Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Cal.: McDonald’s may be employer of franchise employees under ostensible agency theory, (Oct 1, 2015)

By Joy P. Waltemath, J.D.

Although agreeing with McDonald’s that it did not employ employees at franchised restaurants for purposes of California state wage claims, the federal district court in San Francisco allowed the employees to proceed against McDonald’s because of fact issues that existed under an ostensible agency theory. But the employees’ negligence claims were barred as an obvious attempt to use common law claims to seek punitive damages or other relief not provided for in the California labor and employment statutes (Ochoa v. McDonald’s Corp., September 24, 2015, Donato, J.).

Claims against McDonald’s. Most of the employees’ claims fell under the California Labor Code and were asserted against both the Smith franchisees (who owned five restaurants) and the McDonald’s corporate defendants. In addition to minimum wage and overtime claims, they included failure to provide meal and rest breaks as required, legally inadequate earnings statements, and failure to reimburse for required uniform maintenance. The overtime claim was based on McDonald’s In-Store Processor (ISP) software, which was programmed to assign all hours worked on a shift to the day on which the shift started, even if the shift continued into the next day. Negligence claims, asserted against only the McDonald’s defendants, were based on failure to train or inform the Smith franchisees of their legal requirements, and they tracked the state statutory violations.

The Martinez standard. A 2010 California Supreme Court decision, Martinez v. Combs, was the controlling legal authority to determine whether the McDonald’s defendants were directly liable as joint employers. Under Martinez, to “employ” means (1) “to exercise control over . . . wages, hours or working conditions”; (2) “to suffer or permit to work”; or (3) “to engage, thereby creating a common law employment relationship.” Any of the three is sufficient to create an employment relationship.

Under Martinez, an entity employs workers if it directly or indirectly, or through an agent or any other person, employs or exercises control over their wages, hours, or working conditions. “Suffering or permitting to work” means the “basis of liability is the defendant’s knowledge of and failure to prevent the work from occurring.” And the meaning of the common law definition of employment in the franchisor context requires a franchisor to have retained or assumed a right of control over factors such as hiring, direction, supervision, discipline, discharge, and relevant day-to-day workplace aspects of the franchisee’s employees.

Control over franchisees not enough. Applying these factors here, the court found there was not enough evidence of the exercise of control. McDonald’s obviously had the ability to exert considerable pressure on its franchisees, up to and including termination of the business relationship, refusal to renew franchise agreements, and the ability to impose technology, personnel, and training requirements. But McDonald’s strength as a franchisor did “nothing to negate or call into question the dispositive fact that the authority to make hiring, firing, wage, and staffing decisions at the Smith restaurants lies in Smith and its managers—and in them alone,” the court concluded.

The employees pointed to McDonald’s extensive monitoring and evaluation of the restaurants, but mere monitoring of customer service metrics is not active employee control, emphasized the court. That McDonald’s would have to resort to economic and business relationship sanctions to motivate its franchisees to implement service changes “underscores its lack of direct authority or control” over employees. The fact that McDonald’s trains franchisees’ managers, insists on being the owner or primary leaseholder for its locations (allowing it to enter the premises at any time), requires franchisees to purchase furniture and uniforms through McDonald’s-approved vendors, uses business consultants that occasionally spoke with franchisee managers, and requires franchisees to track employees’ service times, simply did not show that McDonald’s exercised control over wages, hours or working conditions.

Required software. The use of McDonald’s-required software—the ISP, which is proprietary to McDonald’s, as well as a point of sale (POS) system—also was not enough to convert McDonald’s into an employer. The court conceded that it was “entirely possible” that the state law violations alleged here would not have occurred if the ISP had been programmed differently; it came pre-programmed, the Smith franchisees did not change the programming, and they relied on the ISP to calculate overtime. Even so, controlling case law is that supplying mandatory software is not sufficient to create an employment relationship; to hold otherwise would “unreasonably expose [franchisors] to employer liability for programming or bugs that result in labor law violations.”

As for the “suffer or permit” and “engage” to create a common law employment relationship factors from Martinez, the employees’ arguments were essentially a restatement of the arguments concerning the exercise of control, and the court did not find they supported the imposition of joint employer liability against McDonald’s.

Ostensible agency. However, because the employees stated that they believed McDonald’s was their employer (they wore McDonald’s uniforms, served McDonald’s food in McDonald’s packaging, received paystubs and orientation materials marked with McDonald’s name and logo, and, except for one employee, applied for a job through McDonald’s website), the court found precedent that the test for ostensible agency could be met. That test requires that (1) the person dealing with the agent does so with reasonable belief in the agent’s authority; (2) the belief is “generated by some act or neglect of the principal sought to be charged,” and (3) the relying party is not negligent. The McDonald’s defendants provided no argument to the contrary here, and the court found that the theory could apply against both McDonald’s USA and McDonald’s, Inc., even though McDonald’s, Inc., had no contractual relationship with the Smith franchisees. That issue, said the court, should be resolved by a jury.

Negligence. Meanwhile, the negligence claims asserted against the McDonald’s defendants alone were an attempt to use “common law claims to seek punitive damages or other relief not provided for in the California labor and employment statutes.” The negligence claims here duplicated the theories of liability the employees asserted under the California Labor Code. California’s “new right-exclusive remedy doctrine,” which provides that when a statute creates a new right that did not exist at common law and provides a comprehensive and detailed remedy, the statutory remedy is exclusive and bars such an approach. The court granted the McDonald's defendants summary judgment on that claim.

The case number is 14-cv-02098-JD.

Attorneys: Barbara Jane Chisholm (Altshuer Berzon) for Stephanie Ochoa. Brent D. Knight (Jones Day) for McDonald's Corp., McDonald's U.S.A., LLC and McDonald's Restaurants of California, Inc. Bruce E. Weisenberg (Freeman Mathis and Gary) for The Edward J. Smith and Valerie S. Smith Family Ltd. Partnership.

Companies: McDonald's Corp.; McDonald's U.S.A., LLC; McDonald's Restaurants of California, Inc.; The Edward J. Smith and Valerie S. Smith Family Ltd. Partnership

Cases: FranchisingDistribution CaliforniaNews