Balancing on a Tightrope: Mandating COVID-19 Safety Protocols Versus Vicarious Liability

The franchise business model is grounded in two main elements. First, quality and uniformity of customer experience. From the trade dress and signage, to the particular goods and services offered, to the method of operations, franchise networks rely customers having the same great experience across all branded businesses, regardless of location or the particular owner of a location. Second, the transfer of legal and operational risks and liability from the brand owner (i.e., the franchisor) to the party actually operating the business (i.e., the franchisee). Here is the bargain: the franchisor foregoes the potential profits it could earn from operating the business itself in order to avoid the potential capital expenditures, risks and liabilities associated with operating the business.

With respect to the first element, ensuring quality and uniformity of customer experience is no simple task. A franchisor must invest significant resources to develop and continuously update and improve its system of operations. It must also maintain a degree of control over, and active enforcement of, its franchisees’ operations in order to ensure those systems are being strictly complied with. Exercising such control and enforcement rights is vital to achieve the desired goal of upholding the quality and uniformity of customer experience. It should be noted that this is not only a business goal, but also a legal pre-requisite for maintaining trademark protection under applicable law. In particular, the Lanham (Trademark) Act of 1946, 15 U.S.C. §§ 1051-1141n (2000) requires trademark owners, such as franchisors, to “maintain[] sufficient control of the licensee’s use of the mark to assure the nature and quality of goods or services that the licensee distributes under the mark.”1 Simply put, if a franchisor fails to maintain sufficient controls, it risks the loss of trademark protection. As a result, a franchisor will typically reserve to itself in the franchise agreement broad rights to require strict compliance with its system standards, as it may modify those standards from time to time.

So, franchisors have both a business and legal interest in ensuring the quality and uniformity of standards across all branded businesses in their network as well as the contractual right to enforce same. While this may sound straight forward, unwitting franchisors sometimes fall into the perilous trap when exercising these rights of nullifying the second element underlying the franchise business model: the transfer of legal and operational liability from the franchisor to the franchisee.

Vicarious liability is a legal doctrine, hinged on agency theory, which imposes liability on a person who did not commit a tortious conduct but who is nevertheless deemed to be responsible for such conduct by virtue of that person’s close relationship with the tortfeasor2. In the franchise context, this means that claimants may allege that a franchisor is liable for the acts, errors or omissions of its franchisees and its franchisees’ employees as a result of the nature of the relationship between the franchisor and the franchisee and the assistance and controls inherent in such relationship. To determine whether a franchisor may be held vicariously liable, the court must determine whether the franchisor exercised sufficient control over the franchisee’s day to day operations to be deemed the franchisee’s actual agent (i.e., “actual agency”) or whether the franchisor, through its action or inaction, caused a third party to reasonably believe that the franchisee was acting as the agent of the franchisor (i.e., “apparent agency”).

Vicarious liability is certainly not a new type of claim. The precise definition and test implemented by courts have periodically changed, but – – if for no other reason than the general public’s misunderstanding of the franchise business model – – the risk to franchisors of being held vicariously liable for their franchisees has persisted over time. The COVID-19 pandemic, however, and the actions certain franchisors have taken or wanted to take in response to same, have brought a renewed concern within the franchise industry that pandemic-related vicarious liability claims may rise.

The coronavirus has caused widespread and unprecedented risks to health and safety. And perhaps now more than ever, customers are demanding to receive communications from the brands they patronize regarding what is being done to keep them safe. As a result, many franchisors have been compelled to adopt new health and safety standards and protocols addressing topics such as cleaning, sanitation, social distancing, face coverings, hygiene, and potentially soon, vaccinations (though as of the date of this writing, the author is not aware of any brand that has required the vaccination of its franchisees’ employees) and to demand their franchisee’s strict compliance with these new standards and protocols. Whereas, in the past, a franchisor may have simply required that a franchisee keep the premises of its franchised business clean, in the post-COVID world, a franchisor may go a step further to provide franchisees with specific guidelines regarding precisely how to keep the premises clean. The concern is that, in providing such detailed guidelines to franchisees, a franchisor arguably controlling the means and details of the processes by which the franchisee accomplishes its ultimate tasks – a circumstance indicating the presence of an agency relationship and trigger for potential vicarious liability.

As a result of the foregoing, present in the mind of franchisor executive since the start of the COVID-19 pandemic has been how to carefully balance the need to modify and enforce its system standards and communicate those standards to franchisees and the consuming public without being held vicariously liable for the acts, errors or omissions of its franchisee, franchisee’s employees and/or franchised business. Unfortunately, there is no single bright line rule that can be followed. Instead, to determine liability, different courts apply different tests and often place heavy emphasis on the particular facts and circumstances present in any particular case. While a franchisor cannot eliminate the risk of being held vicariously liable altogether, there are ways to limit such risk.

Set forth below are five (5) key recommendations to mitigate the risk posed by vicarious liability:

  1. Independent Contractor. A well drafted franchise agreement should specifically disclaim any agency relationship between franchisor and franchisee and instead affirmatively characterize the relationship as that of an independent contractor. While this contractual language may be provided as evidence of the relationship, it is not dispositive. It is also important to put the general public on notice of the nature of this relationship. This can be accomplished through a conspicuous notice of ownership placed on display at the branded business, advising the public and the franchisees’ employees that the business is independently owned.
  2. Legal Advice. The pandemic has resulted in a complex web of federal, state and local laws, rules and regulations – – which have been continuously updated and modified on an almost monthly basis (if not more frequently, in some localities) – – with which businesses must comply. And while franchisors have a clear interest in ensuring that their franchisees comply with the applicable legal framework, they should be mindful not to furnish legal advice to their franchisees as to whether and how these laws, rules and regulations may apply to them and/or how to achieve compliance. In addition to potentially incurring liability if the advice furnished turns out to be incorrect or incomplete, the fact that such advice was given in the first place may be used as evidence of putative control over the means and instrumentality of operation of the business. Therefore, while a franchisor may furnish general guidance as to certain laws and legal developments of which its franchisees should be aware, in doing so, it is recommended to always remind franchisees that they are solely responsible for determining and complying with all applicable laws, and should seek their own legal counsel in connection with same.
  3. Communications. When imparting guidance to franchisees, the franchisor should make clear that: (i) the guidance is being given to protect the goodwill of the brand and the trademarks and to prevent the franchisee from harming such goodwill; (ii) the franchisor does not control the franchisees’ details of work; (iii) the guidance is intended to serve as a brief summary or primer and not as a comprehensive restatement of the applicable law(s); and, (iv) franchisees must take whatever steps are necessary to ensure the health and safety of their customers and comply with applicable law (even if those steps are not mentioned in the guidance and/or beyond the minimum recommendations included in the guidance).
  4. Indemnification. Although some view a franchise agreement’s indemnification clause as boiler plate, undeserving of thorough review, this could not be further from the truth. In fact, the indemnification clause is arguably one of the most business terms of the entire agreement; it safeguards the bargain underlying the franchise model (i.e., a shift in liability and risk from the franchisor to the franchisee in exchange for the franchisor foregoing the profits associated with operating the franchised business itself). As such, a well drafted franchise agreement should cover any and all claims arising from the operation of the business and the premises of the business, specifically including, without limitation, claims against the franchisor for vicariously liable (as well as joint employer liability, which although not covered in this article, is a related topic similarly deserving of close attention).
  5. Insurance. A franchise agreement’s insurance provision is just as critical to the franchisor as the indemnification provision, as sufficient insurance coverage is what ultimately underwrites the force and effect of the indemnification provision (i.e., an indemnification provision is only worth as much as the person or entity standing behind it). As such, it is advised to always require franchisees to obtain insurance coverage for any third party claims against the franchisor and/or its affiliates arising from the franchisee’s business, operations and premises. In addition, such policies should name the franchisor and its affiliates as additional insureds. Lastly, the franchise agreement should require franchisees to provide the franchisor with copies of their insurance certificates, and the franchisor should be vigilant in collecting these certificates.

Footnotes

1. Joseph Schumacher et al., Retaining and Improving Brand Equity by Enforcing System Standards, 24 FRANCHISE L.J.10 (2004).

2. Kerl v. Dennis Rasmussen, Inc., 273 Wis.2d 106, 682 N.W.2d 328, 333 (2004).