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The Ostensible Agency Theory – a Threat to Franchisor Liability? The Ostensible Agency Theory – a Threat to Franchisor Liability?

The Ostensible Agency Theory – a Threat to Franchisor Liability?

Franchise agreements typically provide that a franchisee is a separate and distinct entity from the franchisor and that the franchisor is not liable for the franchise’s employment practices. Traditionally, this language has been sufficient for franchisors to avoid liability as “co-employers” with their franchisees. Two recent decisions, however, threaten to disrupt this longstanding presumption through a novel application of the “ostensible agency” doctrine. Franchisors must now be more careful than ever to ensure they are not ultimately held liable for their franchisee’s employment practices.

The doctrine of ostensible agency, also known as apparent agency or agency by estoppel, permits a plaintiff to hold an actor liable for the harm caused by its apparent agent. For example, if a plaintiff is harmed by a doctor’s malpractice, the plaintiff can hold the hospital liable for the doctor’s malpractice if it appears that the doctor was acting as the agent of the hospital. There are, generally, three elements to this theory: (i) the plaintiff must reasonably believe that the “agent” is under the control of the principal; (ii) the plaintiff’s belief must be the result of an act or omission of the principal to be charged; and (iii) the plaintiff cannot be negligent.

This doctrine has served as an appealing avenue for plaintiffs to hold franchisors liable for the torts of the franchisee in some situations. For example:
  • A customer sued a franchisee and the franchisor after she allegedly bit into a sapphire found in her sandwich.
  • Plaintiff’s decedent died after he took a prescription that had been improperly filled by a franchisee of a pharmacy chain.
  • Parents sued a restaurant franchisor on behalf of a minor child who was injured when the child tried to open a glass door, and the glass door shattered.
  • Guest sued hotel (franchisee) and hotel chain (franchisor) for injuries sustained when he slipped and fell getting out of hotel room bathtub.
  • Homebuyer sued real estate agent and agent’s franchisor for fraud.
Generally, this doctrine applies to third parties who have limited, sometimes one-time, interactions with an individual or business who they believe is an agent of a corporate chain. Two recent California cases have now opened the door and applied this doctrine to a franchisor’s potential liability to its franchisee’s employees.

The courts in both cases held that a franchisor could be held liable for its franchisee’s alleged violations of California’s Labor Code under the theory of ostensible agency. While the courts dismissed the plaintiffs’ claims that the franchisor was a joint-employer along with the franchisee, the courts allowed the cases to proceed under the ostensible agency theory.

In the first case, a group of employees who worked for a California franchisee sued their employer (the franchisee) for violations of California’s Labor Code. The plaintiffs also named the franchisor itself as a defendant, arguing that the franchisor was (i) their joint employer and/or (ii) liable for violations of the California Labor Code under a theory of ostensible agency.

The Court granted summary judgment to the franchisor on the joint employment issue, but held that there was an issue of fact (such that trial is required) as to whether the franchisor and its franchisee shared an ostensible agency relationship. The court explained that ostensible agency could exist if the person dealing with the agent – in this case the employees – reasonably believed that the agent – the franchisee – had the requisite authority based on an action, or absence of action, taken by the principal sought to be charged, and the relying party was not negligent. In that case, the plaintiffs submitted declarations stating that they believed they were employed by the franchisor because of the uniforms they wore, the packaging of the food they served, which included the franchisor’s logo, their paystubs identified the franchisor’s name and logo, and they applied for their jobs through the franchisor’s website. It is unclear whether these allegations will be credible or sufficient at trial, but they were sufficient to withstand summary judgment.

In the second case, the court denied the franchisor’s motion for summary judgment, finding that the franchisee employees could also pursue a claim against the franchisor. These plaintiff employees submitted declarations stating they believed they worked for the franchisor corporation. Additionally they wore the franchisor’s clothes, served the franchisor’s food, applied for a job through the franchisor’s website, and worked pursuant to the franchisor’s store policies.

The court expressed some skepticism that the ostensible agency doctrine (which it noted generally applied only in situations “involving non-employees who had isolated or short-term contact with the defendants”) would actually apply in the context of continuous employment. Nonetheless, the court resolved this “close call” in favor of the plaintiffs and ruled they had submitted enough evidence such that a jury could reasonably find the franchisor to be a joint employer by virtue of an ostensible agency relationship.

The Future

To date, no other courts have adopted the ostensible agency rationale. However, these decisions could open the door for future litigation against franchisors.

So what does this mean going forward? Although some states, including Indiana, have enacted recent legislation to clarify franchisors are not joint-employers, that may not be enough to avoid this new agency theory of liability.[1] Thus, franchisors should take additional steps to make it abundantly clear that they are not the employers or joint employers of the franchisee’s employees. This means ensuring the franchise agreement and disclosure documents are clear that there is no employment relationship. Further, franchisors should take a hands-off approach to the hiring process and managing of employees. All paystubs, employment manuals, and other employment documents should identify the franchise relationship and clarify that the employer is the franchisee.

Whether or not the ostensible agency theory will become a viable theory of liability in the future is yet to be seen. However, any steps that a franchisor can take to remove itself from the employment relationship will help avoid liability in the future.

For more information on this case, contact George Gasper, Christina Fugate or a member of our Franchise practice group.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.

[1] Ind. Code 23-2-2.5-05 states: 
(a) As used in this section, “franchisor” has the meaning set forth in 16 CFR 436.1(k). 
(b) As used in this section, “franchisee” has the meaning set forth in 16 CFR 436.1(i).
(c) For purposes of this chapter, a franchisor is not considered to be an employer or co-employer of (1) a franchisee; or (2) an employee of a franchise; unless the franchisor agrees, in writing, to assume the role of an employer or co-employer of the franchisee or the employee of a franchisee.
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