Franchisee as Employee? An Analysis under Maryland and U.S. law

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1 Franchisee as Employee? An Analysis under Maryland and U.S. law Presented by David L. Cahn, Esq. and Steven Bers, Esq. and

2 Coverall Commercial Cleaning cases a primer Presented by David L. Cahn, Esq. Chair of Franchise Business Law Group at WTP dcahn@wtplaw.com (410)

3 Franchises: Independent Businesses or Hired Hands? Historically, franchising has been viewed as a method to grow a brand and business method by recruiting others to invest their funds and operate in new locations, under the guidance of the franchisor but without day to day franchisor control Most franchise owners employed several employees (if not dozens) and became employers of record. More recently, services franchises have become more prevalent, including those were the franchise owner also provides much or all of the services. Are those franchisees really employees in disguise?

4 Coverall Business Model Janitorial services in commercial real estate. Coverall Commercial Cleaning and competitors like Jani-King and CleanNet utilized this method: Regional offices, typically area franchisees but sometimes run by employee managers; Regional office solicit customers and signs contracts in the name of the regional office; Regional office sells franchises to individuals, who are delegated the work under those contracts; Initial fee is tied to the dollar value of contracts; and Franchisor bills customers and collects payments.

5 Coverall Massachusetts cases Coverall North America s regional office for Massachusetts was company-owned In 2006, the Mass. Supreme Judicial Court held that a terminated Coverall franchisee had been an employee and was therefore eligible for unemployment benefits Awuah v. Coverall North Am., filed in U.S. District Court for Mass. by former franchisees for damages due to misclassification as independent contractors In March 2010, U.S. District Court also held that Coverall violated Mass. s Independent Contractor Act and that the franchisees had been employees

6 Coverall cases -- damages U.S. Dist. Ct. certified questions regarding the categories of damages to Mass. Supreme Judicial Court, and on Aug. 31, 2011 the Court ruled that the following are damages: All amounts deducted for insurance, in lieu of Workers Comp. Ins. and also as required by customers, i.e. janitorial bonding Charge-back amounts withheld from the franchisee s future earnings due to the failure of prior customers to pay their bills within 90 days of invoice. Franchise fees paid to obtain the right to perform under the cleaning contracts; all initial fees tied to the volume of work guaranteed were illegal special contracts.

7 Independent Contractor... Or Not? No Simple Matter Under Maryland and Federal Law Presented By Steven Bers, Esq. Chair, Employment Law Section

8 Presentation Overview The Growth of Misclassification Focus More complicated employment relationships Leased Employees On-call employment Greater use of consultants in economic downturn Franchise Arrangements?? More Focus Perception of Revenue Loss Perception of greater Employer manipulation Greater Employee incentives to avoid FICA and FUTA taxes.

9 Presentation Overview Responses to Misclassification Trend Toward Codification New Initiatives in Enforcement New Cross-agency reporting. New Md. Workplace Anti-Fraud Act New Federal cross agency reporting obligations Abandonment of Common Law definitions in favor of codification Legislative Bills / DOL Initiatives.

10 Presentation Overview Who Cares... Why Does it Matter? Unemployment Tax Workers Compensation Coverage Overtime & Wage Payment Laws NLRB Unionization EEOC Anti-discrimination Laws Employee Benefit Entitlements Md. Workplace Fraud Act Income Tax Withholding Tax

11 Presentation Overview So Who is an Independent Contractor? No Single Definition. Different Definitions Between Agencies. Even Different definitions Within the IRS depending on whether the issue is tax withholding, or tax payment Common Law Definition Maryland Unemployment Definition Workers Comp Definition Maryland Workplace Fraud Act Definition IRS Definition.

12 Common Law Test Traditional Statement Employment exists if the Employer may control both the ends and means of preforming a task. Independent Contracting exists if the Employer only directs the ends. The decisive test in determining whether the relation of master and servant exists is whether the employer has the right to control and direct the servant in the performance of his work and in the manner in which the work is to be done. It is not the manner in which the alleged master actually exercised his authority to control and direct the action of the servant which controls, but it is his right to do so that is important." L.M.T. Steel v. Pierson, 47 Md. App. 633(1981)

13 Newer Common Law Movement to Listing of Factors Newer Case Law More articulated Factors Tests. who has the right to control the work; who has the right to select the worker that will perform the duty; how wages are paid; whether the work is part of the employer s regular business; the intention of the parties when entering into the relationship. Rubin v. Weissman, 59 Md App. 392 (1984) The power to discharge. The power to control the employee s conduct. Harbor Charters LTD v. Joseph 355 Md. 366 (2001)

14 Unemployment Tax The Most Aggressive Definition Issue arises when an employee is terminated, and seeks to claim unemployment benefits. Up until recent times, the only time the misclassification issue actually saw the light of day Up until recent times, the matter would be isolated within the agency No affirmative bleed-over observed

15 Maryland Unemployment Law MD Code, Labor and Employment, Independent Contractors. Work that an individual performs under any contract of hire is not covered employment if the Secretary is satisfied that: (1) the individual who performs the work is free from control and direction over its performance both in fact and under the contract; (2) the individual customarily is engaged in an independent business or occupation of the same nature as that involved in the work; and (3) the work is: (i) outside of the usual course of business of the person for whom the work is performed; or (ii) performed outside of any place of business of the person for whom the work is performed.

16 Maryland Unemployment Law COMAR #1 Free from control or direction Whether the employing unit requires the person to comply with detailed instructions about when, where, and how the person is to work; Whether the employing unit trains the person to perform the service in a particular manner or using a particular method determined by the employing unit; Whether the employing unit establishes set hours of work for the person performing the services; Whether the employing unit establishes a schedule or routine for the person performing the service; and Whether the employing unit has the ability to terminate the person for failure to obey the employing unit's specific instructions on how the service is to be performed.

17 Maryland Unemployment Law MD COMAR #2 customarily engaged in an independently established business maintains a business listing in the telephone directory; has his or her own place of business; has a financial investment /can incur a loss. has own equipment needed to perform the service; determines the price of the service to be performed; employs others to perform the service; carries his/her own liability or WC insurance; performs the service for more than one unrelated employer at the same time; sets his or her own hours; and is paid by the job.

18 Maryland Unemployment Law MD COMAR #3 Outside the usual course of business of the employing unit Whether the person performs the work off the employing unit's premises; Whether the person performs work that is not integrated into the employing unit's operation; Whether the service performed is related to the employing unit's business.

19 Workers Compensation Employers have a responsibility to have WC Insurance coverage for all employees (Maryland Code Annotated, Labor & Employment, Section 9-402) Criminal to fail to have WC coverage Issue arises in the case of injury two ways that the issue arises Employee seeks coverage (to get bills paid) Employer may have been better off - limitation of liability

20 Workers Compensation Law [T]o determine whether a person is an independent contractor or an employee under the Workers Compensation Act, a court must consider: (1) the selection and engagement of the worker; (2) the payment of wages; (3) the right to terminate the relationship; (4) the power to control the worker's conduct; and (5) whether the work is part of the regular business of the employer. Johnson v. Helicopter & Airplane Services Corp.,389 F. Supp. 509 (1974)

21 Employee Benefit Plans Risks from Misclassification Failure to Include in Health Benefit Plan Potential exposure for Medical Treatment? Counting Requirement for the Obama health plan Failure to Include in ERISA Retirement Benefit Plan Potential IRS Plan disqualification for exclusion of employees Potential claim for retirement Benefits? Top-heavy plan calculations? Joint Employer concept.

22 EEOC Risks from Misclassification Employer Obligations Under Anti-Discrimination laws Misbelief that Independent Contracting Title Insulates the Employer EEOC use of Joint Employer Concept Employer exposure for illegal discrimination or sexually offensive condition created by employees

23 NLRB Risks from Misclassification Mistaken belief that independent contractor title relives employer of possible unionization of workforce. NLRB use of Joint Employer concept. If there is shared control of the workforce activity, the independent contractors and employees may be entitled to vote as to unionization.

24 IRS Analysis Income Tax and Withholding Tax The status of the worker for purposes of income tax withholding and FUTA/FICA withholding are different. It is possible that a worker may be required to have FUTA/FICA withhold as a statutory employee, yet the same worker is not an employee for purposes of requiring income tax withholding. Refer to pages 4 10 of IRS Publication 15-A (2011)

25 IRS Implications Withholding FICA & FUTA The employer is always liable for the tax if the employee was Misclassified FUTA & FICA Statutory Employees, even if these are otherwise independent contractors: E.g. Certain Delivery drivers Life Insurance Salesmen Home production workers Certain Fulltime salesmen to businesses

26 IRS Identified Factors Instructions Given to Worker Training for Performance Financial control and Risk Unreimbursed Expenses? Worker Investment Availability to Other Entities for Work Manner of compensation Ability to influence or incur profit or loss Are services key to the regular business?

27 IRS Definition Standard Income Tax The relationship must be examined.all information that provides evidence of the degree of control and the degree of independence must be considered. Behavioral Control Financial control Type of relationship.

28 Maryland Workplace Fraud Act (2009) Construction and Landscaping (and some others) Md s Statutory initiative as to two industries Failure to Withhold Income Taxes Failure to provide Workers compensation coverage Failure to pay Unemployment tax Exclusion from Employer benefit programs Establishing A private cause of action The Act now applies only to Construction Services or Landscaping Services Franchises?? A natural framework that can be expanded in the future to other employees

29 Maryland Workplace Fraud Act (2009) Landscaping Industries: Garden and lawn maintenance, pruning, mulching Construction Industries Building and Alteration Improving and Repair Painting & Maintenance No clear line as to scope of Industries : e.g., Employers that do some Landscape/Construction Services MANDATORY NOTICE OBLIGATION RECORD KEEPING OBLIGATIONS

30 Maryland Workplace Fraud Act (2009) To Be An Independent Contractor, the following must all be true: 1. Operates free from Control or Direction 2. Guided only by the Desired Result 3. Furnishes own tools/equipment 4. Operates a business in which: Person owns all assets and liabilities All business formalities Exercises the Right to work for multiple entities. OR The Employer must show 1, 2 and that the services are outside the usual course of the Employer s business

31 Maryland Workplace Fraud Act (2009) Sanctions for Misclassification Are Serious and Significant: Elaborate Commissioner Investigatory Powers Remedy of paying Restitution 12 month limitation Period Noncompliance shall result in up to $1000 civil penalty per employee ($5000 if knowing )(20K if > twice) Private right of action for Economic Damages Triple damages if knowing Attorneys fees

32 Maryland Workplace Fraud Act (2009) Unemployment Law Amended the Unemployment Insurance law Prohibits misclassification (For all employers) Imposes interest on unpaid premiums at 2% per month from notice Establishes a new civil fine of $5000 per employee for knowingly misclassifying an employee. (2x for repeated violation) Obligation to notify WC, Labor and Industry, Insurance Administration and Comptroller Reinforces Presumption of Employee under Maryland Unemployment Regulations

33 Workplace Fraud Act of 2009 Workers Compensation Act Amended Workers Compensation Insurance law for all employers. Prohibits misclassification for the purpose of avoiding workers comp. liability Establishes a new civil fine of $5000 per employee for knowingly misclassifying an employee. (2x for repeated violation) Obligation to notify WC, Labor and Industry, Insurance Administration and Comptroller Employer may be required to pay Restitution

34 Is Coverall Sui Generis for Franchising? Coverall was held to be Employer mainly on two different bases: Plaintiffs did not have independently established businesses, because Coverall negotiated contracts and pricing directly with clients, billed clients, and provided a daily cleaning plan to which the plaintiffs were required to adhere. Plaintiffs provided the services within the scope of Coverall s core business of providing cleaning services under contracts with Massachusetts clients.

35 Will These Steps Lead to Danger? What if: Franchisor employees are the initial point of contact for prospective customers and scheduling franchisees appointments? Franchisor processes customers payments? Franchisee is only allowed to provide that type of services (e.g., painting) under the Mark? Franchisee is taught the methods for providing the service and is subject to discipline for failing to follow the prescribed methods?

36 Steps to Take? Avoid any guarantees of supplying contracts or base of revenue to the franchisee. Require all customer contracts to be clearly and conspicuously in the name of the Franchisee. Make sure scope of non-competes are sufficiently narrow to focus exclusively on franchised service. Focus mandatory standards on customer satisfaction? Require Franchisees to be an entity taxed as a corporation and to file IRS payroll reports, even if the owner is the sole employee?