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Franchisees or Employees?

Ongoing litigation between Coverall North America Inc., a company in the commercial cleaning business, and its franchisees could change the landscape of the franchise business throughout the country. In the case, a judge has found that the company’s franchisees are actually employees of the company as opposed to independent contractors. Litigation, however, is ongoing.

If a precedent is set indicating that franchisees are to be reclassified as employees, the legal ramifications are immense. The biggest impact for franchisors would be tax implications, required workers’ compensation and company benefits. Also, franchisors are not required to match Social Security and Medicare contributions for independent contractors but would be required to do so for employees.

Legal experts are advising clients involved in franchising to rework their structure and franchise agreements to be sure they are not participating in the same business acts as the franchisees. The franchisor can set itself apart by selling to franchisees the business model instead of the actual product the franchise distributes. Also, certain restrictions placed on the actions of a franchise can be construed by the courts as enough to make the franchise agreement an employment agreement as opposed to an independent contractor agreement. For example, restricting a franchisee’s ability to enter a competitive business may remove the independent nature of an agreement.

There is little legal precedent in this regard. However, the current economic climate has given both the federal and state governments reason to want franchisees to be classified as employees instead of independent contractors.

The Obama administration has called for the hiring of officials whose sole purpose would be to find employers improperly classifying employees as independent contractors.