By Thibaut Khadir and Thomas Corre, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
Overview
Extending commercial activity by franchise is not risk-free. If the franchise contract does not leave a sufficient margin of autonomy to the franchisee, labor law rules may apply. Franchisees tend to claim this requalification when the termination of the contract occurs or if they are facing difficulties in the performance of their activity. As a consequence, labor law rules then apply, subjecting the franchisor to some new obligations. This QuickCounsel reviews the intersection of franchises and labor law in the European Union, with particular focus on French law.
The European Notion Of Franchise
The European Union has not completely harmonized franchise law. Regulation 330/2010 of the European Commission deals with competition rules but doesn't focus precisely on franchise agreements. Nevertheless the Regulations Guidelines of 2010 gives helpful elements about the Franchise regime (§189 and following). In addition, the European Ethics Code for Franchising defines the franchise and its main aspects. But as this Code was released by the European Franchise Federation, which is a private institution, it has not been incorporated into national law. This said, it might be taken into consideration when interpreting national laws.
The "franchise" is broadly defined as an agreement whereby the franchisor transmits to the franchisee the right to use distinctive signs to reiterate commercial success based on a specific know-how. The franchisee will pay fees to his franchisor and will have to respect commercial directives. Although the franchisor naturally tends to give instructions on how to exercise the activity, the notion of independence of the parties is crucial, and universally recognized. Thus, the franchise agreement should preclude the franchisor from creating a dependent situation for his franchisee.
Even though other European countries do not use the same terms, this principle of independence appears clearly confirmed in their jurisdictions. The creation of dependence seems to be dangerous for the franchisor despite the comfort it may bring him.
The Application Of Labor Law Due To A Subordination Link
The franchisees independence is essential. He must have a sufficient margin of initiative to properly exercise his activity.
In France, confronted with an issue concerning qualification of the contract, judges tried at first to determine the existence of a subordination link between the parties. This link is the characteristic element of the employment contract according to the French Court of cassation, who defined it as "the execution of work under the authority of the employer who has the power to give orders and directives and to control the execution and to sanction the failures of the subordinated party" (Cour de cassation, social chamber, 13th November 1996 N.° 94-13.187). Therefore, if such an element is created in a franchise relationship, the qualification of "franchisee" should logically be questioned.
The subordination link appears to be the determining criterion permitting the distinction of the franchisee from the employee. As a consequence, the judge has to appreciate the obligations imposed on the manager by virtue of the contract. This latter will be qualified as a "franchise contract" if it does not reveal strong relations of subordination between the contractors.
Conversely, a strong control of the activity by the franchisor, submitting the franchisee to regular instructions on the exercise of the activity or to a disciplinary power may characterize subordination.
The incorporation of the franchisee does not eliminate the risk of requalification. For those reasons, the French Court of cassation ruled that the franchised company cannot have imposed "detailed obligations" applicable to relations with clients "reinforced by instructions as well detailed" without being "transformed in a simple execution agent". According to this case, the franchisee didn't have any autonomy, and his contract had to be requalified as an employment contract (Cour de cassation, social chamber, 18th January 2012 N.°10-16.342). This case illustrates the risk run by a franchisor when restricting the freedom of action of his franchisee. Legally, the franchisee was constantly placed in a subordination situation. Regarding such relations, the franchisee was in an ideal position to claim he had an employment contract. Furthermore, the incorporation of the franchisee does not eliminate the risk of requalification.
The situation throughout the EU appears to be quite similar. However, notions are not precisely based on the subordination link. They all find a common ground in the lack of independence of the franchisee. For instance, in the Netherlands, courts have ruled that the franchisee might be qualified as employee for similar reasons as in France (it is often the case with self-employed persons). The denomination of "franchisee" is still irrelevant, and judges will attach importance to the intention of the parties and the way they give substance to the relationship. Different criteria are applied such as the instructions given by the franchisor establishing a relationship of authority, the fact the franchisee cannot delegate his functions, the economic dependence and the bearing of the business risks.
In Germany, courts have ruled in the same direction. The franchisee can be legally qualified as an employee whether the franchisor exercises a close control and supports business risks or not. The issue of the franchisors instructions on the exercise of the activity remains prevalent.
In Switzerland, the notion of independence of the franchisee also has significant importance. If the level of control and influence of the franchisor exercised over the franchisee is too strong, the protective provisions of employment law may apply (Federal Tribunal 8th September 2011 - 4A_148/201)
The situation in Austria is apparently similar. Courts have used the notion of personal and economic dependence of the franchisee; he may be treated as an employee. Personal dependence can be the fact of being bound by instructions concerning the work method, time and place, and the subject matter.
In the United Kingdom, risks appear to be similar. Recent case law has shown that an employment contract may exist if the legal elements of an employment relationship are present: control and dependence in the daily conduct of the business, notwithstanding the denomination of the contract. For instance, in Ferguson v. John Dawson & Partners Ltd the Court ruled that if the factual relationship is one of employer and employee, labor law dispositions apply (this case concerns vicarious liability, which normally does not apply to franchise agreements).
The Application Of Labor Law Due To Specific Statutes
The French legislation contains a specific regime dedicated to branch managers (i.e"le gérant de succursale"). In the absence of a subordination link, an alternative is offered to the franchisee, where labor law rules apply. The regime defined by articles L7321-1 and following of the French Labor Code extend the application of part of labor law to this category of managers.
The protection afforded by labor law is conditioned by the attribution of the branch manager qualification. According to article L7321-2 this is possible under 4 cumulative conditions. This regime will apply when (i)the franchisee sells goods (ii)exclusively or quasi-exclusively through a sole company,(iii)in a local attributed or agreed by this company, (iv)under the conditions and prices imposed by this company. Legally, there is a fine line between the definitions of a branch manager and a franchisee, especially due to the multiplication of exclusivity clauses in franchise contracts.
In a case dated 4th December 2001 (N.° 99-44.452), the Cour de cassation applied, for the first time, the dispositions of the article L7321-2 in the above-mentioned situation.
More recently the manager of a beauty center "Yves Rocher" used this legal technique. Her activity was essentially composed of selling products of the brand "Yves Rocher", but the brand imposed prices and conditions of exercising the activity. The Judges therefore decided that the manager should be considered as a branch manager and that French labor law and all its benefits should apply to the former franchisee (Cour de cassation, social chamber, 9th May 2011 N.° 09-42.901).
To conclude, French labor law will apply as soon as the conditions provided by article L7321-2 are united, regardless of the contract provisions, although there is no subordination link characterized.
The Consequences Of The Application Of Labor Law
The consequences of the requalification are important for the supplier.
On one hand it will lead to the application of a part of the protective employee regime to the franchisee. Thus the qualification of the employment contract gives jurisdiction to labor courts. In France, in such a case, the Conseil des Prudhommes was held to be competent instead of the Tribunal de Commerce (Cour de cassation, social chamber, 16th September 2007 N.° 06-44.864).
The requalification leads as well to the application of the employment contract protections. In France for instance, this regime stipulates a minimal remuneration, payment of wage arrears to the franchisee and payment of overtime and leave. Regarding the social protection rules of the country where the franchisee is established, the franchisor, requalified as an employer, will also find himself subject to some social obligations. Under French law, this includes the "URSSAF" fees and the complementary retirement fees. The brand new employer will moreover have to respect the law regarding the weekly rest period, night work, hygiene and security. And those rules may have a significant cost for the franchisor.
The issue of the end of the relationship has to be considered too. Commercial and labor rules are significantly different concerning the termination of the contract. The employer (former franchisor) will have to follow a procedure to dismiss the employee (former franchisee) or the termination will be considered, under French law, as a "dismissal with no real and serious cause" (Cour de cassation, social chamber, 18th January 2012 N.°10-16.342). Following this logic, the franchisor will have to pay indemnities for the dismissal, the lack of sufficient notice, and potential indemnities for an abusive termination of contract. Eventually, he will have to pay damages for non-respect of the proceedings.
It is also important to notice that repressive measures may occur. Indeed if it is established that the franchise was a front for the franchisor to derogate from labor law, the infringement of hidden labor (L8221-1 and following of the French Labor Code) will be characterized and will give the right to the franchisee for another indemnity of the equivalent of six months wages. Moreover, it may be punished by 3 years custody and 45 000 Euro fine or 225 000 Euro for moral persons (L8224-5 of the French Labor Code).
On the other hand the application of labor law will have an impact on previous specific provisions required by commercial law or provided for by the franchise agreement. It may notably lead to the reimbursement of entry fees in the franchise and initial formation costs (Cour de cassation, social chamber, 14th December 2006 N.° 05-40.844). Similarly, non-competition clauses at the end of the contract, which are allowed without financial compensation under commercial law, will be null and void in the way that under French labor law these clauses must be financially compensated (Cour de cassation, social chamber, 10th July 2002 N° 00-45.135). It is the same logic under German law, which provides that non-competition clauses in an employment contract must be compensated with half of the last wage of the employee in order to avoid being declared null and void (Article 74 of the German Commercial Code, « Handelsgesetzbuch »).
The Solutions For The Franchisor
Until now, requalification claims by the franchisees to recognize the applicability of a labor law status have been few. However this practice is in expansion. Due to the economic context, franchisees that do not manage to create a viable activity will try to make the franchisor take responsibility. And it can have catastrophic consequences for the franchisors.
The multiplication of cases those last years in different sectors of activity such as gas stations, hotel, telephony, transport, clothing, or food retailing denote the existence of dysfunctional models of franchise contracts.
For this purpose, the first advice concerns the draft of the franchise contract and its provisions. Indeed in order to limit that risk, a franchisor must be careful not to impose a direct subordination link on franchisees or conditions that would make the franchisee economically dependent. Indeed the franchisor should take care not to limit the freedom of undertaking of the franchisee and his independence. Factually, franchisor and franchisee are interdependent, but the franchisor has to establish a contractual relationship that will allow the franchisee a broad capacity for making decisions. The parties must demonstrate a mutual confidence. The franchisee should be the one who decides his work conditions, his employment and dismissal politics, fixation of prices, his schedule, and his providers. For more security, franchise contracts should be drafted and reviewed very carefully to ensure that they are not considered as either as labor contracts for a salary, as agency contracts or as a contract for a concession (all of which are subject to specific legal rules). Regarding the definition of franchise, other European countries appear to follow the same logic. Indeed as the franchise is a contract based on mutual confidence and independence of the franchisee, it seems that all elements that will reinforce those aspects may be considered as remedies for the franchisors.
The second advice concerns the possibility of interposing a company between the supplier and the distributor if the latter is a natural person. This interposition would be even more efficient if reinforced by specific clauses. Indeed some adjustments could be used in order to avoid such requalification of the contract. Especially clauses, which provide plurality of suppliers for the franchisee in order to avoid the "exclusive or quasi exclusive" condition for the application of the branch manager statute. The other adjustments concern the participation of the franchisee in the capital of the franchisor, which will result in making him a partner instead of a potential employee. Furthermore, he could benefit from preference shares, which would encourage the independent partners to not demand the status of employee. The International Franchise Association gives palliatives used in European countries to avoid the requalification and the application of the labor law. In Germany for example a franchisee organized in the form of a company limited by shares (for example, a limited liability company or a stock corporation) will not run the risk of being qualified as an employee. In Austria the risk of being qualified as an employee may be excluded if the franchisee is organized in the form of a business entity (for example, a GmbH). And finally in Spain the franchisee must itself be a real company with its own assets and liabilities and must retain power over its own materials and personnel to carry out its organizational responsibilities.
Additional Resources
- Fédération Francaise de la Franchise International Franchise Association European Franchise Federation Franchisees: Were employees, not contractors, (Wall Street Journal 2010) Are franchisees independent contractors? Not everyone agrees, (Franchising World 2008)