Contractual Relationships Coming Under Fire

Recent developments in the area of labor and employment are causing concern for many in the business community. A number of recent decisions by courts and important administrative agencies have scrutinized employer relationships with third parties such as franchisees and independent contractors. Many of these relationships are covered by detailed contracts that limit and/or distribute liability among the parties. However, in light of these recent developments, it is becoming increasingly difficult to predict which contractual relationships can withstand the heat and which ones may go up in smoke—no matter how carefully drafted.

Franchisees

Just before the holidays in 2014, the U.S. National Labor Relations Board’s (NLRB) Office of the General Counsel jointly named McDonald’s Corp. and some of its franchisees in complaints alleging labor violations. The complaints treat McDonald’s, the world’s largest restaurant chain, as a “joint employer.” That label exposes McDonald’s to liability along with its franchisees for any violations.

Why is this noteworthy? The NLRB’s General Counsel serves as the agency’s “prosecuting attorney” and decides which cases to pursue. Through these complaints, the NLRB’s Office of the General Counsel is seeking to have the NLRB adopt a broader standard related to “joint employers.” Under its present definition of “joint employer,” franchisors generally have been able to avoid liability for labor violations by their franchisees as long as they are not involved in hiring workers and setting wages. The new standard, however, would look at other aspects of the working conditions at the franchisee’s location over which the franchisor may exert influence.

This may sound familiar to risk managers, claims handlers, and defense attorneys. In other claims in which a franchisor seeks to avoid liability for the acts of a franchisee (and/or a franchisee’s employees), a franchise agreement is an important piece of evidence. Such an agreement may be the strongest evidence to counteract the courts’ analysis of the amount of day-to-day control the franchisor exercises over the franchisee’s business operations, which often is given considerable weight in the overall liability analysis and may tip the scales against the franchisor.

The possibility that the efficacy of franchise agreements may be undermined in another setting certainly is not a welcome one. Therefore, it will be important to monitor the McDonald’s complaints as they make their way through the NLRB and—possibly—the federal courts. The results could impact much more than just labor and employment law.

Independent Contractors

There also has been considerable focus recently at the federal and state level on whether employers are misclassifying their employees as independent contractors. This is yet another setting in labor and employment law wherein familiar contractual arrangements are coming under fire.

The stakes are substantial, too. Potential liabilities for misclassification can include failure to pay minimum wage, overtime, and employee benefits as well as failure to pay workers’ compensation and unemployment premiums. That certainly is not an exhaustive list, however.

From an insurance coverage standpoint, claims by misclassified employees can be particularly problematic for a business. Many insurance policies that potentially provide coverage for labor and employment claims will contain exclusions related to wage and hour claims. Even those insurance policies that do offer some coverage for such claims may have wasting limits and/or low sublimits applicable to the claims. Thus, a business’s assets may be entirely unprotected or protected on a very limited basis.

In the misclassification setting, another large and well-known company, FedEx, has been in the news recently. Within a matter of weeks during the fall of 2014, FedEx was the subject of unfavorable decisions by a federal circuit court, a state supreme court, and the NLRB with regard to its classification of its home delivery and ground division drivers. While each of these decisions involved some unique aspects, the decisions as a whole suggest that FedEx may face significant liability for classifying these drivers as independent contractors instead of employees. These decisions came despite the fact that FedEx had gone to considerable lengths to overhaul its legal relationships with its drivers to attempt to solidify their status as independent contractors.

There is a considerable gray area when it comes to properly classifying these relationships to avoid potential liability because there are a variety of tests that may be used to differentiate between employees and independent contractors. The U.S. Internal Revenue Service has a test, and so does federal wage and hour law. States may have their own tests as well. While the factors to be considered will vary, those analyzed typically include:

• Nature and degree of control by the employer over the worker.
• Worker’s opportunity for profit and loss.
• Worker’s skill and initiative.
• Length of the relationship.
• Party’s relative investments in facilities and equipment.
• Extent to which the work performed is an integral part of the employer’s business.

Notably, the specific language of the contract that governs the relationship often carries little weight. Instead, the decision-maker’s focus will be on the “realities” of the relationship to see if the contract misclassifies an employee as an independent contractor.

With this in mind, businesses must continue to evaluate their classification of workers carefully, and nothing can be taken for granted where potential claims may turn on whether or not a decision-maker will recognize and deem enforceable the terms of an independent contractor agreement. This also is true in terms of managing risk associated with claims against a business’s independent contractors, from which the contracting business may want to separate itself clearly to avoid potential joint or vicarious liability.

Most risk managers, claims handlers, and defense attorneys will encounter franchise agreements and independent contractor arrangements on a regular basis. While it is very important for those handling labor and employment claims to pay close attention to the hot-button issues described above, it is equally important for the defense community to recognize that these issues are of general concern to many others—particularly proactive businesses attempting to manage emerging risks associated with these common contractual relationships coming under fire.