Category: Franchising

A Dark Day for Franchising: Ninth Circuit Reinstates its Misguided Vazquez Decision, Undermining the Franchise Business Model

In the course of a politically-charged frenzy to eliminate the misclassification of employees as independent contractors, the franchise business model has been trampled without respect by both the courts and the legislature in California, disrupting commercial relationships that have been a vital driver of the state’s economy for more than fifty years.  Only five years ago, the California Supreme Court acknowledged the vital importance of franchising to the California economy in generating “trillions of dollars in total sales,” “billions of dollars” of payroll and the “millions of people” franchising employs.  Patterson v. Domino’s Pizza, LLC (2014) 60 Cal.4th 474, 489.

Taking into account the “ubiquitous, lucrative, and thriving” franchise business model and its “profound” effects on the economy, the Patterson court held that the usual tests for “determining the circumstances under which an employment or agency relationship exists” could not be applied to franchises.  Id. at 477, 489 and 503.  To avoid disruption of the franchise relationship and turning the model “on its head,” a different test that took into account the practical realities of franchising had to be applied to franchise relationships.  Id. at 498, 499 and 503.  The “imposition and enforcement of a uniform marketing and operational plan cannot automatically saddle the franchisor with responsibility.”  Id. at 478.  A franchisor is liable “only if it has retained or assumed a general right of control over factors such as hiring, direction, supervision, discipline, discharge, and relevant day-to-day aspects of the workplace behavior of the franchisee’s employees.”  Id. at 497-98.  The special rule for franchising has been commonly referred to as the “Patterson gloss.”

On September 25, 2019, a panel of the Ninth Circuit Court reinstated an opinion it had previously published on May 2, 2019, then withdrew on July 22, 2019, recklessly undermining the delicate framework of the franchise business model in derogation of the California Supreme Court’s “Patterson gloss.”  Vazquez v. Jan-Pro, 923 F.3d 575 (9th Cir. May 2, 2019), opinion withdrawn, 2019 US App. Lexis 21687 (July 22, 2019), opinion reinstated, 2019 BL 357978 (9th Cir. September 24, 2019).

The “Patterson gloss” arose from the California Supreme Court’s subtle appreciation for the historical development of the franchise business model.  At the heart of all franchise relationships is a trademark license.  At common law, trademark licenses were seen as a representation to the public of the source of a product.  An attempt to license a trademark risked the forfeiture of any right to royalties and the abandonment of the licensed mark.  See Lea v. New Home Sewing Mach. Co., 139 F. 732 (C.C.E.D.N.Y. 1905); Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358, 367 (2d Cir. 1959).

Although the Trademark Act of 1905 did not allow for the licensing of trademarks, the Trademark Act of 1946, the Lanham Act, 15 U.S.C. § 1051, did allow a trademark to be licensed, but only where the licensee was “controlled by the registrant. . . in respect to the nature and quality of the goods or services in connection with which the mark is used.”  15 U.S.C. § 1127.   After the passage of the Lanham Act, a trademark could be licensed, as long as “the plaintiff sufficiently policed and inspected its licensees’ operations to guarantee the quality of the products they sold under its trademarks to the public.”  Dawn Donut, at 367.  After the Lanham Act had legitimized trademark licensing, the franchise model began to emerge in the 1950s, as the Patterson court noted (at 489), leading to the explosive growth of franchising over the last seven decades.

“Franchising is a heavily regulated form of business in California.”  Cislaw v. Southland Corporation (1992) 4 Cal.App.4th 1284, 1288.  Franchisors must provide prospective franchisees with detailed pre-sale disclosure documents under the California Franchise Investment Law, Corporations Code § 31000 et seq. and the FTC Rule, 39 Fed. Reg. 30360 (1974).  There are criminal, civil and administrative consequences for failure to comply.  Franchisees’ rights are protected by the California Franchise Relations Act, Business & Professions Code § 20000, et seq., which includes recently enhanced penalties for non-compliance.

Over the years, California courts have acknowledged the fundamental obligation of franchisors to impose controls over their licensees and have uniformly held that such controls do not create an employment or agency relationship.  See, e.g., Cislaw, 4 Cal.App.4th at 1295 (the owner of a brand may impose restrictions on a licensee “without incurring the responsibilities or acquiring the immunities of a master, with respect to the person controlled.”); Kaplan v. Coldwell Banker (1997) 59 Cal.App.4th 746, (“If the law were otherwise, every franchisee who independently owned and operated a franchise would be the true agent or employee of the franchisor.”).  This doctrine came to be known as the “Patterson gloss” and is the glue that holds the franchise business model together—allowing the franchisor to exert the controls necessary to license a trademark without incurring the responsibilities of an employer.

In its September 25, 2019 decision in Vazquez, the Ninth Circuit once again discarded the Patterson gloss like an extra part found in the bottom of an Ikea box after the hasty assembly of an end table.  According to the Vazquez court, Patterson had no relevance because it was just a vicarious liability decision, not an employment decision.  But Patterson was an employment case.

Patterson was a Fair Employment and Housing claim brought by a teenage girl after her supervisor had repeatedly groped her breasts and buttocks.  Patterson, at 479.  It is hard to understand why the Vazquez court considered the wage order claims before it to be more significant than Taylor Patterson’s right to pursue legal claims for sexual harassment.

Even more disturbingly, the Vazquez court disregarded the “Patterson gloss” because Dynamex [Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903] had favorably cited two Massachusetts decisions that applied the ABC test in the franchise context.  Id. at 39.  The Massachusetts cases were cited in Dynamex only as examples of cases where it had been more efficient to address “the latter two parts of the [ABC] standard” on a dispositive motion, rather than all three prongs.  Dynamex, 4 Cal.5th at 48.  The court never mentions franchising or the inconsequential fact that the parties in cited cases were franchises.  The Dynamex court could not be fairly understood to have abandoned its stalwart embrace of the franchise business model in its 2014 Patterson decision, without ever bothering to mention the case or to make any reference to franchising.  Yet the Vazquez court concluded that a passing citation to cases that happened to involve franchise companies in the Dynamex opinion—to make a procedural point that was unrelated to franchising in any way—was an occult signal from the California Supreme Court that the “Patterson gloss” had been abandoned by implication five years after its creation.

Nor was it valid for the Vazquez court to confine the “Patterson gloss” to vicarious liability cases.  As Witkin points out, California law on vicarious liability and employment developed together, so that most “of the rules relating to duties, authority, liability, etc. are applicable to employees as well as other agents.”  Witkin, Summary of California Law (10th ed., Agency & Employment, § 4).  The core obligation to control a trademark licensee—hard-wired by the Lanham Act into every franchise relationship—must be respected in both vicarious liability and employment cases if the franchise business model is to be preserved.

The Vazquez court had it right when it withdrew and de-published its original decision on July 22, 2019.  When the court certified the retroactivity issue to the California Supreme Court that day, it could have also certified the franchise issue back to the court that created the Patterson gloss, but it did not do so.  Franchisors are now left to wonder how they are to maintain existing long-term commercial relationships and to continue to sell franchises after the Vazquez opinion has taken from them the fundamental right to license trademarks without incurring the unintended liabilities of employers.

© 2019 Bryan Cave Leighton Paisner LLP

Read more on the topic on the National Law Review Franchising Law page.

“Do You Want Liability With That?” The NLRB McDonald’s Decision that could undermine the Franchise Business Model (Part II)

 

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Yesterday’s post discussed the decision of NLRB’s General Counsel to hold McDonald’s Corp. jointly responsible with its franchise owners for workers’ labor complaints. The decision, if allowed to stand, could shake up the decades-old fast-food franchise system, but it does not stop there. The joint employer doctrine can be applied not only to fast food franchises and franchise arrangements in other industries, but also to other employment arrangements, such as subcontracting or outsourcing.

This decision could also impact the pricing of goods and services, as franchisors would likely need to up costs to offset the new potential liability. Everything from taxes to Affordable Care Act requirements could be affected if the decision stands.

If you are a franchisor and are currently in what could be determined to be a joint employer relationship, consider taking steps to further separate and distinguish your role from that of your franchisee. While franchisors should always take reasonable measures to ensure that franchisees are in compliance with applicable federal and state employment laws, they should take care to not wield such force over them to give the appearance of a joint-employer relationship.

We will be following the NLRB decision and keep you updated as the issue progresses.

ARTICLE BY

Luke A. Wingfield
 
OF 
McBrayer, McGinnis, Leslie and Kirkland, PLLC

“Do You Want Liability With That?” The NLRB McDonald’s Decision that could undermine the Franchise Business Model

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On July 29, 2014 the National Labor Relations Board (“NLRB”) General Counsel authorized NLRB Regional Directors to name McDonald’s Corp. as a joint employer in several complaints regarding worker rights at franchise-owned restaurants. Joint employer liability means that the non-employer (McDonald’s Corp.) can be held responsible for labor violations to the same extent as the worker’s “W-2” employer.

In the U.S., the overwhelming majority of the 14,000 McDonald’s restaurants are owned and operated by franchisees (as is the case with most other fast-food chains). The franchise model is predicated on the assumption that the franchisee is an independent contractor – not an employee of the franchisor. Generally, the franchisor owns a system for operating a business and agrees to license a bundle of intellectual property to the franchisee so long as on the franchisee adheres to prescribed operating standards and pays franchise fees. Franchisees have the freedom to make personnel decisions and control their operating costs.

Many third parties and pro-union advocates have long sought to hold franchisors responsible for the acts or omissions of franchisees – arguing that franchisors maintain strict control on day-to-day operations and regulate almost all aspects of a franchisee’s operations, from employee training to store design. Their argument is that the franchise model allows the corporations to control the parts of the business it cares about at its franchises, while escaping liability for labor and wage violations.

The NLRB has investigated 181 cases of unlawful labor practices at McDonald’s franchise restaurants since 2012. The NLRB has found sufficient merit in at least 43 cases. Heather Smedstad, senior vice president of human resources for McDonald’s USA, called the NLRB’s decision a “radical departure” and something that “should be a concern to businessmen and women across the country.” Indeed it is, but it is important to note that General Counsel’s decision is not the same as a binding NLRB ruling and that it will be a long time before this issue is resolved, as McDonald’s Corp. will no doubt appeal any rulings.

ARTICLE BY

Luke A. Wingfield
 
OF 
McBrayer, McGinnis, Leslie and Kirkland, PLLC

“Do You Want Liability With That?” The NLRB McDonald’s Decision that could undermine the Franchise Business Model

McBrayer NEW logo 1-10-13

On July 29, 2014 the National Labor Relations Board (“NLRB”) General Counsel authorized NLRB Regional Directors to name McDonald’s Corp.as a joint employer in several complaints regarding worker rights at franchise-owned restaurants. Joint employer liability means that the non-employer (McDonald’s Corp.) can be held responsible for labor violations to the same extent as the worker’s “W-2” employer.

In the U.S., the overwhelming majority of the 14,000 McDonald’s restaurants are owned and operated by franchisees (as is the case with most other fast-food chains). The franchise model is predicated on the assumption that the franchisee is an independent contractor – not an employee of the franchisor. Generally, the franchisor owns a system for operating a business and agrees to license a bundle of intellectual property to the franchisee so long as on the franchisee adheres to prescribed operating standards and pays franchise fees. Franchisees have the freedom to make personnel decisions and control their operating costs.

Many third parties and pro-union advocates have long sought to hold franchisors responsible for the acts or omissions of franchisees – arguing that franchisors maintain strict control on day-to-day operations and regulate almost all aspects of a franchisee’s operations, from employee training to store design. Their argument is that the franchise model allows the corporations to control the parts of the business it cares about at its franchises, while escaping liability for labor and wage violations.

The NLRB has investigated 181 cases of unlawful labor practices at McDonald’s franchise restaurants since 2012. The NLRB has found sufficient merit in at least 43 cases. Heather Smedstad, senior vice president of human resources for McDonald’s USA, called the NLRB’s decision a “radical departure” and something that “should be a concern to businessmen and women across the country.” Indeed it is, but it is important to note that General Counsel’s decision is not the same as a binding NLRB ruling and that it will be a long time before this issue is resolved, as McDonald’s Corp. will no doubt appeal any rulings.

ARTICLE BY

Luke A. Wingfield
 
OF 
McBrayer, McGinnis, Leslie and Kirkland, PLLC

NLRB General Counsel Authorizes Complaints Asserting Franchisor Can Be Jointly Liable With Its Franchisees

Schiff Hardin Law Firm

Earlier this week, the General Counsel of the National Labor Relations Board (NLRB), Richard F. Griffin, authorized the issuance of multiple complaints which include allegations that a franchisor, McDonald’s, USA, LLC, could be liable as ajoint employer with its franchisees for violations of theNational Labor Relations Act (NLRA). The text of the General Counsel’s authorization is available here.

Since 2012, McDonald’s, USA, LLC and its franchisees have been named in 181 unfair labor practice charges filed with the NLRB. In a memorandum issued to the Regional Directors, the General Counsel noted that 43 of those charges were found to have merit, while the remaining charges either were found to have no merit or are pending further investigation. The General Counsel’s action authorizes the regions in which the charges were filed to issue administrative complaints naming McDonald’s USA, LLC and its franchisees as respondents if the parties are unable to reach settlement in the 43 cases that have been found to have merit.

The authorization comes on the heels of an amicus brief filed by the General Counsel in June in Browning-Ferris Industries of California, Inc., urging the Board to adopt a new standard for determining joint-employer status. Under the current standard, the NLRB analyzes whether alleged joint employers share the ability to control or co-determine the essential terms and conditions of employment. TLI, Inc., 271 NLRB 798 (1984). Essential terms and conditions of employment include hiring, firing, discipline, supervision and direction of employees. Laerco Transportation, 269 NLRB 324 (1984). The putative joint employers’ control over these employment matters must be direct and immediate.

In the amicus brief, the General Counsel argued that the Board’s current standard for determining joint-employer status is significantly narrower than the traditional standard and ignores Congress’s intent that the term “employer” be construed broadly. Griffin urged the Board to adopt a new standard that accounts for the totality of the circumstances, including how putative joint employers structure their commercial dealings. Under the proposed test, joint-employer status would exist if one of the entities wields sufficient influence over the working conditions of the other entity’s employees such that meaningful bargaining could not occur in its absence.

The NLRB has not yet decided whether to adopt the General Counsel’s proposed standard, and the Browning-Ferris case is currently pending before the Board.

Implications and Recommendations

Although the General Counsel’s action has sparked a flurry of debate over the proper test for determining joint-employer status, it remains unclear whether the NLRB will accept his position. If the NLRB decides to adopt a new joint-employer standard, it would likely expand the number of entities found to be joint employers and thus potentially liable for alleged unfair labor practices, and could have ramifications under other employment laws as well, including wage and hour and discrimination cases.

ARTICLE BY

Alexis Dominguez
OF
Schiff Hardin LLP

Franchisors Beware: McDonald's Workers Sue for Alleged Wage and Hour Violations by Franchisees

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Seven class action lawsuits were recently filed against McDonald’s Corp. and several McDonald’s franchisees in California, Michigan and New York. The lawsuits are a direct result of the coordinated effort by plaintiffs’ attorneys and the Service Employees International Union to pressure fast-food restaurants to pay their employees at least $15.00 per hour. The lawsuits are also part of a new strategy from the plaintiffs’ bar to sue fast-food and pizza franchisors (i.e., the “deep pocket”) for the conduct of independently owned franchisees.

The Michigan and New York class actions were filed in federal court and primarily allege that McDonald’s Corp. and the franchisees violated federal law by shaving hours from employees’ time cards, requiring employees to work off the clock and failing to pay overtime for hours worked in excess of 40 in a workweek. The California class actions were filed in state court and allege a variety of state labor law violations, including minimum wage and overtime violations and missed meal and rest breaks.

The lawsuits allege that McDonald’s Corp. is not only culpable for the suits relating to its corporate-owned stores, but also for its franchisees because of McDonald’s Corp.’s alleged heavy hand in monitoring and guiding the franchisees’ timekeeping, scheduling and other policies. In particular, the Michigan lawsuits allege that McDonald’s Corp. is a “joint employer” and thus also liable because it provides financial tracking computer software to franchisees, which allegedly guides when individual store managers may permit employees to be clocked in or on the clock. The software purportedly sends alerts to the manager when labor costs exceed a certain level of sales. As a result, the plaintiffs allege that managers prevented employees from clocking in (even though the employees were working) until the restaurant experienced a certain level of sales.

Generally, when determining whether a “joint employer” relationship exists, courts examine the totality of the circumstances, focusing on the economic realities of the particular relationship. A joint employment relationship may exist where two companies are deemed to share control of the employee, or one company is controlled by another company. Courts have considered a variety of factors when making this determination, including the ability to hire or fire the employees, supervision of the employees’ schedules and working conditions, determination of wages and the maintenance of employment records.

These McDonald’s lawsuits will need to overcome some very high hurdles before they may be certified as class actions due to the individualized nature of the plaintiffs’ claims and circumstances in the various stores. For example, certification may be inappropriate on a multi-store basis if McDonald’s can show that individual store managers implemented their own procedures and practices for scheduling and timekeeping. Nevertheless, these cases are a good reminder for franchisors to review the policies, training materials, software, etc., that they share with franchisees to ensure that the materials are lawful and will not inevitably lead to employees working off the clock. Lastly, franchisors should review their relationships and interactions with franchisees to ensure that they are not exercising control in a manner that could support a joint employer relationship.

Article By:

Joseph K. Mulherin
 
Of:
Vedder Price

Awuah v. Coverall: What If I Didn’t Know About The Mandatory Arbitration Provision In My Franchise Agreement?

The National Law Review recently featured an article by Matthew J. Kreutzer with Armstrong Teasdale titled, Awuah v. Coverall: What If I Didn’t Know About The Mandatory Arbitration Provision In My Franchise Agreement?:

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A new ruling by the United States Court of Appeals for the First Circuit in Awuah v. Coverall case, No. 12-1301, — F.3d — (1st Cir. Dec. 27, 2012), is yet the latest in a string of recent court decisions that confirm the strength and enforceability of arbitration clauses in franchise agreements.

The Awuah case first made waves two years ago when the United States District Court for the District of Massachusetts compared the franchise relationship between Coverall (a janitorial service franchisor) and its franchisees to a “modified Ponzi scheme.”  You can read more about that decision in my prior blog posts here and here.  This latest ruling deals with the enforceability of the arbitration clauses in a number of the subject franchise agreements.

The facts can be summarized as follows: a class of franchisees sued their franchisor, Coverall North America, which is a janitorial cleaning service. The franchisees assert several state-law claims against Coverall, including claims for breach of contract, misrepresentation, and deceptive and unfair business practices. In addition, the franchisees claim that Coverall misclassified them as independent contractors when they are, in fact, employees, and that Coverall failed to pay wages due to them.

Appellees, who are a subset of the overall class, challenge Coverall’s contention that appellees should be required to arbitrate the dispute based on arbitration clauses in the subject franchise agreements. Appellees became Coverall franchisees by signing Consent to Transfer Agreements, or Guaranties to Coverall Janitorial Franchise Agreements. These documents did not themselves contain arbitration clauses, but instead incorporated by reference the terms and provisions of the transferor’s franchise agreements, which did contain such clauses. None of the appellees allegedly received (or requested) copies of the franchise agreement signed by its respective transferor.

Appellees argued to the U.S. District Court for the District of Massachusetts that “it is black-letter law in the First Circuit that an individual may not be bound to an arbitration clause if he does not have notice of it,” citing cases brought under federal employment statutes. Appellees made the point that Coverall had not demonstrated that any of them were shown the transferor’s franchise agreement, or that they were shown the arbitration clause contained therein. The District Court agreed, determining that the appellees did not have to arbitrate their claims against Coverall because they did not have adequate notice of the arbitration clause in the franchise agreement. Coverall appealed.

The U.S. District Court for the First Circuit overturned the District Court’s ruling, finding that under governing Massachusetts law, “one who signs a written agreement is bound by its terms whether he reads and understands them or not.” The Court further found that Massachusetts does not impose any requirement that the parties be given special notice of an arbitration provision. In any event, the Court stated, any such requirement would be preempted by the Federal Arbitration Act, 9 U.S.C. § 1, et seq., which requires that agreements to arbitrate be treated in the same manner as other contracts.

This latest decision serves as a reminder for prospective franchisees to carefully review a proposed franchise agreement before signing.  For existing franchisees, it is a warning that mandatory arbitration clauses are not easily avoided.  For franchisors, the decision highlights the importance of ensuring that, when a franchisee transfer or assign their franchises, the new franchisees receive and sign a full copy of the franchise agreement that will be effective post-sale.

© Copyright 2013 Armstrong Teasdale LLP

How Many Calories is in that Burger? PPACA Makes Sure you know.

The National Law Review recently published an article by Molly Nicole Lewis of McBrayer, McGinnis, Leslie and Kirkland, PLLC regarding The Food Industry and The Patient Protection and Affordable Healthcare Act:

 

We all occasionally grab a quick bite on the go. With fall in full swing, and our schedules filling up, it is much more tempting to drive through and pick up dinner rather than slaving over the stove after a non-stop day. Consider this:  What if the menu was labeled with calorie information and you could see that the Hardee’s Thickburger you wanted to order contained 910 calories.  A healthy caloric intake for an average person is 2000 calories per day – that’s also stated on the menu.  The burger just became ½ of your daily allotment of calories. That information would definitely prompt anyone to reconsider their choices.

Menu labeling, as outlined in the Patient Protection and Affordable Health Care Act (PPACA), might actually change the way we eat, when we eat out!  That is exactly what the National Restaurant Association and the National Association of Convenience Stores is grappling with.  In the wake of the Supreme Court upholding the PPACA, it is not just the medical and insurance communities buzzing. The food industry is wadding through their own set of new rules regarding how they present their product and interact with consumers.

As outlined in Section 4205, nutritional menu labeling is required for chain restaurants across the country. The provisions include labeling requirements for restaurants and food vendors, with 20 or more outlets. Calories have to be posted on menus and menu boards, including drive-thru menus. Display tags with additional information, including fat, saturated fat, carbohydrates, sodium protein, and fiber must be available in writing, upon request. Vending machine companies that operate at least 20 machines are also subject to these requirements. For buffet-style or self-serve restaurants, a sign must be placed adjacent to each food and beverage item listing calories per item or serving.  There are some exceptions that will not require calorie disclosure. Items not listed on the menu such as condiments, daily specials or temporary offerings. If an item appears on the menu less than 60 days per calendar year, or a test market items appears on a menu for less than 90 days, they are both exempt.

The Food and Drug Administration (FDA) considered Section 4205 effective immediately. However, without detailed guidance from the FDA, these provisions cannot be required.  The final FDA regulations are expected by the end of 2012.  Industry implementation would become effective six months after publication, in early 2013.  If a restaurant that is not required to comply with Section 4205, voluntarily registers with the FDA and follows the federal disclosure guidelines, they are not subject to any state or local nutrition disclosure requirements.

There is more at stake here then complying with disclosure regulations. For owners and operators in the food industry there are real costs to be considered. The new menu requirements alone will demand printing new menus and menu boards. Nutritional analysis may have to be performed to accurately report the information to the consumer. All of these added expenses could mean thousands in unbudgeted expenditures, and will result in consumer behavioral changes where the full financial impact cannot be determined – until after the fact.

It is interesting to contemplate how each of us will react to menu labeling. Will it help change the health of our country? The jury’s still out, but we are eagerly anticipating the verdict.

© 2012 by McBrayer, McGinnis, Leslie & Kirkland, PLLC

Kansas Supreme Court Decision Declares Resale Price Maintenance Per Se Illegal Under State Antitrust Statute

The National Law Review recently published an article by Lawrence I. Fox, Megan Morley, and Joseph F. Winterscheid of McDermott Will & Emery regarding Resale Price Maintenance in Kansas:

The Kansas Supreme Court recently determined resale price maintenance isper se illegal under state law, becoming the latest state to reject the rule of reason standard mandated by the Supreme Court of the United States.  The decision serves as a reminder that although a supplier’s pricing policies may be permissible under federal law, they may nevertheless be subject to per se condemnation under certain state statutes.

On May 4, 2012, the Kansas Supreme Court announced that resale price maintenance (RPM) is per se illegal under Kansas law in O’Brien v. Leegin Creative Leather Products, Inc.  With this ruling, Kansas joined a growing number of states—including Maryland, New York and California—that have refused to follow the Supreme Court of the United State’s 2007 holding in Leegin Creative Leather Products, Inc. v. PSKS, Inc. that the legality of RPM should be assessed under the rule of reason.  The O’Brien decision therefore serves as yet another sobering reminder that suppliers need to be mindful that although RPM may be subject to rule of reason analysis at the federal level, it remains subject to per secondemnation at the state level in many states under state antitrust statutes

In O’Brien, the plaintiff, a purchaser of accessories, filed a class action litigation against Leegin Creative Leather Products, a manufacturer and retailer of Brighton fashion accessories and luggage (Brighton)—the same defendant involved in the U.S. Supreme Court’s landmark 2007 eponymous decision—alleging Brighton’s pricing practices violated the Kansas Restraint of Trade Act (KRTA).  These practices included calling for retailers to sell Brighton products at a “keystone” price determined by Brighton and for certain “heart store” retailers to sell Brighton products at a “suggested price every day, 365 days a year.”  Brighton did admit to investigating reports it received regarding alleged violations of the policy and, although not occurring in Kansas, it acknowledged refusing to deal with retailers that intentionally violated the policy.

Upon motion for summary judgment, the trial court held the plaintiff’s RPM claims should be evaluated under the rule of reason.  To determine that a rule of reason analysis is appropriate, the court invoked language from Heckard v. Park, 188 P.2d 926, 931 (1948), and Okerberg v. Crable, 341 P.2d 966, 971 (1959): “The real question is never whether there is any restraint of trade but always whether the restraint is reasonable in view of all the facts and circumstances and whether it is inimical to the public welfare.”  Using this standard, the court refused to grant summary judgment because it believed there was a genuine issue of material fact as to the reasonableness of Brighton’s pricing policies.  The trial court, however, still granted Brighton’s summary judgment motion after ruling the plaintiff would be unable to prove antitrust injury.

On the plaintiff’s appeal, the Kansas Supreme Court overturned the ruling of the trial court and declared that horizontal and vertical restraints of trade, including RPM, are per se illegal.  In reaching this decision, the Kansas Supreme Court examined the plain language of KRTA, federal antitrust rulings and past Kansas precedent.

First, the court looked at the statutory language of KRTA.  Section 50-101(d) provides “[a]ny such combinations are declared to be against public policy, unlawful and void.”  Section 50-112 states “[a]ll arrangements, contracts, agreements, trusts, or combinations … designed or which tend to advance, reduce, or control the price … to the consumer … are hereby declared to be against public policy, unlawful, and void.”  Because these statutes do not mention reasonableness, the court believed that this “clear statutory language draws a bright line” against the use of a rule of reason standard.

Second, the court briefly addressed and then dismissed the notion that federal antitrust rulings, such as Leegin, compelled a rule of reason analysis.  Citing a string of Kansas decisions, the court determined “that federal precedents interpreting, construing, and applying federal statutes have little or no precedential weight when the task is interpretation and application of a clear and dissimilar Kansas statute.”

Third, the Kansas Supreme Court looked at prior state cases to assess whether a reasonableness standard should be read into KRTA.  Three of these cases were decided under Kansas’s General Statutes of 1915 and Revised Statutes of 1923, which the court described as the “legislative ancestor[s]” of KRTA and which contained similar language to the present day statute.  In each of these cases, the Kansas Supreme Court held the vertical price-fixing agreements at issue were unenforceable and per se illegal.

In 1937, however, the state legislature enacted the Kansas Fair Trade Act (KFTA).  This statute both permitted contracts controlling resale prices and authorized private actions to punish deviations from these contracts.  Although the legislature repealed this statute in 1963, the Kansas Supreme Court examined whether the per se rule adopted in these pre-KFTA cases had been overruled while KFTA was in effect.  The only relevant cases decided during this period were the aforementioned decisions in Heckard and Okerberg, which did indeed adopt a reasonableness standard.

Analyzing these KFTA-era cases, however, the Kansas Supreme Court determined that this “reasonableness rubric” did not apply to alleged price-fixing agreements.  The restraints of trade at issue in those cases—non-compete covenants and requirements contracts—were “factually and legally distinct from vertical and horizontal price-fixing.”  Moreover, the court went on to state it would have to read unwritten elements into the unambiguous statutory language of KRTA to impose a rule of reason in price-fixing cases, which would require the court to impermissibly encroach on the legislative function.  The court concluded that if Heckard andOkerberg were before it today, it would not impose a reasonableness standard because the clear statutory language does not require it.  The Kansas Supreme Court therefore overruled the reasonableness standard adopted in Heckard andOkerberg and held that price-fixing violations are per se illegal under KRTA.

With the decision in O’Brien, Kansas is the latest state to reject the rule of reason standard mandated by Leegin for federal RPM cases when applying state antitrust statutes.  This decision serves as a reminder to suppliers that although their pricing policies may be permissible under federal law, these same policies may nevertheless be subject to per se condemnation under certain state statutes.  Any programs directed at affecting downstream resale prices must therefore be crafted carefully to ensure they are legally compliant at both the state and federal levels.

© 2012 McDermott Will & Emery

Recent Franchising Stories Focus On Funding And Incentives

An article by Matthew J. Kreutzer of Armstrong Teasdale found recently in the National Law Review focused on Recent Franchising Stories:

At the beginning of 2012, the big story in franchising appears to be the same one that we have seen for the last several years: money.  Franchisors are still looking for answers to questions about growth in a time when it is difficult for prospective franchisees to find funding.  Are banks willing to lend money for small business?  What kind of qualifications does a prospect need to have to get a bank loan?  Are there good alternative sources for funding?  How can we attract new franchisees and support existing ones in a slumping economy?

There are a couple of good articles this week that demonstrate possible answers to these questions.  Yesterday’s Wall Street Journal had an article relating to some of the creative incentives being given by franchisors to assist their franchisees in a continued down economy.  Papa John’s and Denny’s are establishing programs to lend money to their franchise owners, cut back on royalty fees, and assist owners in challenged or growth markets.  These are good examples of the types of programs that a franchisor can implement to help franchisees during challenging economic times. An article on restaurant-focused site MonkeyDish highlights the ways that small business owners can find funding in challenging capital markets.  This includes finding lending sources through relative newcomer Boefly.com (often called the “match.com” for small businesses), which has over 1500 participating lenders, and using middlemen such as Franchise American Finance and American Association of Government Finance, which can assist small business owners in wading through the red tape associated with Small Business Administration loans.

Most prognosticators predict that in 2012, we will start to see economic growth.  One thing is certain: if more small business loans are made, the economy will get better.

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