Similarly to the United States, Canada has pre-sale franchise disclosure laws in six of the 10 provinces in the country, each of which require that a “franchise disclosure document” or “FDD” be provided to a prospective franchisee at least 14 days before a franchise agreement is signed or any consideration is paid in respect of the franchise. Due to the broad application of franchise laws, certain relationships, including licensed or managed hotel arrangements, may be considered “franchises” under Canadian law, even if not so intended as such or characterised under American law. Consequences for failures or errors of disclosure include statutory misrepresentation and rescission, including the right to sue for losses. Canadian franchise laws are historically strictly construed against franchisors, with case law supporting large damage awards against hotel franchisors because of technical errors in disclosure. While the substance of disclosure is relatively similar in both countries, Canadian disclosure obligations include an overriding “materiality” concept which can require a FDD to be modified on a deal-by-deal basis to account for deal-specific facts, including, in some instances, the content of a PIP, as well as an ongoing disclosure obligations in respect of “material changes” between the provision of the FDD and the execution of a franchise agreement. Certain exemptions exist from the obligation to make disclosure, including in Ontario and British Columbia, where the acquisition of the franchise exceeds $5M.

NO “AT-WILL” EMPLOYMENT IN CANADA
There is no “at-will” employment in Canada. No Canadian employer has the ability to terminate a Canadian employee’s employment at any time without cause and without notice, except within the first three months of an employee’s employment (provided the employer has reserved that right, in writing, when it offers employment to be able to exercise it).

Employers have an implied duty of good faith and fair dealing with their employees. Consistent with this is the implied obligation to provide an employee with “reasonable notice” of termination of employment where there exists no “cause”. This entitlement can trigger substantial severance payments and is one of the key reasons that Canadian employers typically enter into formal written employment agreements with their employees.

While employers are permitted to terminate employees’ employment without notice for cause, cause has a very high threshold under a Canadian law. Under employment standards legislation in every Canadian jurisdiction, written notice of termination or pay in lieu of notice is required for the termination without cause of any employee with three months’ service or more. The statutory requirements vary across the country, but generally equal roughly a week of notice or pay in lieu for each year of service to a maximum of eight weeks.

Employment standards legislation cannot be contracted out of; attempts to do so are deemed void. The Supreme Court of Canada has set aside an employment agreement where the employee agreed no notice of termination was required. In that case, the Court required the employer to pay an amount consistent with the common law obligation to provide reasonable notice (which is typically much greater than the minimum imposed by employment standards legislation).

The common law obligation to provide reasonable notice is based on a number of factors such as age, length of service, position performed, and prospects for securing alternate, comparable employment. While there is no “rule of thumb”, awards of one month per year of service, and more, are commonplace in Canada.

Reasonable notice generally includes not just pay, but benefits, commissions, most incentives or bonus, pension, deferred payments, car allowances, continued stock option vesting, etc. The employer is required to keep the employee “whole” for the period of reasonable notice and, if paying in lieu, is required to maintain all of the compensation and benefits associated with the employment relationship, unless there is very careful drafting in the applicable plan to prevent this.

CANNABIS LAW
As of October 17, 2018, it has been legal to cultivate, posses, acquire and consume cannabis and cannabis products across Canada. Permitted products include cannabis and cannabis accessories, but excluded, until October 17, 2019, “edibles” and other cannabis-infused products, such beverages and vaporizers. The legal framework which regulates cannabis consists of federal, provincial and municipal laws and regulations. Federal legislation focuses on public health and safety, with jurisdiction over such things as production licensing, packaging, labelling and promotion and taxation. Provincial legislation focuses on distribution, retail, as well as setting rules regarding where individuals may smoke cannabis. The decentralization of jurisdiction to the provinces has created a lack of uniformity across the country. For instance, consumption in public areas is prohibited in some provinces, while others, like Ontario, permit consumption anywhere tobacco smoking is permitted, with certain exemptions (such as vehicles or where children frequent). Certain provinces, like Alberta, have created rules to permit (at a later date) the regulation of consumption spaces (such as lounges or cafes), while others have not. In Ontario, British Columbia, and other provinces, cannabis can be smoked in designated guest rooms in hotels, motels and inns. Local or municipal governments may impose further restrictions which could limit provincial rules.

DESTINATION MARKETING FEE LITIGATION – KNUTH V. BEST WESTERN ET AL…
In Canada, destination marketing programs have been established by local tourism authorities, hotel associations or other bodies, for the purpose of promoting tourism in a particular city or region. These programs raise money for their promotional activities by soliciting hotels and other tourist service providers to remit a percentage or fixed amount of their revenues to the marketing program. These contributions may be funded by the hotels in whatever manner they see fit, but usually take the form of a percentage surcharge on the quoted room rate; surcharges, referred to as Destination Marketing Fees (“DMF”), are collected voluntarily by the hotels, and have no statutory basis.

DMFs are distinguished from lodging or accommodation taxes which are also levied in some provinces over and above applicable sales taxes. These are collected and remitted to provincial authorities. Generally, municipalities in Canada lack the authority to levy local taxes on hotel rooms.

In Canada, a consumer must be provided with clear, unambiguous notice of the DMF prior to the consumer entering into the agreement, particularly as the consumer will use the pricing information to determine if he or she will enter into the agreement. The DMF must be disclosed as a separate item/charge and must not be combined with applicable taxes or any other amounts payable by the consumer.

In the ongoing case of Knuth v. Best Western et al, the plaintiff made claims based on, among other things, the following:

1. the characterization (during the booking process on the hotel website) of a DMF as a tax, and
2. misleading or incorrect disclosure (during the booking process on the hotel website) of the DMF or the applicable tax.

In many instances the website/software platforms being used by certain hotels could not easily set out the DMF on a separate line at the point of booking. In some instances, it is claimed that the DMF was included with the tax giving the appearance of taxes being charged in excess of the applicable rate. Further many systems could not charge the correct tax on the full room rate such that the tax was on top of the DMF.

By way of update, certain of the franchisors in the action brought a motion for summary judgement to have the action dismissed against them on the basis that they are not liable for the actions of their franchisees. In August 2019, the Court dismissed the summary judgement motion. It is expected that the next major step will be certification as a class action.

LOYALTY PROGRAM LAW UPDATE
There are recently-enacted laws in Ontario (January 2018) and Quebec (August 2019) regulating loyalty programs. Subject to prescribed exceptions, the new laws prohibit the expiry of reward points due to the passage of time alone.

The key exceptions include:

• if the customer has not earned or redeemed any points within a specified period, and such expiration is provided for in the agreement (note that in Quebec, the inactivity must last at least one year)
• rewards for a specific good or service identified at the outset (e.g. coffee stamp card)
• gratuitous points

It is anticipated that other Canadian jurisdictions will adopt similar loyalty specific legislation in the coming years.

CANADA’S ANTI-SPAM LEGISLATION (“CASL”)
In Canada, there are disclosure and consent requirements for the sending of a commercial electronic message (“CEM”). The sender must obtain explicit opt-in consent unless implied consent or an exception applies. This differs from the US “opt-out” model. The key exception is where there is an existing business relationship within a 2-year period immediately preceding sending of the CEM.

There are requirements for every CEM delivered, including:

• the contact information of the sender must be included in the CEM
• the CEM must provide an unsubscribe mechanism that is capable of being readily performed and is clear and prominent
• the sender must retain a clear and comprehensive record of opt-in/opt-out

MERGERS & ACQUISITIONS
Acquisitions of US hotels are almost always completed as asset deals unless there is a specific reason that an entity deal must be utilized. While asset deals are common in Canada, entity deals are sometimes utilized to take advantage of the lifetimes capital gains exemption. The exemption allows a Canadian individual who holds shares of a qualified small business corporation to a lifetime capital gains exemption equal to approximately CAD $850,000. There are a number of requirements in order to take advantage of this exemption including that the shares were held for a minimum of 2 years, the corporation was a Canadian-controlled private corporation, and that the corporation had during such time “active” business income. Further, land transfer tax is not payable in connection with a transfer of shares of a corporation but is payable on a transfer of assets which is further incentive to structure as a share deal.

AUTHORS
Jason Arbuck
Partner and Co-chair, Hospitality Group Cassels Brock & Blackwell LLP
jarbuck@casselsbrock.com

Frank Robinson
Partner and Co-chair, Hospitality Group Cassels Brock & Blackwell LLP
frobinson@casselsbrock.com

This article is part of our Conference Materials Library and has a PowerPoint counterpart that can be accessed in the Resource Libary.

HospitalityLawyer.com® provides numerous resources to all sponsors and attendees of The Hospitality Law Conference: Series 2.0 (Houston and Washington D.C.). If you have attended one of our conferences in the last 12 months you can access our Travel Risk Library, Conference Materials Library, ADA Risk Library, Electronic Journal, Rooms Chronicle and more, by creating an account. Our libraries are filled with white papers and presentations by industry leaders, hotel and restaurant experts, and hotel and restaurant lawyers. Click here to create an account or, if you already have an account, click here to login.

ADA/Standing
1. Brito v. Wyndham Hotels and Resorts, LLC, 2018 WL 317464 (D. Colo., 01/08/2018). Plaintiff is a paraplegic and requires the use of a wheelchair to ambulate. While at defendant hotel he encountered multiple violations of the Americans with Disabilities Act (ADA) that effected his use and enjoyment of the premises and sued. The hotel challenged plaintiff’s standing. To establish standing, a plaintiff must show, inter alia, that he suffered an injury in fact. To prove that, plaintiff must establish a likelihood that he will return to defendant’s premises. Factors a court considers are the proximity of the business to plaintiff’s residence, the plaintiff’s past patronage of the business, the definitiveness of plaintiff’s plan to return, and the plaintiff’s frequency of travel near defendant. In the complaint plaintiff stated he lives in the same county as defendant, he has frequented defendant hotel for “pleasure purposes,” he was a guest at the premises for a two day stay, and he alleges an intention to return within four months. This constitutes a personal stake in the outcome to constitute standing and avoid dismissal of the complaint.

Bankruptcy
2. In Re Lorraine Hotel 2017 LLC, 2018 WL 5288893 (N.D. Ohio, 10/22/2018). Plaintiff hotel filed a Chapter 11 petition in bankruptcy. The debtor’s sole asset was a 93-room hotel, of which 54 rooms were rentable. The debtor did not have casualty insurance covering destruction of, or damage to, the facility. The Bankruptcy Code, Section 1112(b) authorizes a judge to dismiss or convert a Chapter 11 case to Chapter 7 “for cause.” Cause exists where a debtor fails to maintain appropriate insurance resulting in risk to the estate. The court stated appropriate insurance coverage is of “paramount importance” in this case because of the single asset in the estate and the status of the business as a struggling downtown hotel. The court thus dismissed the Chapter 11 case and denied conversion to Chapter 7. Instead, creditors can pursue their state remedies.

Class Action
3. Valverde v. Xclusive Staffing, Inc., et al, 2018 WL 4178532 (D. Co., 08/31/2018). Plaintiff is an employee of Omni Hotel. Per the written employment policies of the management company that operates the hotel, a $3.00 processing fee is deducted from each paycheck plaintiff and other employees receive. Plaintiff objected and seeks certification of a nationwide class of plaintiffs. Defendant objected arguing the allegations were insufficient to show that plaintiffs from other states were subject to the same policy. The court noted that defendant management company’s policies are national and controlled centrally from its Colorado headquarters. They are contained in its written employment policies used nationwide. The court thus found the evidence sufficient to certify a nationwide class.

Contracts
4. Murphy Elevator Co., Inc., v. Coco Key Hotel & Water Resort, 2018 WL 1747924 (Ohio Appls Crt, 04/11/2018). The parties had a two-year elevator maintenance contract. After the first year and a half, the hotel failed to pay. The elevator company stopped performing and sued for breach of contract. The hotel argued that it should only be liable for the unpaid moneys up to the time plaintiff stopped performing. The court rejected this argument and granted the elevator company lost profits. Noted the court, an award of damages should put the injured party in the same position it would have been in had there been no breach.

5. Stanciel v. Ramada Lansing Hotel and Conference Center, 2018 WL 842907 (Mich. Appls, 02/13/2018). Plaintiff fell when entering a hot tub at defendant hotel. Plaintiff attributes the fall to a broken support bar leading into the tub. Plaintiff sued, and the parties purportedly agreed to a settlement. Defendant prepared a written settlement agreement and submitted it to plaintiff. The documents included a “Medicare addendum.” Defendant’s attorney told plaintiff’s counsel to advise if he had a problem with any of the wording. Plaintiff returned the signed documents to defendant but unilaterally crossed out language in the addendum. Plaintiff now seeks to enforce the settlement agreement. Defendant argued the agreement was not valid because defendant was not willing to agree to the settlement without the eliminated clause. Plaintiff argued the clause that was crossed out was not an essential term of the settlement agreement so there was still a meeting of the minds on all the essential terms. The court ruled the parties did not reach an enforceable settlement agreement. Case dismissed.

6. Claris, Ltd. v. Hotel Development Services, LLC, 2018 WL 3203053 (Crt. Appls, Ohio, 06/29/18). Per contract dated 8/2005, defendant agreed to build plaintiff a 4-floor, 122 room hotel which plaintiff planned to operate as a Candlewood Suites. The construction was completed in late summer 2006. In 2013 the hotel began experiencing water penetration when rain occurred. Plaintiff’s expert witness investigated defendant’s construction work of the hotel’s walls and identified five deficiencies. The expert excluded one of the five as the cause of the water problem but did not identify the extent to which the other four may have contributed to the damage. Therefore, plaintiff failed to establish that a breach of contract by defendant caused the leakage. Thus, the court reversed a jury verdict in favor of plaintiff and directed a verdict for defendant.

7. Couture Hotel Corporate v. US, 2018 WL 3076847 (Crt. of Fed. Clms, 06/21/2018). Plaintiff purchased a $9 million hotel near Nellis Air Force Base intending to participate in the off-base lodging business for visitors to the base utilized when on-base lodging is full. To meet the base’s requirements, plaintiff made modifications costing in excess of $1 million. When the work was completed, defendant advised plaintiff that, due to lowered demand, it was not adding any new facilities to its overflow listings at the time. Plaintiff sued, claiming that defendant’s refusal to permit plaintiff to compete for off-base services violated the Competition in Contracting Act, various associated procurement regulations, and a contract implied-in-fact. The court held for the government finding procurement rules were not violated, and a contract-in-fact did not exist. While the government representative talked to plaintiff about prerequisites to qualify for the lodging overflow business before plaintiff purchased the facility, documents provided to plaintiff clearly stated that a prerequisite to the government signing a contract were various inspections and approvals. Said the court, “[I]n negotiations where the parties contemplate that their contractual relationship would arise by means of a written agreement, no contract can be implied.” The complaint was thus dismissed for failure to state a claim.

Default Judgment
8. Travelodge Hotels, Inc. v. Durga, LLC, 2018 WL 5307809 (D. NJ, 10/26/2018). Defendant was a franchisee of plaintiff. Defendant ceased operating and plaintiff filed suit for damages for breach of contract. Plaintiff ultimately received a default judgment. Defendant now seeks relief from that judgment. He argued his failure to defend was excusable because he was traveling the world searching for experimental medical treatments for their daughter who suffers from a rare anoxic brain injury which worsened about the time of the lawsuit. Per defendant, this search “consumed” his life. The court granted the relief, noting that the defendant’s inattention to the lawsuit was excusable given the daughter’s illness.

Eminent Domain
9. North Carolina Dept. of Transportation v. Laxmi Hotels, Inc., 2018 WL 2207793 (05/15/2018). Defendant operates a Super 8 Motel. The Department of Transportation (DOT) sought to widen and improve the street on which the hotel was located. As a result of the work, the hotel lost several parking spaces. Also, due to a 15-foot tall retaining wall installed, visibility of the facility from the nearby thoroughfares was totally lost. The DOT claims it explained the extent of the work to be performed. The hotel’s president stated the DOT assured him the hotel would not lose any parking spaces and failed to explain the height of the retaining wall. As a result of the lost parking and street visibility, the hotel claims the DOT significantly underpaid for the taking since the loss of parking and visibility severely impacted the value of the hotel. The court agreed that the DOT did not adequately inform the hotel of the extent of the taking of hotel property. The court thus ordered the DOT to provide just compensation. The case was remanded for further calculation of appropriate reimbursement for the hotel.

Employment/Actual Employer
10. Frey v. Hotel Coleman, et al, 2018 WL 4327310 (7th Cir., 2018). Plaintiff worked at a Holiday Inn Express in Algonquin, Illinois. The hotel was owned by Hotel Coleman, Inc. which hired Vaughn Hospitality, Inc. to manage the facility. Vaughn Hospitality consisted of Michael Vaughn and his wife. Plaintiff’s paychecks came from Hotel Coleman; she was trained, supervised, evaluated, assigned, etc. by Vaughn Hospitality. Plaintiff claimed Michael Vaughn sexually harassed her and she filed a claim with the EEOC. She was thereafter fired and sued Hotel Coleman and Vaughn Hospitality for retaliatory discharge. The lower court determined Vaughn Hospitality was not plaintiff’s employer and dismissed the charges against it. Following trial against Hotel Coleman, plaintiff appealed Vaughn Hospitality’s dismissal. The appeals court reviewed several factors to consider when determining who is an employer, the most important being the right to control and supervise the worker. The court vacated the ruling that Vaughn Hospitality was not a joint employer and remanded the case. In doing so the court commented that the district court will “likely” conclude that Vaughn Hospitality was plaintiff’s employer.

Interested in more? Click here to continue reading.

This article is part of our Conference Materials Library and has a PowerPoint counterpart that can be accessed in the Resource Libary.

HospitalityLawyer.com® provides numerous resources to all sponsors and attendees of The Hospitality Law Conference: Series 2.0 (Houston and Washington D.C.). If you have attended one of our conferences in the last 12 months you can access our Travel Risk Library, Conference Materials Library, ADA Risk Library, Electronic Journal, Rooms Chronicle and more, by creating an account. Our libraries are filled with white papers and presentations by industry leaders, hotel and restaurant experts, and hotel and restaurant lawyers. Click here to create an account or, if you already have an account, click here to login.

Authors

KAREN MORRIS
(585) 256-0160
Judgekaren@aol.com

Karen Morris is an elected Town Justice in Brighton New York, a Professor of Law at Monroe Community College (MCC), and an author. She was elevated to the title of Distinguished Professor, awarded by the Chancellor of the State University of New York.

She has written several textbooks including numerous editions of Hotel, Restaurant and Travel Law, the latest of which was published in 2017 by Kendall Hunt and won a Textbook Excellence Award from Text and Academic Authors Association. She also wrote two editions of New York Cases in Business Law for Cengage Publishing. In 2011, she published Law Made Fun through Harry Potter’s Adventures, and in 2017, Law Made Fun through Downton Abbey. She also co-authors Criminal Law in New York, a treatise for lawyers. She writes a column for Hotel Management Magazine entitled, Legally Speaking, and a blog for Cengage Publishing Company on the law underpinning the news.

Among the courses she has taught are Hotel and Restaurant Law, Business Law I and II, Constitutional Law, Movies and the Law, “The Michael Jackson Trial” and “O.J. Simpson 101; Understanding Our Criminal Justice System.” Her course offerings include some in traditional classroom settings and others online. She won the Excellence in Teaching Award in 1994, having been selected by her peers, and the Chancellor’s Award for Teaching Excellence in 2002, conferred by the Chancellor of the State University of New York.

DIANA S. BARBER
(404) 822-0736
dsbarber@gsu.edu
Diana@LodgeLawConsulting.com

Diana S. Barber, J.D., CHE, CWP is currently an adjunct professor teaching hospitality law and hospitality human resource management at Georgia State University in Atlanta, GA. In addition, she conducts a one-day workshop on contracting and risk management for the Events and Meeting Planning Certificate Program offered by The University of Georgia in Athens, Georgia.

In 2017, Diana became a co-author of Hospitality Law, Managing Legal Issues in the Hospitality Industry (5th Edition), along with Stephen Barth.
Ms. Barber is a recipient of the J. Mack Robinson College of Business Teaching Excellence Award in 2011 and was awarded 2011 Study Abroad Program Director of the Year by Georgia State University. In addition, Ms. Barber is the recipient of the 2010 Hospitality Faculty of the Year award and in 2012, received a Certificate of Recognition from the Career Management Center for the J. Mack Robinson College of Business. Ms. Barber is a member of Phi Beta Delta, an honor society for international scholars. Diana also completed her certification as a Certified Wedding Planner through the nationally recognized [the] Bridal Society.

Ms. Barber has recently launched a consulting/speaking company called LodgeLaw Consulting using her combined academic and hospitality legal skills; specializing in providing education to hospitality companies on preventative measures to reduce legal exposure, as well as a full range of legal services to hotels, motels, restaurants, event planning companies and private clubs. She has over thirty years of legal hospitality experience. Diana began her law practice as an associate attorney at King & Spalding in Atlanta, Georgia after graduating cum laude from Walter F. George School of Law at Mercer University in Macon, Georgia. She then spent over fourteen years with The Ritz-Carlton Hotel Company, LLC serving as vice president and associate general counsel. She is a member of the State Bar of Georgia, G.A.H.A., and the Georgia Hotel & Lodging Association (“GHLA”).

For example, a franchisor’s manual may set out the formula for its secret recipes or the procedures for successfully running the day-to-day operations of the business. Gaining access to a franchisor’s confidential information is what motivates franchisees to buy into the franchisor’s system. Without becoming a franchisee, interested persons cannot tap into the franchisor’s valuable sources of information. Therefore, when a franchisor’s confidential information is stolen, the value of the brand is put at risk. To protect their trade secrets and confidential information, franchisors in Texas should be familiar with the Texas Uniform Trade Secrets Act.

Pre-emption under the Texas Uniform Trade Secrets Act
In September 2013 Texas became the 48th state to adopt the Uniform Trade Secrets Act, a uniform law prohibiting the theft of trade secrets. Before the enactment of the Texas Uniform Trade Secrets Act, (1) franchisors – and any owners of confidential information – could pursue various common law tort, restitutionary, or contract theories under Texas law to recover for a misappropriation of trade secrets or confidential information.

In 360 Mortgage Group, LLC v Homebridge Financial Services, Inc, (2) the US District Court for the Western District of Texas held that the Texas Uniform Trade Secrets Act pre-empts many such theories. Under Texas law, franchisors must generally bring claims relating to misappropriation of a trade secret under the Texas Uniform Trade Secrets Act. The act expressly “displaces conflicting tort, restitutionary, and other laws of [Texas] providing civil remedies for misappropriation of trade secret”. (3) Accordingly, the court held that the act pre-empts claims – except for contract claims – that seek civil remedies for misappropriation of trade secrets. By contrast, a claim is not pre-empted if the plaintiff can show that the claim is based on facts that are unrelated to the misappropriation of the trade secret.

Impact of the Texas Uniform Trade Secrets Act on franchisors
It is common for a franchisor to initiate litigation when a former franchisee uses the franchisor’s confidential information or trade secrets in connection with a competing business or otherwise fails to return such information following the expiration or earlier termination of the franchise agreement. As 360 Mortgage makes clear, franchisors in Texas must pursue any tort claims relating to a franchisee’s improper use of the franchisor’s trade secrets or confidential information under the Texas Uniform Trade Secrets Act.

Furthermore, franchisors should continue to rely on their franchise agreements to protect trade secrets and confidential information. The act does not affect contractual remedies. (4) As long as the franchise agreement obligates the franchisee to protect the confidential information and return the confidential information when the relationship ends, a franchisor can sue a franchisee for breach of contract if the franchisee fails to return or otherwise misuses the franchisor’s trade secrets or confidential information.

Comment
Below is a list of recommendations for how franchisors can use the franchise agreement to further protect their trade secrets and confidential information:

• Incorporate confidentiality obligations into the franchise agreement for the franchisee and its employees, including a process for returning all confidential information upon expiration or earlier termination of the agreement.
• Describe and define all confidential information as property of the franchisor (eg, operations manuals, trade secrets, customer information, business policies and procedures, financial information, sales information and marketing plans).
• Use expressed acknowledgements in the franchise agreement, whereby the franchisee acknowledges the value of the confidential information, acknowledges that such information constitutes trade secrets and agrees to maintain it as confidential both during and after the franchise relationship.
• Provide contractual remedies for breaches of the confidentiality agreement.

S.L. Owens is an associate in the corporate practice group and a member of the ’s global supply network industry team. Her practice is dedicated to representing national and global brands. She advises clients on creating efficient supply chain systems, building strong franchise, distribution and supply chain networks, and complying with international sales laws.

For further information on this topic please contact S.L. at Gardere at 720.437.2000 or email
s.l.owens@gardere.com. The Gardere website can be accessed at www.gardere.com.

Endnotes
(1) Tex Civ Prac & Rem Code § 134A.007.
(2) 360 Mortgage Group, LLC v Homebridge Financial Services, Inc, Case No A-14-CA-00847-SS, 2016 WL 900577, at *8 (WD Tex March 2, 2016).
(3) Tex Civ Prac & Rem Code § 134A.007(a).
(4) Id § 134A.007(b)(1).

This article was first published in the Franchising Newsletter of the International Law Office – www.internationallawoffice.com.

WHD’s Guidance

On January 20, 2016, the Department of Labor’s Wage and Hour Division (WHD), which is charged with enforcing federal minimum wage and overtime laws, issued an Administrator’s Interpretation (AI) regarding joint employment under the Fair Labor Standards Act (FLSA) and Migrant and Seasonal Agricultural Worker Protection Act (MSPA).¹ Noting that the definition of employment under these laws is “the broadest definition” in all U.S. employment laws — broader than the common law or the federal law at issue in Browning-Ferris — the AI argues that joint employment under the FLSA and MSPA is “as broad as possible.”

While the NLRB focused on the concept of the control in Browning-Ferris (including notions of indirect control and the reserved right to control), the WHD relies on a substantially broader “economic realities” standard to determine joint employment under the FLSA. According to the AI, this standard covers “a multitude of circumstances where the alleged employer exercised little or no control or supervision over the putative employees.”

The AI breaks joint employment into two scenarios — horizontal and vertical:

Horizontal joint employment may exist “when two (or more) employers each separately employ an employee and are sufficiently related to each other with respect to the employee.” For example, a horizontal joint employment relationship may exist when a server works at two restaurants owned by the same company.

Vertical joint employment may exist where an employee has an employment relationship with one employer (such as a staffing agency or subcontractor) and the “economic realities show that he or she is economically dependent on, and thus employed by, another entity involved in the work.” The AI list seven factors relevant to determining whether economic dependency exists for vertical joint employment purposes:

• Whether the potential joint employer, directly or indirectly, directs, controls, or supervises the work performed;
• Whether the potential joint employer has the power to hire or fire the employee, modify employment conditions, or determine the rate or method of pay;
• Whether the employee and potential joint employer have an indefinite, permanent, full-time, or long-term relationship;
• Whether the employee’s work for the potential joint employer’s business is repetitive and rote, is relatively unskilled, and/or requires little or no training;
• Whether the employee’s work is an integral part of the potential joint employer’s business;
• Whether the employee’s work is performed on premises owned or controlled by the potential joint employer; and
• Whether the joint employer performs common administrative HR or labor relations functions for the employee, such as handling payroll.

Relevance to Franchisors

Though the AI itself does not mention franchise relationships, an accompanying Question and Answer sheet issued by the WHD declares that “whether a particular franchisee and franchisor jointly employ a worker is based on the facts of each situation and must be made on a case-by-case basis applying the analyses discussed in the AI.” ²

As noted above, the WHD’s “economic dependence” standard is broader than the NLRB’s control standard. When joint employment exists, all joint employers are jointly and severally liable for compliance with the FLSA’s minimum wage and overtime requirements. That is, each joint employer is individually responsible for the entire amount of wages due. As a result, under the WHD’s expansive view of joint employment, a franchisor could be liable for any minimum wage or overtime violations by its franchisees.

Unlike a law or formal regulation, the AI does not carry the weight of law or receive deference in courts, which are free to disregard it. Nevertheless, some courts may find the AI persuasive. Moreover, expect plaintiffs’ attorneys to use the AI to try to pin liability for a franchisee’s FLSA violations on the franchisor.

Further, the AI comes at a time when the increased threat of joint employer liability is already harming the industry. Fearing joint-employment exposure, some franchisors are offering less guidance, training, and support to franchisees. Less franchisor support could foster increased franchisee costs.

Advice for Franchisors to Minimize Exposure

In light of Browning-Ferris and the WHD’s AI, there are steps a franchisor should take to minimize its risk of being declared a joint employer of its franchisees’ employees. These steps will also reduce the risk of a finding of common law vicarious liability for a franchisee’s employment practices in most states:

1. Clear Documentation Disclaiming Right to Control Franchisee’s Employees: Franchisors should review their franchise agreements and other documentation for evidence of actual or reserved control regarding a franchisee’s employees. Franchise agreements and other documentation, including manuals and handbooks, should make clear that franchisees are solely responsible for all employment and personnel matters, including the hiring, firing, supervising, disciplining, scheduling, and managing of their own employees. Franchisors should expressly disavow in writing any right to control these employment matters. Language regarding a franchisee’s personnel matters should be phrased as recommendations instead of requirements or, if requirements, described in the context of maintaining objective operational standards such as having ethical and courteous employees trained to provide a certain level of service and accommodate customer needs.

2. Avoid Actual Control Over Franchisee’s Employees: Franchisors should, in practice, implement only those controls necessary to protect the goodwill of the brand. Though the reach of the NLRB’s Browning-Ferris decision and WHD’s AI will not be known for some time, franchisors should still be entitled to implement controls over trademark, advertising, quality control, and unit appearance issues. This should include enforcement of operational requirements aimed at brand standards, including regarding sufficient staffing levels to meet customer needs and having courteous, trained employees. On the other hand, franchisors should avoid actual control over personnel policies or actions, including the hiring, firing, disciplining, and scheduling of the franchisee’s employees, whether direct or indirect. In addition, given the fact that it was reportedly McDonald’s USA’s use of technology that allowed it to make real-time staffing recommendations to individual franchisees based on real-time restaurant revenue that captured the NLRB’s attention, franchisors should be wary of technology that provides real-time employee-scheduling recommendations to franchisees.

3. Limit Contact with Franchisee’s Non-Management Employees: Franchisors should limit interactions with a franchisee’s non-management employees. When conducting inspections and site visits, the franchisor’s personnel should review operations only with the franchisee or its manager. The franchisor’s personnel should give directions or suggestions directly to the franchisee’s owner or manager and not to its employees. Because indirect control may trigger joint employment status, any such directions or suggestions should be focused on enforcing standards necessary to protect the goodwill of the brand, not the franchisee’s employment or personnel matters.

4. Avoid Administrative Functions For Franchisee’s Employees: The franchisee—not the franchisor—should perform all administrative functions regarding the franchisee’s employees, including handling payroll, providing workers’ compensation insurance, and providing the tools, materials, or safety equipment required for employees’ work.

5. Announce Independent Relationship: Franchisors should take steps to ensure that the franchisee’s employees and general public know they are employed by the independent franchisee and not by the franchisor. For example, franchisors should require franchisees to place conspicuous signage stating that the unit is independently owned and operated. In addition, franchisors should prohibit franchisees from using the franchisor’s name or marks in the franchisee’s corporate name or in employment-related documents, such as applications, employment agreements, evaluations, etc. If a franchisee imposes a personnel handbook on its employees, then the franchisor should request that the handbook expressly states that the worker is an employee of the franchisee—not the franchisor—and that the franchisor does not possess the right to control the employee’s performance of duties, scheduling, or other conditions of employment.

Gardere will continue to monitor how developments regarding the joint employer standard may affect franchisors. For questions, please contact experienced counsel.

¹ U.S. Department of Labor, Wage and Hour Division, Administrator’s Interpretation No. 2016-1 (Jan. 20, 2016), available athttp://www.dol.gov/whd/flsa/Joint_Employment_AI.htm.

² U.S. Department of Labor, Wage and Hour Division, “Joint Employment AI: Questions and Answers” at Answer 5, available athttp://www.dol.gov/whd/flsa/Joint_Employment_AI_faq.htm.

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In the hotel industry, the myriad of complex business relationships also creates legal land-mines for the unwary. In that regard, hotel asset managers, hotel operators and franchisors should be extremely mindful of their legal obligations to their client, the owner of the hotel. Even if the hotel is a single asset, there are potentially four groups that, for a better term, have their fingers in the pie – the owner, hotel asset manager, hotel operator and franchisor. But at the end of the day, each of these relationships confer legal rights for the benefit of the owner and potentially, to the detriment of the asset manager, hotel operator and franchisor.

Hotel Asset Managers

In this day and age, it is very common for an owner of multiple hotels (whether it be individual owners, investors, and lenders) to hire an asset management company to oversee the hotel operator’s day-to-day management of the hotel. For instance, the hotel asset manager will have oversight of operations and the physical asset (the hotel), which includes monitoring ongoing financial performance, the competitive set, the hotel asset, provide support and review of the budgeting process and advise ownership as to management issues.

The hotel asset manager will also manage the hotel by advising the ownership as to optimum investment strategies, the investment community, select and oversee operators, franchise affiliations and consultants, negotiate and administer contracts and approve/monitor capital expenditures. In addition, the hotel asset manager should oversee the actions of the franchisor as well. Regardless of what role the hotel asset manager has undertaken, it will review and analyze daily-reports, financial statements, and other hotel reports prepared by the hotel operator. Even though the hotel asset manager is one step-removed from the hotel operator, the owner is relying on the hotel asset manager to be its “eyes and ears” for the hotel owner. Simply said, the hotel asset manager is the agent for the hotel owner.

Hotel Asset Managers Bound by Agency Law Principles

Historically, the Bible of Liability in the hospitality industry has been the RESTATEMENT (SECOND) OF AGENCY. It has served as the basis for seminal legal changes in the hospitality industry that now generally govern the conduct of hotel operators, and is relied upon extensively in hotel management disputes and is equally applicable to hotel asset managers. Under agency law principles, the hotel asset manager is the agent for the owner, its principal and is legally bound to disclose anything and everything to the owner, its principal. Generally speaking, the failure to disclose such information would constitute a breach of fiduciary duties. The elements of a claim for breach of fiduciary duty are: (1) existence of a fiduciary duty; (2) breach of that duty; and (3) damage caused by the breach.

As an agent of the owner, the hotel asset manager owes certain fiduciary duties to the owner and those duties include but are not limited to, the following: (a) a duty to act in the owner’s best interests; (b) a duty of loyalty; (c) a duty to disclose all information relevant to the owner affairs (candor); (d) a duty to keep and render accounts; (e) a duty not to accept secret payments or other amounts not authorized by the owner; (f) a duty to ensure that the principal’s profits are maximized; (g) a duty of care and skill; (h) a duty of good conduct; (i) a duty to act only as authorized; (j) a duty to obey; and (k) a duty not to act for an adverse party without the principal’s consent.

A hotel asset manager’s intentional breach of a fiduciary duty is a tort for which the plaintiff may recover punitive damages. While it is a general rule in many jurisdictions that courts allow the recovery of punitive damages where the defendant, in committing a tort, acted willfully, maliciously, or fraudulently, where punitive damages are awarded for breach of fiduciary duty, the actual motives of the defendant and whether the defendant acted with malice are immaterial. But something more than a simple breach is required for the recovery of punitive damages; the acts constituting the breach must have been fraudulent, or at least intentional. An intentional breach may be found where the fiduciary intends to gain an additional benefit for himself.

The hotel asset manager can get into trouble real quick if it fails to monitor reports prepared by the hotel operator, fails to review third-party contracts or avoids “drilling-down” in the financial data, agreements, and contracts to understand the operational side of the hotel. And sometimes, the big hotel asset management companies might have a cozy relationship with national hotel operators and/or hotel franchisors and on occasion, look the other way, because the hotel asset manager is more concerned with cementing future hotel asset management assignments.

Hotel Operators

In 1925, the Hotel Association of New York City designed a hotel account system to provide uniform classification of revenues, expenses, assets, liabilities and equities for hotels to attain and provide comparable financial statements. The system has since then been adopted by the American Hotel & Lodging Association (“AH&LA”) and is now referred to as the ”Uniform System of Accounts for the Lodging Industry.” In addition, the American Hotel & Lodging Educational Institute provides industry leadership in certifications necessary to operate hotels pursuant to the “Uniform System of Accounts for Hotels.”

i) Violations of the “Ten Commandments”

Notwithstanding these operational “Ten Commandments”, the landscape is replete with litigation against hotel operators. For example, there have been cases where the operator has “cooked the books” to obtain incentive fees. Specifically, the hotel operator allegedly ordered items in the last quarter of the calendar year and told the hotel’s vendors to bill the hotel in the first quarter of the next year, in order to obtain an incentive bonus. It’s a simple equation – the hotel operator fraudulently understated the hotel’s expenses to increase net operating income to achieve its performance bonus. That could be called theft, conversion, fraud or any number of things that would serve as the basis for a lawsuit.

ii) Control of Hotel Operations Equates to Potential Liability

In another case, the hotel operator (also the franchisor) threw an expensive party at the owner’s hotel but the hotel received no benefit at all – – the party was for the sole benefit of the hotel operator (and franchisor), yet the owner’s hotel was charged the costs for throwing the party. Despite uniform financial controls that are essentially mandated by the “Ten Commandments”, hotel operators still manage to open themselves up for litigation by doing bad acts.

In the context of hospitality litigation, it is much easier to find negligence, malfeasance and/or willful misconduct against the hotel operator because their scope of involvement is “more-hands-on”, more “real-time” and covers a “24/7” cycle with day-to-day operations of the hotel, as opposed to the asset manager that reviews reports after the fact. From an operational stand-point, the hotel guests, the restaurant guests, the bar and lounge patrons and banquet guests all “trigger” immediate responses, needs and crisis’s, whether someone falls, is too drunk, gets food poisoning or the invitee of the guests causes a problem. For the hotel operator, the potential for liability is exponential vis-à-vis the hotel asset manager, due to guest check-ins and check-outs, safety issues, food & beverage operations, convention/meeting room banquets, and failing to implement competent financial controls at the hotel property level so the owner can make money.

iii) Hotel Operators Are Bound by Agency Law Principles

In the past two decades or so, there has been a plethora of hotel management contract decisions that held “hotel owners had the power to terminate a hotel management contract based on agency law principles.” For a long time, the legal rationale for terminating hotel management agreements was based on the RESTATEMENT (SECOND) OF AGENCY. That is true, because the RESTATEMENT (SECOND) OF AGENCY sets forth the common law concept that a principal (hotel owner) has the power to terminate an agent (hotel operator) at any time unless the agency is coupled with an interest (which means an economic interest by the hotel operator in the hotel). But despite these adverse rulings, national hotel operators have attempted to disclaim that hotel management agreements constituted an agency relationship – – but the courts looked to the actual relationship of the parties and held that the “common law of agency trumps explicit contract language.”

In 2011, the Court in the Turnberry decision re-affirmed with crystal-clear clarity, that the hotel owner, based upon agency law principles, can terminate a hotel management agreement:
The notion of requiring a property owner to be forcibly partnered with an operator he does not want to manage its property is inherently problematic and provides support for the general rule that a principal usually has the unrestricted power to revoke the agency.

iv) Agency Coupled With an Interest

With regard to an economic interest, the courts have further held that for an agency to be coupled with an interest, the hotel operator must have a specific, present, economic interest in the hotel i.e., an equity interest or key money in the deal to create an agency coupled with an interest. But recent decisions seem to suggest that hotel operators have an uphill battle to argue their hotel management contract is an agency coupled with an interest and therefore, the hotel owner cannot terminate the hotel management contract.

v) Personal Services Contracts

In Marriott International v. Eden Roc and RC/PB, Inc. v. The Ritz Carlton Hotel Company, the RESTATEMENT (SECOND) OF AGENCY was not the basis for terminating the hotel management contracts. Instead, in the Eden Roc and Ritz Carlton cases, which applied New York and Florida law, respectively, the courts held that because the hotel operator had a broad delegation of power of discretionary authority that required the operator to exercise special skill and judgment, that the hotel management agreements were personal services contracts and could not be enforced by injunction or specific performance.

Both court’s analyzed the hotel management contracts under “the concepts of involuntary servitudes and assessed the difficulties courts would encounter in supervising the performance of special skills and judgment,” and ruled hotel management contracts may not be enforced by injunction or specific performance. Both holdings resulted in the hotel owners having the power to terminate hotel management agreements under the theory the contract was a personal services contract and not an agency law concept.

vi) Summary

In summary, California, New York and Florida courts have held that hotel owners can terminate hotel management contracts under agency law principles (unless an agency is coupled with an interest) or as personal services contracts. It appears the law is now settled.

vii) Wrongful Termination and Damages

But it is extremely important for the hotel owner to understand, that although it has the power to terminate a hotel management contract under either theory, the hotel owner may not have the contractual right to terminate the hotel management agreement. Therefore, the hotel owner may be liable for wrongful termination and the hotel operator may seek damages for the remainder of the hotel management contract term. So, the moral of the story is simple – – the power or right of termination can be expensive.

Franchisors

Although agency law principles have been applied in the context of terminating hotel management contracts (and should be applicable to asset managers), franchise agreements have been generally immune from these legal challenges. The reason is simple – the franchisor doesn’t really exercise control over the franchisee, unlike hotel operators that control the entire hotel operation for the hotel owner.

Historically, franchisees’ have filed lawsuits against franchisors for claims such as wrongful termination and nonrenewal, breach of contract (failing to provide support, training, advertising, territorial protection and the like), claims for market withdrawal by franchisor, the ability to transfer a franchise, misrepresentation claims (earnings, revenue, success/failure rates, etc.), encroachment claims (area of protection clauses), failure to provide certain disclosures pursuant to Federal Trade Commission mandates, antitrust claims and breach of fiduciary duty claims (advertising fund expenditures). However, filing lawsuits based on agency law principles and breach of fiduciary duty are far and few between.

In 1998, a little known lawsuit was filed that could serve as the guide post for future lawsuits that could find an agency law relationship between the franchisor and franchisee. In the Empire Holdings LLC v. Radisson Hotels Int’l case, the New York Supreme Court (trial court) came dangerously close to ruling that an agency relationship existed between the franchisor (Radisson) and its franchisee (Empire Holdings). In the Radisson case, the dispute dealt with the franchisee’s right to terminate the franchise agreement if Radisson failed to produce a fixed number of gross room reservation nights through Radisson’s national reservation system in a fiscal year. One of the claims against Radisson was based on agency law and an alleged breach of fiduciary duty. In the franchise agreement, there was a clause stating that Radisson was the “agent” for Empire Holdings as it related to booking hotel reservations, etc. In denying Radisson’s motion to dismiss, the court stated in dicta that Radisson’s role as an “agent” for Empire Holdings in booking hotel reservations could result in a fiduciary relationship between the franchisor (Radisson) and franchisee (Empire Holdings). Although the Supreme Court in New York is a trial court, the door was opened, albeit very little, to finding a franchise agreement constituted a fiduciary duty relationship between the franchisor and franchisee.

Agency law principles and fiduciary duties are found in the context of control – the hotel operator controls the operation, management, and pursue strings of the hotel. In other words, the more control the party has, the more likelihood there will be an agency relationship between the two parties. In the context of a franchise agreement, there is generally no control by the franchisor over the operation, management, and pursue strings of the hotel. But as illustrated in the Radisson case, if the agreement remotely states or implies the franchisor is the agent for hotel reservations, or the agent for collecting marketing fees, etc., or requires the franchisor to be in charge of funds paid by the franchisee to the franchisor, then the traditional agency law principles and fiduciary duties might be applicable to franchise agreements. Arguably, if the franchisor is controlling funds paid to it by the franchisee and misuses those funds, then the franchisee could bring a claim for conversion, which could be the catalyst to trigger agency law and fiduciary duty obligations and related claims against the franchisor.

The evolution of case law can take years. But I suspect there is a franchise agreement that effectively vests more than “nominal control” in the franchisor over the franchisee’s operation. That test case could be the one that finds a franchise relationship can be terminated like a hotel management agreement under agency law principles. If that time comes, then the franchisee’s power to terminate a franchise relationship versus its legal right to terminate, must be balanced against a wrongful termination claim by the franchisor and subsequent damage claims. When that ruling is decided, it will send shock-waves through the entire hotel industry and immediately create a “new” legal relationship between the franchisor and franchisee.

Originally published on Sunday, January 4, 2015
1186 views at time of republishing