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Vicarious Liability of Franchisors

One of our Firm’s specialties is representing Franchisors and Franchisees. In the context of the franchisor-franchisee relationship many issues can arise which the parties try to anticipate in the Franchise Agreement. One of those issues is the potential liability of the franchisor for the wrongful or negligent actions/inaction of the franchisee, which we refer to as “vicarious liability”. The critical element of vicarious liability in the franchise context is the amount of control a given franchisor has over the operations of a franchisee. In the franchisor/franchisee situation, this “control” issue can be very tricky.

On the one hand the backbone of any franchise system is uniformity of service or product. For example, you know what a “Big Mac” hamburger at a McDonald’s restaurant is going to be whether you order it in San Diego or Memphis. To ensure this uniformity throughout the franchise system, a franchisor necessarily must establish guidelines in order to maintain the standards of quality and operation of the system which are typically expressed in the franchisor’s Operations Manual. Obviously, the franchisor must maintain a certain amount of control over franchisees’ operations in order to ensure the operating guidelines and hence the uniformity of the franchise system are maintained at each franchise location. In addition, the franchisor must maintain the ability to enforce the operating guidelines and take action against franchisees who fail to follow the guidelines.

On the other hand, a typical franchise agreement makes it clear that each franchisee is an independent contractor wholly and exclusively responsible for the safe and uniform operation of his/her franchise establishment. The typical franchise agreement will require that each franchisee clearly identify itself has a franchise establishment and that the franchisee is independently owned and operated and solely responsible for the services and products provided at the facility. These contractual provisions are meant to prevent the franchisor from being held vicariously liable for the activities conducted at the franchise establishment.

So herein lies the dilemma, to what extent can a franchisor exert “control” over a franchisee to ensure compliance with the uniform operation of the franchise establishment while not being held liable for arguably “running” the franchisee’s business and hence being held liable along with the franchisee when trouble arises.

Unfortunately, two recent legal cases come to apparently opposite decisions on the issue of franchisor vicarious liability with California taking the stronger view on imposing potential vicarious liability on franchisors.

In Ketterling v. Burger King Corp. a customer in Idaho slipped and fell on snow in the parking lot of a franchised Burger King restaurant and sued the franchisee operator and Burger King Corp. (as franchisor) claiming the franchisor was also to blame for the franchisee’s failure to keep the parking lot clear of snow. The district court dismissed the lawsuit against Burger King Corp. and in March, 2012 the Idaho Supreme Court agreed. The Idaho Supreme Court based its opinion on the Burger King operations manual which, among other things, required its franchisees to keep snow and ice off the restaurant premises during winter months which the franchisee failed to do. The Idaho Court also found that the franchisor did not have “…control or a right of control over the daily operation….of the franchisee’s business that is alleged to have caused the harm.” The Idaho Court seemed to rely heavily on the written operations manual and franchise agreement which made clear that the franchisee was an independent owner and operator of the restaurant and responsible for the day-to-day operation of the restaurant. Well, this holding seems to make sense so score 1 point for franchisors avoiding vicarious liability.

However, just 3 months later, in June 2012, a similar case arose in California in Patterson v. Domino’s Pizza LLC. In the Patterson case a female employee of a Domino’s Pizza franchisee alleged she was sexually harassed by an assistant manager of the franchisee. Like the Ketterling case, the trial court dismissed Domino’s Pizza (as franchisor) from the case but the California Court of Appeals reversed the dismissal and allowed the franchisor to remain a defendant in the case. Here as in Ketterling, the franchisor had amble written evidence to show that the franchisee was an independent operator and solely responsible for the day-to-day operation of the restaurant and solely responsible for hiring, firing, training, scheduling, supervising and paying its employees. Nevertheless, the Appellate Court found that Domino’s rights to control the franchisee’s computer system; audit the franchisee’s tax records; and determine the franchisee’s location, store hours, advertising, the procedure for handling customer complaints, signage, email capabilities, equipment, décor, method and manner of customer payment, pricing of items, book and record keeping methods and insurance requirements substantially usurped the franchisee’s independence “in areas that go beyond food preparation standards.”   Not to play favorites here, but all the “rights” the Court mentioned is, in my opinion, precisely what establishes the uniformity of business which defines a franchise system!   One other aspect that might’ve tipped the scales here was evidence that Domino’s area reps often inserted themselves in directly controlling franchisee employee conduct and discipline and in fact it was a franchisor area rep  that “instructed” the franchisee to fire the accused assistant manager, which the franchisee did. The only good news for a franchisor from this case is that the Appellate Court only decided that Domino’s, as the franchisor, could not be summarily dismissed as a defendant. Consequently, it will still be up to a jury to determine whether Domino’s will ultimately be found vicariously liable for the actions of the franchisee’s assistant manager. So franchisors, it’s a 1-1 tie.

The take-away here is the following. 1) It is in the best interest of the franchisor and franchisee to have effective written documents which defines their relationship and respective responsibilities. While a well written franchise agreement and comprehensive operation manual may not be “bullet proof” they are nevertheless essential to both the franchisee and franchisor in establishing a successful working relationship.

2) When monitoring franchisee operations and providing suggestions and/or instructions to a franchisee, the franchisor or its area rep should deal exclusively with the franchisee and/or its appointed manager(s) such that instructions come to employees from the franchisee or its manager(s) and not directly from agents of the franchisor. Also if improvements are necessary, the franchisor can make necessary improvements known to the franchisee or its manager(s) but let the franchisee or its manager(s) implement the necessary changes to achieve those improvements.

3) If the franchisee requests (or the franchisor ultimately determines) that the franchisor or one of its representatives provide more direct operational assistance to a franchised business (which every franchise agreement provides for), the franchisor should realize that its liability for problems which occur in the operation of that franchised business would be more likely. In such a case the franchisor is well advised to have a Management Agreement in place to clearly establish the rights and responsibilities of the franchisor and franchisee during this operational assistance phase. The duration of, compensation for and indemnification during this assistance phase should also be spelled out.

Article by Roger D. Linn © Barnett & Linn

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