AB-5 Litigation Update (4/1/21)

Claim:

IFA, AAHOA, SFA and DDIFO seek a declaration that California’s ABC Test as applied to the relationship between franchisors and franchisees is preempted by the FTC Franchise Rule and the Lanham Act, imposes excessive burdens in violation of the Commerce Clause of the U.S. Constitution, and violates the Fifth and Fourteenth Amendments, and a corresponding injunction prohibiting Defendants from applying California’s ABC Test to the relationship between franchisors and franchisees, as well as costs and attorneys’ fees.

Status Update

• Complaint filed on November 17, 2020.
• California filed a motion to dismiss on January 14, 2021.
• Amended complaint filed on Friday, March 26, 2021.
• California’s response (likely a motion to dismiss) is due on April 23, 2021.
• Assuming California files a motion to dismiss, our response will be due on May 28th, 2021, and their reply will be due on June 14, 2021.
• There would only be oral argument on the motion to dismiss if the Judge decides to have it.

Summary of California’s Motion to Dismiss (January 14, 2021)

• California brought a motion to dismiss, arguing that we lack standing, our claims are not ripe, and that the Complaint fails to state a claim as a matter of law.

• Standing/Ripeness:
  • To establish standing, we must allege that: (1) they suffered an injury in fact – an invasion of a legally protected interest that is (a) concrete and particularized, and (b) actual or imminent, not conjectural or hypothetical; (2) there is a causal connection between the injury and the conduct complained of; and (3) it is likely, as opposed to merely speculative, that the injury will be redressed by a favorable decision.
  • California argues we lack any allegation that our members have been threatened with enforcement under the ABC Test.

• Arguments Against Pre-emption:
  • There are three species of preemption: “express,” “conflict” and “field,” but the Complaint alleges only conflict preemption.  Plaintiffs do not and could not contend that express preemption applies; rather, they contend that the Franchise Rule and the Lanham Act impliedly preempt the ABC Test.
  • FTC Franchise Rule
    • The FTC does not intend to preempt the franchise practices laws of any state or local government.
    • Plaintiffs’ claim of Franchise Rule preemption fails because only the Commission, and not private parties, can enforce the FTC Act and its associated Franchise Rule.
  • Lanham Act
    • The Lanham Act protects a trademark holder’s interests in its trademarks, but does not govern franchise relationships or, more particularly, whether a franchisee should be deemed an employee or an independent contractor.
    • Complaint simply assumes that any franchisor that avoids creating an employment relationship under the ABC Test will necessarily expose itself to a finding that it has abandoned its trademarks. But trademark abandonment is a fact-dependent inquiry.
• Precedent:
  • The recent Ninth Circuit decision in California Trucking Ass’n v. Su, 903 F.3d 953, should foreclose any argument that the ABC Test is preempted by the Franchise Rule. There, the Ninth Circuit held that the Federal Aviation Administration Authorization Act (“FAAAA”) does not preempt the California Labor Commissioner’s use of the Borello standard to determine whether a motor carrier has properly classified its drivers as independent contractors.
  • Congress did not intend to preempt laws that implement California’s traditional labor protections powers, and which affect carrier’s rates, routes or services in only tenuous ways.” The Ninth Circuit emphasized the strong presumption “that the historic police powers of the State were not to be superseded by the Federal Act unless that was the clear and manifest purpose of Congress,” and the fact that the challenged regulation was in “a field of traditional state regulation, minimum wages to be paid to employees, and the text of the Lanham Act does not indicate an intent to preempt such an ordinance.”

Summary of IFA’s Amended Complaint

• Standing issue:  Plaintiffs have standing under the associational/representational theory because: (a) one or more of each of their members would have standing to sue in their own right; (b) the interests asserted in this litigation are germane to their purposes as associations promoting and defending the franchise business model; and (c) neither the asserted claims nor the requested relief requires their members to participate individually.
  • Plaintiffs also have standing under the organizational theory because: (a) the application of the ABC Test to their members frustrates their organizational missions; and (b) has resulted in the diversion of Plaintiffs’ resources to combat the application of the ABC Test. See Havens Realty Corp. v. Coleman, 455 U.S. 363, 379 (1982).
  • Plaintiffs’ members are suffering actual injuries in fact, including, without limitation, an invasion of a legally protected interest that is concrete and particularized. Among other injuries, California’s ABC Test causes Plaintiffs’ members to bear legal, administrative, and operating costs to address the impact of the ABC Test on their franchise systems and the interference with their contractual relations.

• All Legal Theories
  • Supremacy Clause: Under the Supremacy Clause of the U.S. Constitution, Plaintiffs’ members may not to be subjected to or punished under state laws that are preempted by federal law.  The Lanham Act and FTC Franchise Rule pre-empts the ABC test as applied to franchising.  
    • California’s ABC Test is irreconcilable with the federal laws that regulate franchising.
    • Under Prong A of the ABC Test, a person may not be classified as an independent contractor unless that person is “free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.”
    • Under Prong B of the ABC Test, a person may not be classified as an independent contractor unless that person “performs work that is outside the usual course of the hiring entity’s business.” Cal. Labor Code 2775(b)(1)(B). In the context of a franchise relationship, under California law, the operation of a franchisee’s business must be “under a marketing plan or system prescribed in substantial part by the franchisor,” and “substantially associated with the franchisor’s trademark.
    • This dissonance between the ABC Test and the franchise business model was emphasized by the United States District Court for the District of Massachusetts in the case of Patel v. 7-Eleven, Inc.
  • Commerce Clause
    • Congress expressed its intent to regulate Commerce in the Lanham Act, specifically creating a statutory right to license a trademark, as long as there is control over the goods or services associated with the licensed mark.
    • State regulations like Cal. Labor Code § 2775(b)(1) violate the Commerce Clause of the United States Constitution if they place a substantial burden on interstate commerce that is “clearly excessive in relation to the putative local benefits.” Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970).
    • The burdens imposed on franchise relationships are clearly excessive in relation to the state’s interest in protecting employees. If the franchise relationship is an employment relationship, franchisors are in direct and imminent danger of being required to pay for all expenses and losses of a franchised business and for statutory penalties. Application of this provision to a commercial franchise relationship would be disruptive because it suggests that the goodwill of a franchise owned by a franchisee belongs to the franchisor.
    • There are already franchise companies that are unwilling to enter into or remain in the California market due to the uncertainty and disruption caused by the overlay of employment rights and obligations over franchise relationships and may close off the California market to a large swath of franchisors who rely on franchisees to maintain their brand and to franchisees for whom the franchise model provides the most-desirable means by which to own and operate their own business.
  • Fifth and Fourteenth Amendments
    • The Fifth Amendment says to the federal government that no one shall be "deprived of life, liberty or property without due process of law. The Fourteenth Amendment, ratified in 1868, uses the same eleven words, called the Due Process Clause, to describe a legal obligation of all states.
    • When applied to franchise relationships in accordance with its express terms, Cal. Labor Code § 2775(b)(1) violates the Fifth and Fourteenth Amendments of the United States Constitution because California’s ABC Test constitutes a regulatory taking of franchisor and franchisee contractual rights qualifying as independent contractor relationships.