The Franchise Memorandum

Last year, we reported on a ruling that shocked the franchise community when a Massachusetts district judge compared a franchise to a modified Ponzi scheme and held, in a putative class action case, that a commercial janitorial services franchisor had misclassified its franchisees as independent contractors when they were employees. Awuah v. Coverall North America, Inc., 707 F. Supp. 2d 80 (D. Mass. 2010). We subsequently reported on a later damages ruling in which the district court appeared to favor Coverall’s arguments, but ultimately certified various damages questions to the Massachusetts Supreme Judicial Court. Awuah, 740 F. Supp. 2d 240 (D. Mass. 2010). Two weeks ago, the Massachusetts high court ruled on the certified questions, holding that Coverall had violated Massachusetts state wage law in its method of payment to the plaintiff in question Graffeo and in charging him various insurance-related and franchise fees. Awuah v. Coverall North America, Inc., 2011 Mass. LEXIS 734 (Mass. Aug. 31, 2011).

The certified damages questions involved the Massachusetts Wage Act, which requires that employees be paid all earned wages on a weekly or biweekly basis and prohibits any “special contract” to exempt the employer from these requirements:

• The court considered two questions related to Coverall’s method of paying Graffeo: (1) whether Coverall could lawfully use customer accounts receivable financing to pay Graffeo; and (2) whether Coverall could withhold wages based on an agreement with Graffeo that wages weren’t earned until the customer remitted payment. The court held that the answer to both of these questions was “no.” The court rejected Coverall’s comparison of its payment method to a commission system and its arguments that no wages were due until all contingencies, including customer payment, were satisfied. The court ruled that Coverall’s method improperly deferred payment of Graffeo’s wages, which were earned when he completed performing his services. The court also held that Coverall’s system violated the “no special contracts” language of the Wage Act and that the charge-backs to Graffeo were improper wage deductions.
• The court also considered two questions related to charges imposed on Graffeo for costs such as bonding, worker’s compensation, and unemployment insurance: (1) whether Graffeo could recover such costs as damages; and (2) whether an employee can lawfully agree to pay some or all of an employer’s costs for statutorily mandated insurance coverage or other items designed to alleviate the employer’s liability. On these questions, the court held that Coverall could not pass on the cost of statutorily mandated insurance coverage, such as worker’s compensation or unemployment insurance. The court found that costs for bonding or insurance designed to alleviate an employer’s risks are incidental to doing business and cannot be unilaterally passed on to an employee.

The court also accepted the district court’s invitation to provide guidance on whether Graffeo could recover franchise fees paid to Coverall. Specifically, the court addressed the initial and additional royalty fees that Graffeo paid for the franchise relationship, which the court viewed as a direct employment relationship. The court stated that such fees were impermissible as a matter of public policy because they required employees to buy their jobs, and employees cannot be required to pay for the privilege of working.

The Awuah ruling provides an important reminder that franchisors must be careful to structure relationships to ensure that franchisees are truly independent contractors, and of the significant monetary costs of misclassifying franchisees. Importantly, in issuing its ruling, the Massachusetts Supreme Judicial Court was careful to point out that its damages rulings have no application to properly classified independent contractors operating under franchise agreements.