozen restaurants when they may not even be open.

Tankel, an industry veteran with a long track record of doing good for his employees and communities in the New York metro area--hiring former convicts and opening his Applebee's in areas considered iffy at best by most brands--says that while this is a very difficult time for restaurateurs, he still loves the business and, at 75, has no plans to get out soon. "There are good things on the horizon. It certainly won't get worse. But we will be left with some of this legacy legislation in place. It won't just go away," he says.

Metz says predictive scheduling makes sense within reason, but thinks some of the proposed rules are unreasonable. On the employee side, "What right do we have as an employer to have somebody on the schedule and 30 minutes after they're there to cut them? There has to be some give and take," he says. "We really can work as an industry to give people more control over their schedule."

Metz says he has found a happy medium for his restaurants: an employee scheduling tool called HotSchedules that works for employees to give them advance notice of their schedules yet still allows enough flexibility to make it work for him as an employer.

Overtime, over-burdened

Headline: "21 States File Suit Challenging the DOL's New Overtime Rule" (September 2016).

Announced by the Department of Labor in May 2016, the ruling to raise the threshold for overtime from $23,660 to $47,476 per year (from $455 to $913 per week) was quickly criticized and challenged. Nevertheless, franchisees scrambled to meet the DOL's December 1 deadline--only to learn at the 11th hour that the deadline was put on hold by the courts.

Metz says he made the change well in advance of December 1 and he's sticking to it. "As soon as Obama said that's what he wanted to do, we immediately took action as if it would happen." Those changes apply to everyone at corporate, as well as to the managers at his franchised and corporate locations. "I'm very happy with hourly managers and one salaried manager per store," he says. And while he thinks the previous number was much too low, he says the new number is a little high.

"Everybody we're hiring now is hourly, and I think those people are making less," says Robins. Without the new rule, he says he would have hired more people into salaried positions. Today he is not only hiring people on an hourly basis, he also is not allowing them to go overtime. "I'll continue to make that change in 2017 until we get some clarity around that rule."

In the big picture, the employer-employee relationship has been changing over the years, and it's past time the country's businesses and regulators caught up with the times. Much of the shift to the so-called flexible economy has been made possible by technology, with Uber, Lyft, and Airbnb the most prominent examples of "two-sided marketplaces" that essentially are middlemen connecting buyers and sellers. But so are online ordering and delivery services and staffing agencies (see "The Gig Economy," page 70).

Lotito refers to a 2014 book by David Weil, Wage and Hour Administrator at the DOL since May 2014. In The Fissured Workplace, Weil argues that the traditional relationship between the employer and employee has broken down and that gig economy workers need more protection. And yes, Virginia, there are plenty of documented abuses of the employer-employee relationship that have, again, drawn increased scrutiny from regulators and legislators (think misclassified workers, independent contractors, and companies that try to mask control of the situation and move the liability of the employment relationship to someone else.)

Again, Lotito cites the "10 percent factor" of bad actors, who tend to define their industries, create negative headlines, and result in compliance requirements that burden business owners. "Employees become more expensive because of all this compliance," he says. "The incoming administration will take a hard look at this."

ACA (aka Obamacare)

As of this writing, what's happening with the Affordable Care Act (ACA) is anyone's guess. Even with the Republicans in control of both the White House and Congress (and some of the more fervent members salivating at the prospect of finally repealing "Obamacare" after at least 60 failed votes), the future is far from clear. Trump and Congress already can't agree, and Republican legislators have begun arguing among themselves about what to repeal, what to replace it with, and when. Some are even wondering now if the "known evil" of the ACA is better than the current state of uncertainty in Washington, D.C.

Yet, amidst all the political and ideological posturing, there's still the real world of competition, market share battles, and brand building. "I have different worries," says Metz. "I'm not particularly worried about the regulatory environment." Instead, he says, it's the growth of new kinds of competition in the restaurant industry for consumer dollars and mindshare--not so much from other restaurants, but from new competitors such as convenience stores and grocery stores offering fully prepared takeout foods, and from prepared food delivery services like Blue Apron. He does, however, like the growth in delivery concepts such as UberEats, which along with online ordering will drive sales. Then there's the simple fact of more consumers dining at home more often as their disposable income shrinks and they worry about the uncertainties affecting their own future.

"Obamacare affects everybody across the spectrum," says Tankel, not only employers. He says the flat rate penalty of $695 for not having insurance (even if you're a 30-year-old in perfect health) is equal to about 15 average checks at one of his Applebee's, roughly one visit a month. That adds up.

While he objects to "picking peoples' pockets and redistributing that income to the more needy" in the healthcare pool, he strongly supports coverage for people with pre-existing conditions. "They need to be covered, but we have to find a better way."

Get out there!

"The narrative of franchising is still misunderstood by legislators and the public," says Robins, who has participated in the CFA's efforts to educate elected officials on CFA Day, which includes a visit to "The Hill" to meet with members of Congress. "Not only the federal legislators, but the state and local ones still don't understand that it's small guys operating a business under a flag. And the employees. We need to do a better job all around."

Not only does most of the general public think the franchisor is the employer at the local level, so do a majority of employees, according to a recent survey. Says Robins, "We're still local businesses that operate in the communities we serve. I'm not one big business, but 51 little businesses."

Operators must learn to educate people--customers, communities, city councils, and Congress--about the franchise model and its role in the economy, agrees Lotito. And while the chances to do so are plentiful, for the most part they're being wasted. "Generally speaking they don't take advantage of the opportunity: 'Let me tell you how many people I promoted last year, how many wage increases we gave, jobs we created, our health insurance plan, how we helped celebrate the birth of an employee's new child with time off.'" Instead, he says, franchisees are letting others define who they are, "a horrible mistake."

Lotito, who says he's constantly amazed by franchisees doing so many wonderful things and not telling the world, suggests investing time to train their managers to have those talking points at hand when they interact with the public. "Running the business is a lot more than pumping out a donut, a coffee, or a pizza."

IRS Proposed Rule Change Hurts Franchisees

This past August, the IRS proposed a rule changing the valuation of interests in closely held businesses. In plain English, the proposed rule change is bad for franchisees.

Multi-unit franchisees were well represented among the more than 8,000 written responses to the proposed change. And on December 1, among the nearly 40 citizens who spoke at the IRS public hearing ("Estate, Gift, and Generation-Skipping Transfer Taxes; Restrictions on Liquidation of an Interest") were Keith Miller, a Subway franchisee and chair of the Coalition of Franchisee Associations (CFA), and Rob Branca, a Dunkin' Donuts franchisee and vice chair of the CFA. The CFA represents 41,000 franchisees at 86,000 locations employing about 1.4 million people.

While speakers from businesses as varied as auto dealers, CPAs, and the National Cattlemen's Beef Association testified to the rule's negative effects, Miller and Branca explained why the proposed change would be particularly harmful to franchising. In their own words, here's why. (Note: They are transcribed from the hearing and may contain inaccuracies.)

Branca: Franchises are especially vulnerable if these regulations are amended because of factors particular to franchising that naturally depress a business's price. A franchise inherently becomes less valuable for every second ticking by after a franchise agreement is signed; ownership of a franchise is only for a set, continually declining term of years. There is no certainty of renewal for an additional term.

The traditional methods of business valuation that the IRS applies simply do not accurately capture vital facts that affect value. Perhaps more notably, there is an omnipotent third party in franchise transfers that is not present in a non-franchised family business: the franchisor. Franchisors typically possess the power to not only apply not insubstantial fees on transfer, franchisors can also deny them outright.

Franchisors also typically possess a right of first refusal to step into the shoes of any transferee. Transferees often price the uncertainty created by these franchisor rights into the purchase price, knowing that the time and money spent on due diligence, negotiation, attorneys, and accountants can be completely lost. However, perhaps the most discounting factor in valuation of an interest in a franchise is the severely limited pool of buyers. Only an approved franchisee of the system is even eligible to buy at all.

Miller: While our ongoing business may be valued at one price, our ability to sell at that price is often severely impacted by the franchise business model. Many obstacles to our ability to sell may not be included in our contract, the actual franchise agreement, but may be inserted over time unilaterally in our operations manual during the life of that franchise. I'll give some specific examples in my own brand, Subway.

There are clauses that state that transfers cannot have multiple franchises on one contract or include conditional contracts. For example, the sale of one franchise is conditional in the sale of a second franchise or the real property related to that franchise.

It also has a clause in there that says you can only transfer one store at a time to a new franchise owner or up to three to existing franchise owners, and they do limit us in this way.

So these specific clauses negatively impact the value of our franchises. For example, if you own the property that your franchise is located on, you can't conditionally sell them both on the same contract.

Or if you own say 10 or 20 stores, you would have to break up your company to sell the individual units. I think you can clearly see that in total, a company of a large franchise owner, with all the overhead structure and efficiencies in place that are built into that larger company is more valuable than when broken into individual stores and without the real estate.

So I ask you, how can you properly value a company when you can't sell the company? While these examples are specific to Subway, many franchises follow similar policies, so we would respectfully ask that you reconsider this rule change.

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