Franchisor Could Be Liable Under Workers’ Compensation Act

April 20th, 2012

David Cahn

An appeals court has held that Doctor’s Associates, Inc., the franchisor of Subway® sandwich shops, could be liable for the payment of workers’ compensation benefits for the injured employee of a franchisee under the Kentucky Workers’ Compensation Act because the franchisee could fit the Act’s definition of a “subcontractor” and Doctors Associates could be considered a “prime contractor”.  Uninsured Employers’ Fund v. Brown, et al., Case No. 2010-CA-000283-WC (Ct. App. Ky., Sept. 3, 2010).

The court sent the case back to the lower courts to allow for: (1) presentation of additional proof regarding the nature of the franchisor’s business and whether the work that the franchisee performed was a regular or recurrent part of the franchisor’s business; and (2) additional findings of fact after presentation of that evidence.

In late 2011, the Kentucky Supreme Court reversed the decision to remand the case for further fact-finding and ended it in favor of Doctors Associates, Inc. (“DAI”). However, that court expressly held that franchisors are not immune from scrutiny as a “statutory employer” of franchisees’ employees under Kentucky’s workers’ compensation law. Since Maryland and other states have similar workers’ compensation laws, this principle of law applies to offering a franchise in Maryland or elsewhere. Doctors Associates, Inc. v. Uninsured Employers’ Fund (KY Nov. 23, 2011).

An employee of one of the franchisor’s Kentucky franchisees had sustained injuries while working at the restaurant. The franchisee carried no workers’ compensation insurance at the time. Accordingly, the employee’s medical and disability expenses were paid by the Uninsured Employers Fund which sought indemnity from the franchisor, under a provision of the Act requiring contractors to pay compensation to an injured employee of a subcontractor if the subcontractor did not carry workers’ compensation insurance.

The ALJ concluded that he could not impose liability for workers’ compensation benefits upon the franchisor for the franchisee’s injured employee for a number of reasons. First, the franchisor was a “commercial franchisor”, a category of business not specifically covered by the statute.  Second, a contractor-subcontractor relationship existed under the statute only where the contractor paid the subcontractor to perform work. Because the franchisee was paying the franchisor, the franchisee could not be the franchisor’s subcontractor.

The Court Says, “It’s Always an Issue of Fact”

The appellate court reversed the decision because there is no blanket exemption from the worker’s compensation system of “commercial franchisors.”  In jurisdictions outside of Kentucky, courts resolved whether franchisors were liable for workers’ compensation benefits based on the specific facts of the cases, rather than by general rules of exemption, the court observed. A natural tension existed between the types of franchisor controls inherent in franchising and the types of control over day-to-day operations that courts traditionally evaluated to determine whether an employment relationship existed.  The factual issue to be determined in the context of a franchise is whether the alleged subcontractor has performed work of a kind which is a regular or recurrent part of the work of the trade, business, occupation, or profession of [the contractor],”.

The resolution of whether the franchisee was performing work for the franchisor under the meaning of the Act required the finder of fact to put aside the fact that the franchisee purchased a franchise from the franchisor, and instead look to the nature of the lasting relationship that was created between the franchisor and franchisee thereafter, the court decided. If the franchisor essentially contracted with the franchisee to perform a function that was a regular and recurrent part of its business, then the arrangement between the franchisor and franchisee was that of contractor and subcontractor and subject to the Act.

Thus, if selling sandwiches to the public was a regular and recurrent part of Doctor’s Associates, Inc.’s business, then the franchisee was unquestionably performing work that Doctor’s Associates, Inc. otherwise would have had to perform for itself and with its own employees, and the franchisee would fit within the Act’s definition of “subcontractor.”

Concurrence Goes Further on Franchisor’s Liability

A concurring option also raised the issue of whether a franchisor that failed to enforce the franchise agreement requirement that the franchisee maintain adequate insurance and name the franchisor as an additional insured, thereby becomes liable to third parties due to the franchisee’s failure to have such insurance.  This could open the door to even great legal liability in franchising in Maryland and other states.

Supreme Court reverses due to deference given to Workers Compensation Board

The Kentucky Supreme Court agreed that the ALJ erred in finding that franchisors are immune as a matter of law from being a statutory employer of franchisee’s employees. However, the Supreme Court nevertheless ended the case for the following reason: “The [Uninsured Employers’ Fund] is the claimant bearing the burden of proof to show that DAI is a contractor subject to up-the-ladder liability. The ALJ and the Board found that DAI was in the business of franchising, not the business of selling sandwiches. So the franchisee did not perform a regular or recurrent part of DAI’s business. Substantial evidence supported this finding, and we find that the evidence does not compel a finding for the UEF.”

Conclusion

This court decision demonstrates the importance of franchisors vigorously enforcing its contract provisions regarding insurance coverage, as well as other contract provisions that, if not complied with by the franchisee, may lead to liability to franchisee’s employees and customers.  It also supports the notion that entrepreneurs beginning a franchising program should not offer franchises through a company that also operates the business being franchised, but instead create a new company used solely for franchising activities. It is important for companies offering franchises in Maryland to consult with an attorney and minimize this risk.

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