California has long been a key market for franchising. Its consumer-oriented culture has also made it one of the most active venues for regulatory and legal issues. Legal developments over the past year affecting the franchise community include 1) the cascade of "Bounty Hunter law" actions; 2) a franchisee's escape from arbitration requirements deemed "substantively unconscionable"; and 3) a lesser-known ruling narrowing the interpretation of franchise fees.
1) "Bounty hunter" alert
California's unique wage and hour regulations provide fertile ground for lawsuits. Always vexing for California employers because of rigid and sometimes counterintuitive requirements, wage and hour compliance has become even more critical because of substantial modifications in the laws and their interpretation over the last several years.
One of the most significant recent legal developments has been the boom in litigation under the "Labor Code Private Attorneys General Act of 2004" (Labor Code sections 2698 and 2699), colloquially and aptly referred to as the "Bounty Hunter law."
On average, one or more class action and/or Bounty Hunter suits were filed every day in California in the past year, a dramatic increase since the law's enactment. The statute creates a private right of action for any employee who was subject to at least one alleged violation, and permits that employee to initiate a class action for the recovery of 25 percent of the civil penalties on behalf of himself or herself and all other current and former employees. The remaining 75 percent of the recoverable penalties are paid to the state's general fund and the Labor and Workforce Development Agency to promote labor education. An employer found to have violated labor laws is liable for penalties, which begin at $100 per employee, per pay period, per violation, in addition to attorneys' fees and costs.
It is the almost automatic award of attorneys' fees that has set off a tidal wave of litigation under the Bounty Hunter law. Also, the increasing availability of class actions in the wage and hour arena has allowed plaintiffs to group multiple employees' claims together to assert a much larger lawsuit. Given the complexity and the inflexible application of California's wage and hour laws, most cases afford a likelihood of establishing at least one labor violation against most employers. Supporting violations for an action may be as minor as a single day on which the requisite meal or rest period was not given or cannot be proven. Substantial compliance with the law is not a defense; any violation, however technical or inconsequential, is actionable. As a result, plaintiffs' employment attorneys have a significant economic incentive to bring these cases.
Some attorneys are taking their exuberance to the public in ways that seemed previously reserved for personal injury law and asbestos claims. There are now advertisements appealing to employees with wage and hour complaints on bus shelters and billboards, broadcast on the radio, and appearing in newspapers.
The crux of a typical complaint for employer wage and hour violations is that the employer failed to give an uninterrupted 30-minute meal break and/or failed to give the required 10-minute rest periods to non-exempt employees. The timing of these meal and rest periods is set by law and, in most cases, cannot be waived by the employee. A common problem encountered by employers is the employee who prefers to skip meal and rest breaks in order to leave work early.
Restaurateurs, retailers particularly vulnerable
Another occurs in the restaurant business where a server may wish to work through a rest period during peak hours to receive more tips. Unfortunately, an employer who permits one employee to skip a mandated break as an accommodation may find the practice asserted as a violation by another employee. Because of the class action nature of these suits, the records of the failure to give required breaks are often evidence of a substantial number of violations. The employee's desire for and agreement to this schedule is immaterial.
For franchised businesses, another common trouble spot in California's wage and hour law requirements is the misclassification of employees who are subject to these laws. Under current standards, an employee not working in a field subject to specific exceptions under the law must meet both a salary test and a duties test in order to be exempt from wage and hour requirements regarding meals, rest periods, and overtime. The salary test requires that the employee earn double the state's minimum wage (a minimum salary of $31,200 in 2007), and be paid a fixed salary rather than hourly wages. The duty requirements include, among a number of other detailed requirements, that an employee qualifying based on their position as a manager uses independent discretion and judgment in executing tasks and spends a minimum of 51 percent of their day engaged in supervisory activities.
Many employees currently classified as exempt do not meet the minimum salary requirement, or are paid hourly. Even more do not meet the duties requirement, particularly at small businesses. A typical manager at a franchised restaurant spends more than half of each work day on non-managerial tasks such as serving customers and receiving inventory. Many retail franchises similarly employ people who are managers or assistant managers by job title, but who are nonetheless not exempt from the meal and rest period requirements because their daily job duties require little supervision of others or are subject to such narrow instructions that they do not exercise any independent discretion in completing their duties.
Avoiding the bounty hunters
To avoid being the target of a Bounty Hunter suit, both franchisors and franchisees who employ anyone in California should 1) take time to review the state's wage and hour requirements, 2) train managerial staff to administer meal and rest periods, 3) update employee handbooks to ensure that the written policy is consistent with current law, 4) maintain detailed time records, and 5) conduct an audit of all staff categorized as "exempt" from overtime and from meal and rest breaks to ensure that they meet, and continue to meet, the required criteria.
2) Out-of-state arbitration negated
In another important legal development, the Ninth Circuit sat en banc to review the matter of Nagrampa v. MailCoups, Inc. involving a California franchisee's challenge to an arbitration provision. In a lengthy opinion, including a dissent by four justices, the Court found the arbitration provision unconscionable, based on lack of mutuality, inadequate notice of the provision's validity in the offering circular, and an unduly burdensome venue for the franchisee.
In this case, after suffering substantial financial losses during two years of operating her franchise, the California franchisee, Connie Nagrampa, unilaterally terminated her agreement with MailCoups, the franchisor. MailCoups initiated American Arbitration Association (AAA) arbitration pursuant to its franchise agreement and attempted to compel Nagrampa to travel to Boston, the venue specified in the agreement.
The franchisee, who ran her franchise on her own, out of her home, objected, and sought MailCoups' agreement to move the arbitration to Fresno, which was refused. She also sought a fee waiver from AAA, which was likewise refused. She then filed suit.
Arbitration clause "unconscionable"
The Court found evidence of both procedural unconscionability, involving "oppression" or "surprise," and substantive unconscionability, involving "overly harsh" or "one sided" results, if enforced.
On the subject of procedural unconscionability, the Court observed that Nagrampa was a first-time business purchaser with an income of $100,000 at the time she entered the franchise agreement. MailCoups rebuffed her attempts to negotiate portions of the contract and was in a far stronger bargaining position; its parent company, Advo, had billion-dollar revenues. The Court concluded that "MailCoups had overwhelming bargaining power, drafted the contract, and presented it to Nagrampa on a take-it-or-leave-it basis." It rejected MailCoups' defenses that there were competing companies with which Nagrampa could have chosen to do business and that Nagrampa was a sophisticated business woman, finding that these facts alone were insufficient to defeat a finding of "weak" procedural unconscionability.
There was more evidence of substantive unconscionability. The Court concluded that the arbitration provision's drafting, which permitted MailCoups to seek injunctive relief in court to protect its intellectual property but limited Nagrampa's remedies to AAA arbitration and required her to travel to Boston, were unconscionable. The Court found that the burden of forcing a California franchisee to travel to Massachusetts to protect her rights was likely calculated to discourage franchisees from seeking redress for their disputes.
Arbitration provision negated
In addition, the offering circular contained a statement that suggested that the arbitration provision could not be enforced against Nagrampa: "The franchise agreement requires application of the laws of the State of Massachusetts. This provision may not be enforceable under California law." The Court echoed its 1999 opinion in Laxmi Investments, LLC v. Golf USA, holding that an offering circular indicating that the forum selection clause may not be enforceable in California does not sufficiently warn the franchisee that the franchisor will attempt to enforce the provision. The arbitration provision was therefore outside of Nagrampa's reasonable expectations.
Nagrampa also challenged the arbitration clause's fee-splitting provision, which required her to bear half the AAA expenses, as contrary to public policy and in violation of the California Franchise Investment Law, California Unfair Competition Law, and California Consumer Legal Remedies Act. The Court declined to consider this issue.
3) Franchise fees claim nixed
In Thueson v. U-Haul International, Inc., a California appellate court recently added its interpretation of what constitutes a franchise fee under the California Franchise Investment Law (CFIL) and California Franchise Relations Act (CFRA). In this action, a terminated U-Haul distributor sued for wrongful termination under the CFIL and CFRA. Thueson argued that the $20 monthly fees he paid to U-Haul for a telephone line acquired and maintained by U-Haul in order to protect its trademarks constituted a franchise fee. Likewise, he argued that the expenses of a credit card processing computer terminal, acquired by separate contract with U-Haul after a representative urged him to obtain one, also constituted a franchise fee.
The appellate court rejected Thueson's liberal interpretation of a franchise fee and focused on statutory interpretations of the CFIL and CFRA as protections for investors. None of Thueson's payments constituted an investment or contribution of capital and there was no unrecoverable payment to the franchisor. He purchased no inventory or services from U-Haul. The Court concluded: "Our statutes define a franchise fee as a fee paid for the right to do business, not ordinary business expenses paid during the course of business."
Mary Beth Trice, of counsel with Oakland, Calif.-based Fitzgerald Abbott & Beardsley LLP (www.fablaw.com), is a member of the firm's Business and Corporate Transactions Practice Group. She focuses her practice on franchise transactions and regulatory matters and franchise and dealer relationship issues. She can be reached at 510-451-3300 or firstname.lastname@example.org.
Dawn Newton is an associate and a member of the Litigation Practice Group of Fitzgerald Abbott & Beardsley. She practices in federal and state courts representing clients in business and franchise matters. She can be reached at 510-451-3300 or email@example.com.
* Written by Mary Beth Trice and Dawn Newton. Provided by Area Developer Magazine, Copyright (c) 2007, by Franchise Update Media Group
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