McDonald’s and Others Face New Rule That Could “Destroy the Franchise Model,” Company Says
Story by Catherine Dunn, Barrons, 10/2/23
More than 800,000 people work at a McDonald’s restaurant in the U.S. But the question of who works for McDonald’s is a thornier one. Today, about 95% of the restaurants bearing the Golden Arches are franchises. And McDonald’s Corp. is quick to say that the workers flipping burgers, running registers, and mopping floors at those restaurants are employed by the franchisees, not the company headquartered in Chicago’s West Loop.
To McDonald’s (ticker: MCD), this distinction is vital—and under imminent threat.
The National Labor Relations Board is preparing to issue a highly anticipated, and in some circles, highly controversial new rule expanding the definition of “joint employer,” or when a company is considered to hold a joint responsibility for another businesses’ employees. The proposed NLRB rule would make it easier to hold franchisors liable in labor disputes and bring them to the bargaining table with unions. The same goes for businesses that use contractors or subcontractors and temporary staffing services. That has important implications for franchise-heavy industries like fast food and hotels, as well as sectors like logistics, construction, and even big tech.
The revised rule was unveiled more than a year ago, and in July the NLRB estimated that it would be released in final form by August. An agency spokesperson didn’t comment on the revised timing, but labor experts expect it to be published soon.
A key factor in evaluating whether a business is a joint employer is determining which company or companies control the essential working conditions. Under the current, narrower rule, the threshold is whether a business has “direct and immediate control” of those conditions; the proposal says evidence of indirect control could also suffice. In the case of McDonald’s, franchisees must follow corporate-set rules for how food is prepared and customers are served, among other things. Unions leaders and others have argued that franchisors’ strict operating standards, and their systems for monitoring sales transactions and stores, are forms of control that can also affect workers’ employment conditions. In the past, such arguments have usually failed, but it’s possible that would change under the new rule.
For unions and other labor groups, the revised joint-employer proposal is a much-needed corrective that would make it easier to hold big corporations responsible for labor law violations, like threatening or retaliating against workers for supporting a union.
But for McDonald’s—one of the biggest franchise companies in the world—and others whose business model depends on franchising, the rule has the potential to be, at the least, a very expensive problem. McDonald’s has said in comments to the NLRB that the proposal threatens to “destroy the franchise model” and the agreement at its core: Franchisees get access to the “world’s premier” restaurant operating system, and in exchange they pay fees to McDonald’s, make capital investments, and agree to take on liability, including for employment matters. Franchisees hire, assign job positions, determine employee pay, supervise staff and are “thus the exclusive employers of their employees with responsibility for employment law violations,” McDonald’s says. The company also points out that it “has never been found to be a joint employer with any franchisee under any state or federal law in over 70 years.” When asked for comment on the impending rule change, McDonald’s referred Barron’s to its public comments to the NLRB.
A franchise trade group is already at work on lobbying efforts to overturn the rule through Congress and plans to challenge it in court.
“We are confident there will be bipartisan opposition to this rule,” says Michael Layman, senior vice president for government relations and public affairs at the International Franchise Association. To add a new liability risk to franchisors, Layman says, is “a fundamental changing of the rules in the middle of the game.”
The proposed rule, which could go into effect imminently, raises urgent questions for workers, the industry, and investors in McDonald’s and other franchise businesses. Will the effort to block the rule be successful, and if not, how will the repercussions play out? And are the industry’s dire declarations about the impact of the change overblown, or could this rule change actually become an existential threat to the franchise model?
The current upheaval over the NLRB proposed rule is just the latest in a long push-pull over the responsibilities of franchisors, led by whichever party currently holds the White House and with it, the power to appoint a majority of the agency’s five-member board. Under the National Labor Relations Act, the NLRB investigates and hears cases on workers’ rights to organize in a union, or take part in activities like protesting work conditions, even if they’re not in a union.
In the Obama years, the NLRB moved to make it easier for a company to be considered a joint employer. In 2014, the agency’s general counsel brought a case alleging unfair labor practices against McDonald’s franchisees and attempted to hold the company responsible as a joint employer, and the following year, a separate case known as Browning-Ferris broadened the joint-employer standard. That momentum reversed during the Trump administration. The McDonald’s case settled in 2019 with no finding that the company was a joint employer, and in 2020 the agency issued a rule defining the standard on narrower terms, much to the relief of the franchise industry.
Now the pendulum is set to swing again, this time under President Biden. The expected change didn’t shock labor watchers, given that Biden has previously said he intends to lead “the most pro-union administration in American history,” a theme illustrated during the United Auto Workers strikes, when he joined a picket line with striking workers.
McDonald’s and other franchise companies have made it clear they believe the stakes are high. The “reality is that our business model is under attack,” CEO Chris Kempczinski said of possible joint-employer regulations in a speech at a franchising industry conference in Las Vegas earlier this year, in remarks he also published on LinkedIn. Changes by the NLRB, he said, would transform franchisees “from independent small-business owners to employees of the parent brands.”
Heightened joint-employer liability could hurt the franchise model in two main ways, according to the International Franchise Association. One possibility, along the lines of what Kempczinski described, is that a franchisor would exert more control over the franchisees. That undercuts one of franchisors’ big selling points to potential franchisees—that they’re offering a path to running their own business, with all of the freedoms that provides. It could also add compliance costs, and potentially, legal and liability expenses.
Those increased costs are also a frequent worry for franchisees, says restaurant consultant John Gordon, principal at Pacific Management Consulting Group. Franchisees typically pay franchisors a percentage of their sales, and their profit comes after those fees and their operating expenses. Franchisees are “justifiably afraid of the franchisor passing costs onto them that weren’t part of the franchise agreement,” he says, and wary of joint-employer liability for that reason.
Still, some legal experts say the proposal isn’t as dire for franchising as some in the industry would portend. The question of joint-employer status would still be determined on a case-by-case basis. “The rule is important, and in close cases it’s going to make a real difference,” says Jeffrey Hirsch, a law professor at the University of North Carolina. “But it’s not going to make as big a difference as a lot of the actors involved are saying.”
What’s more, the NLRB’s rule making applies only to the area of law it oversees on unions and worker organizing, and not to other types of joint-employer liability for issues such as harassment and discrimination—though it is possible that a shift in NLRB rulings could, over time, start to influence other areas of law.
Another possible outcome of a revised NLRB rule is that a franchisor would offer fewer support services to its franchisees, to try to reduce the risk it could be viewed as a joint employer. An economic analysis commissioned by the International Franchise Association found that this so-called “distancing” behavior led to lost sales and increased costs for franchisees after the NLRB broadened the joint employer standard in its 2015 Browning-Ferris decision. Measured as lost potential output, the analysis estimated the cost to the sector of that broader standard to be between $17.2 billion and $33.3 billion a year when it was in effect.
A September survey on joint employer released by the IFA found franchisees were troubled by both scenarios: 74% said they had a high level of concern about franchisors exercising more day-to-day control of their operations, and 55% expressed high concern about reduced support for services like training and technical guidance.
The issue isn’t just being battled at the federal level. McDonald’s recently averted potential regulations on joint liability in California, when a coalition of restaurant brands and trade groups agreed to a legislative compromise with the Service Employees International Union, the longtime supporter of the Fight for $15 movement. The industry agreed to raise fast food wages to $20 an hour starting in April 2024, but managed to eliminate the joint-employer provisions from the pending bill. The revised bill was signed into law Thursday.
McDonald’s tells Barron’s the company “stood up a dedicated team of staff and franchisees” to work on an action plan in response to the legislation, but did not comment directly on the removal of the joint-employer provisions.
Brands are relying on support from franchisees as they plan to counter the NLRB rule. The International Franchise Association is pursuing a strategy to get the rule nixed by a Congressional Review Act resolution. The law allows Congress to overturn an agency rule though a simple majority vote in both chambers, and Layman says the IFA believes it will be able to muster the bipartisan support needed to pass the resolution. That said, it could still be blocked by a presidential veto, and there’s little reason to believe Biden wouldn’t use that power.
In the meantime, a court challenge is likely once the public gets to see the final version of the rule. Says Layman: “It’s going to be incumbent on business organizations like the IFA to stick up for our members and challenge this unworkable rule in court.”