Potential Franchise-Related Policy Changes Under the Biden Administration

By Kristen M. Harvilla

Last week, President Biden was sworn in and his administration has already begun to take form. Below are a few key franchise-related policy changes that may arise in light of this change in administration.

  1. The Biden administration may reverse or modify current DOL guidance on independent contractor versus employee worker classification, and may seek to federalize components of California’s Assembly Bill 5 (“CA-AB 5”).

On January 6, 2021, the DOL issued a new worker classification rule to determine whether a worker is an employee under the federal Fair Labor Standards Act (“FLSA”). The rule sets out a five-factor “economic realities” test used to classify a worker as either an employee or independent contractor. Employers are only obligated to comply with FLSA for their employees, but not for independent contractors.

The five-factor test emphasizes the first two factors – (1) the degree of the worker’s control over its work, versus the employer’s and (2) whether the worker has the opportunity to profit or loss based on his/her own initiative. If both factors lean toward the same classification, the analysis ends there. If the first two factors yield different classifications, the remaining factors are used as tiebreakers, although, the rules states that the five factors are not exhaustive.

The DOL has specifically stated that quality control standards and health and safety standards imposed by an employer do not contribute to whether or not the employer controls the work. This carve-out is beneficial in the franchising context where such controls may exist despite franchisees being independent contractors.On balance, the test provides a significant degree of flexibility and subjectivity, which enables employers to more easily classify workers as independent contractors when appropriate.

This new rule, which is to become effective on March 8, 2021, applies only to classification under FLSA and does not apply to any other federal or state statutes. State regulators and courts may choose to follow this guidance for classification under state wage and hour laws, but that has yet to be seen.

Since the rule was enacted prior to start of President Biden’s term, it is possible that his administration may seek to postpone the effective date of the rule, modify the rule, or even rescind the rule in favor of different guidance. More specifically, the Biden administration has expressed support for the federal PROAct, which would federalize portions of California’s AB 5 rule (“CA-AB 5”), which we have written about previously.

California legislation, CA-AB 5 imposes a three-part “ABC Test” to determine whether a worker is classified as an employee or independent contractor. The test assumes a worker is an employee, rather than an independent contractor unless three requirements are met – that the worker is:  (a) free to perform services without the control or direction of the company; (b) is performing work tasks outside of the usual course of the company’s business activities; and (c) is engaged in an independently established trade. The test makes it more difficult for companies to classify workers as independent contractors.

The impact of the ABC Test on franchising in California is two-fold. First, the test is important to “gig-economy” franchise systems that rely on franchisees having a workforce of independent contractors rather than employees. Second, presently-pending litigation leaves open the question of whether or not the ABC Test could be applied to the franchise relationship itself to determine whether a franchisee is an employee, rather than independent contractor, of its franchisor.

Implementation of the ABC Test at the federal level to classify workers under FLSA or other federal regulations is generally unfavorable for franchisors for the reasons set forth above. We recommend monitoring this area of the law which remains in flux and working with your lawyers to ensure compliance.

  1. The Biden administration may reverse or modify current joint employer guidance issued by the Department of Labor (“DOL”).

As we’ve written about previously, in January 2020, the DOL published a new “joint employer rule” that established a standard for when, and under what circumstances, two or more entities are considered “joint employers” of an employee for purposes of liability under labor laws. This new standard was positive for the franchising industry, as it emphasized the actual, direct control that an employer exerts over a worker in determining whether an entity is a joint employer. However, in September 2020 a NY federal court invalidated the new rule based on the court’s finding that the change to the existing standards were “arbitrary and capricious,” inconsistent with prior rulings, and in conflict with other DOL policies and definitions. While this ruling is currently under appeal, the DOL is in the process of re-examining the rule.

Prior administrations have focused not only on the control actually exerted over workers, but the amount of control the employer reserves or may exert over the worker, contractually or otherwise. Since this issue has been ever-changing, we expect the Biden administration to influence changes to the joint employer standards during President Biden’s term.

We recommend that franchisors and franchisees stay up to date on joint-employer developments in order to evaluate risks of potential joint-employment claims.

  1. Partial repeal of the Tax Cuts and Jobs Act (“TCJA”) and other changes to the Tax Code.

While in office, President Trump signed the TCJA, which includes, among other things, income and payroll tax deductions for pass-through entities that have incomes above $400,000. It is estimated that this provision saves businesses in the franchise sector approximately $8 billion per year, as nearly 2,000 franchisors and 200,000 franchisees qualify for such deductions. President Biden has supported removal of these deductions, and has expressed support for changes to the Tax Code which include increasing the corporate tax rate from 21% to 28%.

We recommend working with your accountant and financial advisors to assess how these changes may impact your business and what preemptive actions you can take to best position your business to prepare for any such changes.

  1. The Biden administration may institute a federal increase of the minimum wage and elimination of the tip credit.

The Biden administration has expressed support for an increase of the minimum wage and elimination of the tip credit. Biden has expressed support for an increase of the federal minimum wage to $15 per hour. The proposed increase could cause financial hardship or even closures for many small businesses including franchised businesses. Additionally, many states have independently increased their minimum wage — California’s minimum wage is now $14 per hour, and Washington’s is $13.69 per hour. See a full state by state breakdown of minimum wages increases.

Elimination of the tip credit could further exacerbate this issue in the restaurant industry. A tip credit lowers the amount an employer must pay tipped employees by crediting a portion of the tips they receive toward minimum wage. Restaurant workers, both owners and servers, favor the tip credit because it allows restaurants, which operate on thin profit margins to begin with, to keep menu prices competitive, since their labor costs are low due to the credit. Elimination of the tip credit could force restaurants that rely on it to close or reduce their staff.

If you have any questions about how the current or forecasted state of the law in the above areas may affect your business, please contact us for a consultation.

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