Source: https://barnettandlinn.com/category/uncategorized/
Timestamp: 2019-04-18 12:40:59+00:00

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There are currently two “employer/employee” issues that could be of major concern to franchisors, one which has been previously discussed in my prior postings and one which is a new menace for companies and franchisors in California.
Joint employer status arises when employees claim that they work for not one but two “employers” thus making both “employers” liable for tax withholding, employment benefits, wage & hour violations, etc. For years the National Labor Relations Board (NLRB) had applied a test which required that to be held as a joint employer, a company had to be shown to not only have the power to exercise control over a workforce’s terms and conditions of employment but also had to be shown that such company had actually exercised that control over the working environment. Exercising such control would include hiring and firing, setting wages and working schedules, etc.
The typical franchise agreement has always provided the franchisor with certain powers to insure the franchisee was in compliance with the franchise agreement and Operations Manual (prepared by the franchisor) in order to promote and maintain uniformity within the franchise network. However, so long as the franchisor avoided involvement in the day-to-day activities of a franchisee’s employees, the franchisor was considered safe from being held as a joint employer of the franchisee’s employees.
However, as I posted back in September 2015, in 2015 the NLRB made a decision in Browning-Ferris Industries in which the Board adopted a new test to determine when joint employment was present. Under the new test a company only had to possess the potential to exercise control over a workforce’s terms and conditions of employment regardless of whether the company had actually exercised that power. Needless to say, this sent shock-waves throughout the franchise industry. Under the new test, a franchisee’s employees could argue that the franchise agreement provided each franchisor with sufficient power (whether or not actually exercised) to satisfy the new test and make the franchisor a joint employer and thus jointly liable for any and all work place violations occurring at a franchisee’s establishment!
Sensing the disaster the Browning-Ferris decision posed, in 2017 the NLRB, in deciding the matter of Hy-Brand Industrial Contractors, over-ruled the Browning-Ferris test and reinstated the traditional test which had been in place prior to the Browning-Ferris decision (ie power to control + actual exercise of that power). Unfortunately the relief felt by all franchisors was short-lived as the NLRB’s Inspector General issued a subsequent finding that one of the Board’s members deciding the Hy-Brand case had a conflict of interest and should not have voted. As a result, the Hy-Brand decision was vacated earlier this year thus reinstating the Browning-Ferris test for defining joint employer status.
However, good news might be on the way for employers and franchisors. The newly appointed NLRB Chairman, John Ring, has promised to consider rulemaking to modify the current standard the Board uses to evaluate whether joint-employment exists. So, stay tuned for the next episode of this continuing saga.
Additional good news for franchisors was delivered in April, 2018, when the federal US District Court for the Central District of California granted summary judgment in favor of franchisor, 7-Eleven, Inc., finding that 7-Eleven was not a joint employer of franchisees’ employees under California law or federal law. In that case, employees of four 7-Eleven franchisees brought suit against franchisor 7-Eleven, Inc. alleging the franchisor was jointly liable for violations of the federal Fair Labor Standards Act (FLSA) and the California Labor Code.
The California Supreme Court has recently decided a case which could have a profound effect on franchisors/franchisees and indeed the entire gig economy. For nearly three decades California courts have determined an individual’s status as an “employee” or “independent contractor” using a multi-factor test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations. The Borello test provided that an individual hired as an independent contractor was presumed to be an independent contractor unless the application of the multi-factor test clearly indicated that such individual was in reality an employee and not an independent contractor. Under this test, the individual had the burden of proof to show he/she was in fact an employee.
However, in April, 2018, the California Supreme Court, in the case of Dynamex Operations West, Inc. v. Superior Court of Los Angeles County, abandoned the Borello test in favor of a new test referred to as the “ABC Test” that is used by some other states.
The individual customarily engages in an independently established trade, occupation, profession or business of the same nature as that involved in the work performed.
So hiring an attorney, accountant or janitorial company would still be deemed independent contractors, but many other workers hired as independent contractors to perform specific projects for high tech companies or drivers for Lyft and Uber, for example, would now be subject to scrutiny as potential employees unless the hiring company can meet the ABC Test to show such individuals are properly classified as independent contractors. Indeed several independent contractor groups including Lyft drivers have already filed lawsuits claiming they are misclassified as independent contractors and should be declared employees instead with all the rights and benefits an employee is entitled to.
In light of the above, one can well imagine the consequences this decision could have on the franchising industry in which franchisees have always been deemed independent operators of their own business and not as employees of the franchisor.
This is a proverbial “sea change” in the employee – independent contractor analysis and is undoubtedly on its way to the US Supreme Court for a final decision.
President Trump signed the Economic Growth, Regulatory Relief and Consumer Protection Act (the Act). As part of this Act, Section 508, titled “Improving Access to Capital”, amends Regulation A under the Securities Act of 1933. Since Regulation A was adopted and the fund raising limits were increased to $50 million (i.e. Reg A+), it was always limited exclusively to non-reporting companies. “Non-reporting companies” included any companies not filing annual and quarterly reports with the US Securities and Exchange Commission (SEC) pursuant to the Securities Exchange Act of 1934 (the 1934 Act). Compliance with Reg A requires the filing of an “Offering Circular” with the SEC which then must review and approve the Offering Circular disclosures. However, once approved, the issuer could sell such securities publicly much like a full-blown registered offering. As a general rule, the disclosure requirements of a Reg A Offering Circular were less burdensome and the Reg A filing was processed somewhat faster by the SEC, than a full-blown registration statement. One particular aspect of a Reg A offering was, unlike a registered offering, after the Reg A offering was completed, the issuer did not have to become a “reporting company” under the 1934 Act. Rather, the issuer could remain a private, non-reporting company post-offering and only required to file limited disclosures with the SEC for a limited time after the offering was completed. Reg A also offered a few additional perquisites like the right to “test the waters” by making a preliminary solicitation of potential investors with an abbreviated disclosure notice to see if there was sufficient investor interest in the issuer’s securities to justify proceeding with a Reg A offering.
As part of the “Improving Access to Capital” section of the Act, Congress mandated that Reg A should be made available to reporting companies as well as non-reporting companies. Reporting companies would still need to file and have approved by the SEC an Offering Circular to be used in the actual offering. However, the post-offering filing requirements of Reg A would be satisfied by the reports already being filed by the reporting company under the 1934 Act.
While expanding the use of Reg A to reporting companies as well as non-reporting companies certainly provides an added tool for raising capital, its use might be somewhat limited. This is because companies trading on a national exchange (i.e. NYSE or Nasdaq) as well as companies traded over-the-counter (i.e. OTCQB) with market capitalizations in excess of $75 million and current in their 1934 Act filings, can use the short Form S-3 registration statement which is generally much quicker, cheaper and simpler than even a Reg A offering.
So, practically speaking, the reporting companies most likely to utilize a Reg A+ offering would be those over-the-counter companies with capitalizations of less than $75 million or reporting companies which missed a 1934 Act filing deadline during the past 12 months.
We will await the SEC’s regulatory action implementing this expansion hopefully in the near future.
One of our Firm’s specialties is representing Franchisors and Franchisees. In the context of the franchisor-franchisee relationship many issues can arise which the parties try to anticipate in the Franchise Agreement. In late 2012 I wrote an article discussing one of those issues which was the potential liability of the franchisor for the wrongful or negligent actions/inaction of the franchisee, which we refer to as “vicarious liability”. As I pointed out previously, the critical element of vicarious liability in the franchise context is typically the amount of control a given franchisor exercises over the operations of a franchisee. In the franchisor/franchisee situation, this “control” issue can be very tricky.
On the one hand, the backbone of any franchise system is uniformity of service or product. To ensure this uniformity throughout the franchise system, a franchisor necessarily must establish guidelines in order to maintain the standards of quality and operation of the system which are typically expressed in the Franchise Agreement and franchisor’s Operations Manual. Obviously, the franchisor must maintain a certain amount of control over franchisees’ operations in order to ensure the operating guidelines and hence the uniformity of the franchise system are maintained at each franchise location. In addition, the franchisor must maintain the ability to enforce the operating guidelines and take action against franchisees who fail to follow the guidelines.
On the other hand, a typical franchise agreement makes it clear that each franchisee is an independent contractor wholly and exclusively responsible for the safe and proper operation of his/her franchise establishment.
So herein lies the dilemma, to what extent can a franchisor exert “control” over a franchisee to ensure compliance with the uniform operation of the franchise system while not being held liable for arguably “running” the franchisee’s business and hence being held liable along with the franchisee when trouble arises. Courts generally start with the proposition that a bona fide franchisor will not be deemed vicariously liable as an “employer” when a plaintiff works for or was injured by an independently owned and operated franchised business. However, cases continue to arise in which a franchisor has crossed that imaginary “control line” resulting in the franchisor being held liable to a third party along with the franchisee due to the franchisor’s level of control/involvement. For example, in the case last year of Orozco v. Plackis, franchisor-chef Craig Plackis was held liable along with his franchisee for violations of the Fair Labor Standards Act because he got too involved in the day-to-day operation of a franchisee including advising the franchisee about terminating employees and arranging employee work schedules.
DO NOT run payroll or maintain employment records for franchisee employees. While a franchisor may designate a payroll or bookkeeping service to be utilized by franchisees, such service should not be the franchisor or a subsidiary of the franchisor.
DO NOT set or enforce franchisee’s employment policies. While the franchise agreement and operations manual may provide certain employment policies like requiring professional, courteous conduct of employees, or the wearing of certain uniform clothing, the specific work rules and procedures to be followed by the franchisee’s employees should be determined by and enforced by the franchisee not the franchisor.
DO NOT micromanage, train or directly supervise the franchisee’s employees. While the franchisor will typically provide initial and ongoing training to the franchisee and its managers, training the franchisee’s employees should be left to the franchisee. Similarly, if the franchisor is aware of certain operational deficiencies with the franchisee, the franchisee should be made aware of such deficiencies and it is the franchisee who should take remedial action.
DO NOT establish, control or change the employment conditions of the franchisee’s employees (e.g. scheduling, meals and breaks, timekeeping, etc.). While the franchise agreement and/or operations manual may require certain aspect of the work environment such as hours of operation, staffing requirements, types of service to be provided and equipment to be used, how the services are rendered and the operation of equipment and the day-to-day operation of the franchised business should be left to the franchisee.
DO NOT control the hiring, firing, pay, promotion, demotion or classification of franchisee’s employees. While the franchise agreement and/or the operations manual may specify certain minimum age, experience, or certifications of franchisee’s employees, all decisions as to who to hire, terminate, promote and the pay scales of employees should be made by the franchisee.
While the above precautions are not an exhaustive list of control indicators to avoid, they hopefully provide some guidance is recognizing when the “control line” may be crossed.
The above would also suggest that should a franchisor enter into a management agreement with a franchisee or find it necessary to take over temporary operation of a franchisee’s business (as often times permitted by the franchise agreement under certain circumstances), the franchisor would most likely be exposed to liability during the period of such direct involvement and operation of the franchisee’s business.
The above list should also be instructive to franchisees. The franchisor provides a model for operating a franchised business and can monitor and assist (but not control) the franchisee in achieving a successful business. However, the operation of, and ultimately the success or failure of, the franchise business rests with the franchisee.
This document has been provided for informational purposes only and is not intended and should not be construed to constitute legal advice. Please consult your attorneys in connection with any fact-specific situation under federal law and the applicable state regulations that may impose additional obligations on you and your company.
As if corporate officers didn’t have enough to worry about, i.e. properly evaluating the market place, making strategic moves, evaluating business transactions, divining future trends, and getting and keeping customers, here in California, decisions by corporate officers that turn bad are a little more risky to that corporate officer.
Years ago, in order to encourage companies to innovate, States adopted the “Business Judgment Rule” (“BJR”). The BJR simply states that if a business decision is made in good faith, the fact that such decision, in hindsight, ends-up being poorly reasoned or even negligent, the decision makers won’t be held personally liable. In general, the BJR creates a presumption that if the decision maker used reasonable care, including reasonable diligence, in making the decision, and the decision is made in good faith, then the decision maker will not be liable if such decision turns out badly unless there if proof of gross negligence or fraud. In California the BJR is codified in California Corporations Code §309.
However, §309 as written, only extends the BJR presumptions and protections to directors of a corporation but does not mention officers. Most other state courts and commentators, either explicitly (i.e. written in the BJR statute) or implicitly (i.e. intended to be covered by the BJR statute) have extended the BJR to include corporate directors and officers. Unfortunately, California has taken a different, more restrictive position. In a recent decision in the case of FDIC as Receiver for IndyMac Bank FSB v. Matthew Perry, a federal District Court in California has ruled that since the California BJR statute (§309) only refers to “directors”, the BJR is not available to corporate officers. In the FDIC v. Perry case, Mr. Perry was both a director and CEO of IndyMac Bank and in those capacities, made certain investment decisions which eventually created huge losses for the Bank. The Bank eventually failed and the FDIC sued Mr. Perry for the investment losses sustained by the Bank. Mr. Perry sought to assert the BJR in his defense but the Court ruled that he made the investment decisions in his officer capacity as CEO (not as a director) and went on to rule that §309 does not apply to corporate officers. Consequently, Mr. Perry could not claim the protections of the BJR.
What this means for officers of California companies is that, absent the protections of the BJR, corporate officers can be second-guessed and held liable for decisions that don’t produce the intended results or result in losses to the company, even if such decisions, when made, were made in good faith and with the best of intentions. On the other hand, corporate directors can rely on the BJR to protect themselves from liability for the same bad decisions.
The take-away is that corporate officers in California must be careful to make informed, considered decisions and be prepared to defend those decisions if they eventually prove to fall short of their intended goal or, worse yet, result in losses to the company. With regard to such a defense, corporate officers should make sure they are indemnified by the corporation or by Officer/Director liability insurance to the maximum extent permitted by California law under California Corporations Code §317.
As most folks are aware back in April, 2012 Congress passed and President Obama signed the “Jumpstart Our Business Startups Act” (the JOBS Act). One of the most notable and controversial sections of the JOBS Act was §201(a) wherein Congress told the Securities and Exchange Commission (the SEC) to amend Rule 506 under Regulation D to permit startup companies to use general solicitation and advertising in order to raise investment capital from the public. The only caveat being that sales could only be made to “accredited investors” (as defined in Rule 501(a) of Regulation D) whom the issuer had taken “reasonable steps to verify” were in fact accredited investors.
For those of us practicing in the securities field, this mandate by Congress represented a sea change for the SEC. Never before has an issuer been allowed to use general solicitation (ie internet, web sites, advertisements, etc.) seeking investment capital from potentially hundreds of people without first submitting a complete disclosure document (a prospectus) which was reviewed by, commented upon and (hopefully) eventually allowed (ie declared effective) by the SEC staff in the Division of Corporation Finance. Having worked for several years in this Division many (too many) years ago, I can attest to the thorough review and the many “comments” issued by the Staff requesting changes to a prospectus before it was declared effective and the not insignificant number of proposed prospectus’s that never satisfied the “full and fair” disclosure standard required by the SEC and were ultimately withdrawn. Reviewing these proposed public prospectus’s was the bread and butter of the Corp. Fin. Division and it’s what we spent the majority of our time doing. It also represented one of the most important functions performed by the SEC.
So when Congress decided to require the SEC to allow an issuer to utilize general solicitation to raise capital without preparing or filing a complete prospectus for the SEC Staff to review and clear, you can imagine the concerns and angst of the SEC Staff. This concern was justified in view of the fact that the expected (indeed targeted) primary users of this new exemption would be relatively new, startup companies in which the risks of failure are always substantial. From the beginning of the SEC back in 1934, public offerings of securities had always been filed with and reviewed and cleared by the SEC. This procedure was deemed fundamental to the SEC’s mission of protecting investors. Now I’m not criticizing the mandate from Congress to implement a new, faster and certainly less expensive way for startup and emerging companies to access investment capital which is the life-blood of any new enterprise. Infact, many of my small to medium size business clients can’t wait to give it a try. However, from the SEC’s point of view, this was unheard of before so, understandably, the SEC did not rush to implement these changes. Infact, the SEC was told by Congress to propose new rules for implementation of this new offering concept by July 5, 2012 but, not surprising, the SEC did not issue proposed rule changes until August 29, 2012. And did not adopt final rule changes, after considerable debate and controversy, until July 10, 2013. Not surprising, upon her confirmation as the new SEC Chairperson, Mary Jo White promised Congress that her first priority would be to respond to the various congressional mandates gathering dust over at the SEC.
The new provisions of Rule 506 will now go into effect on September 23, 2013. New Rule 506(c) will allow issuers to use public solicitation and advertising to raise as much capital as they want from as many investors as they want so long as all investors are accredited investors. There is no requirement for review of the offering by the SEC or any State Securities Agency. Infact, there is no disclosure/prospectus requirement at all.
However, the issuer will be required to take “reasonable steps” to verify that each purchaser in the offering is in fact accredited. This requirement now shifts the burden of determining accreditation to the issuer, not the investor. In the traditional Rule 506 private placement, an issuer could require and rely upon basic investor representations of accreditation such as whether the investor qualified by income, net worth or affiliation with the issuer and some basic representations as to the amount and source of income or net worth. Furthermore, if the representations were incomplete or false, it would be the investor’s fault.
Under the new verification requirements of Rule 506(c)(2)(ii), the “reasonable steps” will require much more such as obtaining 2 years of tax returns to substantiate an investor’s income or written confirmation from an investor’s financial advisor, attorney or CPA to substantiate his/her net worth. Furthermore, if a non-accredited investor does manage to participate in a Rule 506(c) offering, the SEC will hold the issuer responsible unless the issuer can show it met the “reasonable steps” standard of care and show that the investor (or his/her agents) knowingly submitted false or misleading information to support his/her accredited status. This is obviously a far cry from the previous reliance on simple investor representations in a subscription agreement. The SEC has stated its position that a sale to a non-accredited investor will not automatically prevent reliance on Rule 506(c) so long as the issuer took reasonable steps to verify the purchaser’s accredited status and had a reasonable belief that such purchaser was an accredited investor at the time of the sale. However, if an issuer loses its Rule 506(c) exemption for any reason, then, unlike a traditional Rule 505 or 506 private placement exemption, there are no statutory exemptions like Section 4(a)(2) of the Securities Act of 1933 (the “1933 Act”) to fall back on. Selling securities publicly without registration with the SEC or an available exemption (like Rule 506(c)) is a violation of Section 5 of the 1933 Act and a really bad way to start off an issuer’s capital raising efforts.
Perhaps the biggest concern for me is the absence of any required disclosure. I have heard commentators tout the fact that New Rule 506(c) will reduce the burden of preparing disclosure documents and the expense of hiring securities attorneys. Not surprisingly I disagree. As a securities practitioner, my role has always been twofold; first to assist my client in successfully raising capital and second to make sure my client can keep the proceeds despite how bad the business might eventually turn out to be.
A comprehensive and understandable disclosure document (let us call it a “general placement memorandum” or “GPM”) is invaluable in describing an issuer’s business, management, use of proceeds and the company’s potential for success as well as candidly describing the risks that the company’s business could face. This GPM is the backbone of any securities offering and allows the each purchaser the ability to make “an informed investment decision” which is the goal, indeed the mandate, of any successful securities offering. Without the benefit of SEC review and clearance of such disclosure document, having an experienced securities attorney assist with its preparation becomes more important than ever.
Secondly, in those cases where an issuer falls short of its performance expectations or fails altogether, unhappy investors will usually look for some basis to demand their money back, most often claiming that the issuer omitted material information in the offering disclosures or somehow mislead the investor with the information the issuer did provide. It is in these circumstances that a complete and candid (ie disclosed risk factors) GPM becomes a godsend to refute any such allegations. As I often tell clients preparing to raise investor capital, if you fail or fall short of expectations, so long as the reason is due to one of the disclosed risk factors, they may encounter many problems but a securities law violation should not be one of them. Hence the adage that a well drafted GPM is both a selling document and an insurance policy.
I would also point out two final aspects of Rule 506. First, the entire Rule 506 is now subject to a “Bad Actor” provision (new Rule 506(d); similar to Rule 262 of Regulation A) whereby any issuer having an executive officer, director of a corporate issuer or manager of an LLC issuer, or a 20% owner of the issuer, who has been convicted of certain crimes, become subject to certain judicial orders or suspended from certain securities activities will not be eligible to use the Rule 506 exemption for either a private or public placement.
Lastly, an issuer using Rule 506 will still be required to file a Form D with the SEC within 15 days after the first sale in an offering. This would include filing the Form D in each state in which sales are anticipated and the issuer is asserting reliance on federal Rule 506 for compliance with that state’s blue sky regulations.
It will be interesting to see how many issuers choose to use new Rule 506(c) and how receptive investors will be to this new public capital raising technique. As always, feel free to contact me if you would like to discuss the changes to Rule 506 further.

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