In a significant win for franchisors, the California Supreme Court ruled 4-3 that although Domino’s “imposes comprehensive and meticulous standards for marketing its trademarked brand and operating its franchises in a uniform way,” it cannot be held vicariously liable as an “employer” or “principal” in a sexual harassment lawsuit filed by an employee of a Domino’s franchisee. The Court’s ruling is important for several reasons:

• • Under Patterson, franchisors will not be held vicariously liable for employment and tort claims brought by their franchisees’ employees, unless they exercise control over the manner and means by which their franchisees hire, fire, discipline, or manage their employees;

  • Patterson authorizes franchisors to impose a “comprehensive operating system” designed to protect their trademarks, trade names, and goodwill without creating a principal-agent relationship with their independent contractor franchisees; and

  • The ruling is a significant contrast to the current National Labor Relations Board’s (NLRB) quixotic attempt to redefine joint-employer status vis-à-vis franchisors, such as McDonald’s (discussed here), in an attempt to pave the way for widespread union organizing efforts.

The Court’s ruling in Patterson confirms the validity and intent of the franchise model and provides franchisors with a road map on how to structure and operate the system to promote and protect their brand without exposure for tort claims brought by their franchisees’ employees.

Summary of Patterson v. Domino’s Pizza, LLC

Sui Juris, LLC (franchisee) entered into a franchise agreement with Domino’s Pizza Franchising, LLC (franchisor) to operate a pizza franchise in Southern California. Under the franchise agreement, Domino’s imposed and enforced standards for marketing and operating the franchise to ensure customers received a similar experience each time they patronized any franchised store; however, the franchisee retained the autonomy to implement Domino’s operational standards on a day-to-day basis, hire and fire store employees, and regulate workplace behavior. The franchisee was an independent contractor under the agreement.

The franchisee hired Taylor Patterson in 2008, and shortly thereafter Patterson alleged that she was sexually harassed by the assistant manager, Renee Miranda, whenever they worked the same shift. Patterson complained to the franchisee, who suspended Miranda pending an investigation.

Although Miranda never returned to work, Patterson resigned and filed a lawsuit asserting claims for sexual harassment, assault, and battery, among others. In addition to suing Miranda and the franchisee, Patterson sued Domino’s on the theory that the franchisor should be held strictly liable as an “employer” under California’s Fair Employment and Housing Act. Patterson also claimed that Domino’s should be held vicariously liable under traditional agency principles for the acts of its franchisee. Patterson argued that because business-format franchisors wield detailed control over their franchisees’ general operations, liability for personal harm sustained in the course of a franchisee’s business should be borne by the franchisor.

Domino’s moved for summary judgment on the grounds that it did not exercise day-to-day control over the specific instrumentality that caused the alleged harm—the franchisee’s assistant manager. The trial court granted the franchisor’s motion, but the California Court of Appeal reversed, finding that material issues of fact existed as to whether Domino’s exercised sufficient control over the manner and means of the franchisee’s operations, including employee relations, such that it could be held strictly liable as an “employer” or vicariously liable under common law agency principles.

The California Supreme Court’s Decision in Patterson

In a 4-3 decision authored by Justice Baxter, the California Supreme Court rejected the argument “that a comprehensive operating system alone constitutes the ‘control’ needed to support vicarious liability claims” and, after a detailed review of the relationship and respective rights and responsibilities under the contract and in practice, concluded that Domino’s “lacked the general control of an ‘employer’ or ‘principal’ over relevant day-to-day aspects of the employment and workplace behavior of [the franchisee’s] employees.”

The Court began its analysis with “the contract itself,” which disclaimed any employment or principal-agent relationship between the franchisor and franchisee and made the franchisee “solely responsible for managing its employees.” Then, because “the franchise contract is not dispositive,” the Court analyzed the parties’ actual conduct. Although the franchisor provided training to the franchisee, inspected the store (and during those inspections provided suggestions to franchisee employees in certain operational areas), and had in the past provided notice of default with respect to conduct by employees that could harm the brand, the Court found that it was the franchisee who “exercised sole control” over hiring, firing, and disciplining the employees who worked in the franchisee’s store.

Under the circumstances, the Court reasoned that the “imposition and enforcement of a uniform marketing and operational plan cannot automatically saddle the franchisor with responsibility for employees of the franchisee who injure each other on the job.” The Court further found that the “contract-based operational division that otherwise exists between the franchisor and the franchisee would be violated by holding the franchisor accountable for misdeeds committed by employees who are under the direct supervision of the franchisee, and over whom the franchisor has no contractual or operational control.”

The three dissenting justices would have found that Domino’s retention of “control over employee selection, training, personal appearance, interaction with customers, and compliance with in-store procedures,” coupled with “the threat that a noncompliant franchisee will be placed in default, presents occasions for the franchisor to act as an employer by forcing the termination of problematic employees.” Citing the Court’s recent decision in Ayala v. Antelope Valley Newspapers, Inc., the dissent singled out the franchisor’s right to terminate the franchise agreement as strong evidence of the “fact of control and of the ultimate existence of an employment relationship.”

Impact of Patterson

After Patterson, franchisors doing business in California can protect themselves from lawsuits brought by their franchisees’ employees by ensuring that franchisees retain the right to hire, fire, discipline, and manage their own employees. Patterson also provides useful guidance on the extent to which a franchisor may exercise control to protect its trade name, professional methods, customer goodwill, or commercial image without converting to a joint employer with its franchisee. Although the NLRB is not bound by Patterson, the Court’s ruling stands in contrast to the recent attempts to redefine joint-employer status and unleash union organizing efforts on franchisors across the country, including the NLRB’s general counsel’s recent authorization that the NLRB file lawsuits against McDonald’s Corporation asserting such a theory.

Companies that use, or would like to use, franchising as a business model should consult with their counsel to ensure that their franchise agreements comply with the latest legal developments in this complex and rapidly evolving area of the law.

© 2014 Perkins Coie LLP