Over the past few years, the health care industry has really taken a hit. There have been changes in the delivery of health care, reductions in payments for services and increasing regulatory burdens. These developments have forced health care entrepreneurs, investors and providers to think outside of the box and explore opportunities to open and grow franchises in a number of ambulatory care and ancillary service areas. These include home health, medical spas, physical therapy, vaccine and travel medicine centers, vision centers, direct-to-consumer laboratory testing and urgent care centers, to name a few.

However, along with these opportunities come myriad federal and state health care laws that can impact the structure and operation of these businesses and, potentially, their ultimate success or failure. Therefore, when contemplating a health care franchise, it is important for franchisors and franchisees to be aware of these laws and, at the outset, assess whether any will pose hurdles, if not complete roadblocks, to their franchising plans before sinking money into a business that may not work. While federal laws may apply in every state, each state in which a franchisor or franchisee will operate will have different rules.

1. The corporate practice doctrine

A number of states’ laws prohibit a legal entity from engaging in the practice of a profession that requires individual licensure unless it meets certain requirements. This is often referred to as the “corporate practice” or “corporate practice of medicine” doctrine. Generally, in “corporate practice” states, in order for a legal entity to provide health care services, the legal entity must be owned by professionals who are licensed to provide the same services the corporation will provide. Ownership of legal entities that provide professional health care services by unlicensed laypersons or other non-professional corporations is not allowed. A corporation that fails to comply with state rules could be subject to civil fines and penalties, lawsuits by the state’s attorney general, and/or revocation of the entity’s authority to transact business in that state.

2. Anti-kickback laws

The federal government and most states have laws prohibiting the payment of compensation or anything of value in exchange for patient referrals. In the case of federal law, this includes any services paid for by any federal health care program (e.g., Medicare, Medicaid, TriCare, Champus). State laws may be broader to include services paid for by any third-party payor, including commercial payors. Many arrangements you would think of as common in operating a business — space or equipment leases, services and management contracts, the issuance of ownership shares, etc. — may implicate anti-kickback laws, particularly if any of these arrangements are between a business and a health care provider who refers patients to the business. Violations of federal and state anti-kickback laws can result in civil fines and penalties, professional disciplinary action (pursuant to many state professional licensing laws), and, in some cases, potential criminal penalties.

3. Fee-splitting

Many state licensing laws prohibit licensed professionals from splitting their professional fees or other revenue with entities or other licensed people who are not legally affiliated with the licensed professional (such as through an employment arrangement) and did not provide any professional service. Fee-splitting laws go hand-in-hand with anti-kickback laws, as the underlying rationale for both is the prohibition of payments to individuals who did not provide the service being billed and/or in exchange for patient referrals. Because most, if not all, fee-splitting laws are found under state professional licensing laws, violations of fee-splitting prohibitions may result in professional disciplinary action against licensed professionals engaged in the improper arrangement.

4. Physician self-referral laws

Federal law and some state laws prohibit physicians from referring a patient for certain health care services to any entity with which the physician has a financial relationship. A financial relationship is broadly defined and includes investment interests. In the absence of an applicable exception, physicians may not refer patients to such entities, and any entity providing services related to an improper referral could be (and in the case of federal law, is) barred from billing for the services. Improper physician self-referrals may result in disciplinary action against the referring physician (in the case of many state prohibitions), overpayment liability for the entity billing for services related to an improper referral, and potential false claims liability under state or federal law.

5. Business format franchises

Health care franchises typically are structured as business format franchises, in which the franchisor generally provides operating systems, designs, layouts, equipment and supplies, accounting, computer and point-of-sale systems, group advertising and promotions, training, a common trademark and brand recognition. However, the medical professional (who may also be the franchisee) is responsible for the actual practice of medicine or other related profession, and nothing the franchisor provides or requires can or should supersede the independent professional judgment of the health care professional. Both the franchisor and franchisee should understand the limits on the franchisor’s services, as well as the limits on the franchisor’s ability to impose certain system standards as it relates to the practice of the underlying profession.

Whether, and to what extent, any of these laws apply to any particular health care franchise involves a complex analysis of the structure and proposed operation of the franchise and the applicable state and federal laws. Although the offer or sale of health care franchises will be subject to the registration and disclosure rules similar to other franchises, there may be special issues to consider. Because of the potential legal liability, those considering establishing or taking ownership in a health care franchise would be wise to consult with legal counsel experienced in the health care regulatory landscape and the issues unique to health care franchising.

For more information, please contact attorneys in Greensfelder’s Health Care Group.

Today the Office of the General Counsel of the National Labor Relations Board (“NLRB”) took its next step in the investigation of labor practices within the McDonald’s franchise system and issued consolidated complaints against McDonald’s franchisees and the franchisor – McDonald’s USA, LLC on the theory that the franchisor is a joint employer with its franchisees. Consistent with General Counsel’s amicus brief in the Browning-Ferris matter that was filed this summer, the focus of the complaints appear to be on the use of technology and tools that allows franchisors insight and potential control over franchisee operations.

According to the NLRB website:

“Our investigation found that McDonald’s, USA, LLC, through its franchise relationship and its use of tools, resources and technology, engages in sufficient control over its franchisees’ operations, beyond protection of the brand, to make it a putative joint employer with its franchisees, sharing liability for violations of our Act. This finding is further supported by McDonald’s, USA, LLC’s nationwide response to franchise employee activities while participating in fast food worker protests to improve their wages and working conditions.”

The NLRB faces an uphill battle in seeking to consider franchisors joint employers with their franchisees. The Browning-Ferris amicus brief signals a desire to revise the joint employer standard under the National Labor Relations Act to a former, more permissive standard than the one currently applied by the NLRB. However, case law applying the old standard has found that franchisors of typical franchise systems are not joint employers with their franchisees. The case law, however, dates back to the late 70s and it appears that the NLRB is trying to look deeper to differentiate the franchise system of old with modern operations.

More information is available on the NLRB website: http://www.nlrb.gov/news-outreach/fact-sheets/mcdonalds-fact-sheet

Although most prominent for its overhaul of national healthcare insurance rules, as part of its overall dedication to the improvement of American health, the Patient Protection and Affordable Care Act (“ACA”) also mandated regulations governing food labeling requirements in an effort to promote conscious, and hopefully healthier, food choices by American consumers. As its core directive on this issue, the ACA required the posting of calorie and other nutrition information for food items sold at restaurants and similar retail food establishments that are part of a chain of twenty (20) or more locations doing business under the same name and offering the same or substantially similar menu items. Similarly, subject to certain exceptions, all vending machine operators who own or operate more than 20 vending machines must disclose the calorie information for their goods. 

On November 25, 2014, the United States Food and Drug Administration (“FDA”) finally released its regulations implementing the ACA’s nutrition labeling provisions. (See 21 CFR Parts 11 and 101, final rules to be published December 1, 2014) Until official publication of the rules, you can access a copy of the FDA’s guidance here now: https://s3.amazonaws.com/public-inspection.federalregister.gov/2014-27833.pdf. The new FDA rules do a number of things, including:

• Declares the types of establishments that are subject to the rules (watch out, there are some potentially surprising inclusions, such as movie theatres and bakeries);

• Establishes what foods are subject to the nutrition labeling requirements;

• Requires menus and menu boards to list calorie information and suggested daily caloric intake information;

• Requires operators to maintain basic written nutrition information for standard menu items and provide them at a consumer’s request;

• Establishes guidelines for determining and substantiating the nutrient content of menu items;

• Establishes methods of compliance for vending machine operators;

• Establishes terms and conditions for voluntary compliance by restaurants or similar retail food outlets that would not otherwise be subject to mandatory compliance with the rules

The new rules go into effect for covered restaurants on December 1, 2015, and for covered vending machines on December 1, 2016. If you have questions about whether your business must comply or how to implement the new rules, we are here to help.

On September 16, 2014, the Franchise and Business Opportunity Project Group of the North American Securities Administrators Association (“NASAA”) adopted a Multi-Unit Commentary (“Commentary”) that affects the disclosure of multi-unit franchise development, including traditional area development, subfranchising and area representative arrangements. This guidance must be adopted by franchisors within 120 after the fiscal year end of a franchisor with an effective Franchise Disclosure Document (“FDD”), or within 180 days for a new franchisor. Compliance with the Commentary may dramatically alter a multi-unit franchisor’s cost of compliance due to the way in which NASAA addresses one type of multi-unit development arrangement: the area representative.

Area Representatives

Under the Commentary, an area representative is a party granted the right to solicit third parties to enter into unit franchise agreements, but unlike a subfranchising program, the franchisor and not the area representative is the party to the unit franchise agreement.

The reason the Commentary has the potential to increase a franchisor’s cost of compliance with franchise disclosure and registration laws is because the Commentary now requires that an area representative program be disclosed in an FDD that is separate from a franchisor’s single unit and/or area development programs. This means that franchisors who offer single unit franchises and have area representative programs will have two (2) FDDs with separate registrations to manage in the various registration states. Prior to NASAA’s adoption of the Commentary, members of the Greensfelder Franchise and Distribution Group voiced concern that requiring two (2) FDDs in this situation could lead to confusion because area representatives will typically need to receive both disclosure documents as a result of the typical obligation imposed under area representative programs to require the representative to open at least one model unit under a franchise agreement. The need for multiple disclosures might be further complicated if a franchisor’s area representative FDD has been approved but they are still waiting approval on the single unit FDD. Furthermore, with the growing demand on state franchise regulators, the Commentary’s position on requiring these multiple registrations will only add to the states’ burden.

Under the Commentary, the area representative program will also have an impact on a franchisor’s single-unit franchise offering. For example, the area representative that has management responsibility relating to the sale or operation of franchises will need to be disclosed in Item 2, which will trigger litigation and bankruptcy disclosures relative to that individual, and rebates received by the area representative or its affiliates (to the extent a franchisor is aware of them) must be disclosed in Item 8.

In addition to dealing with area representative disclosures, the Commentary clarified and confirmed aspects of the disclosure obligations of the other common types of multi-unit franchise programs: area development and subfranchising.

Area Development

Area development typically involves a single developer being granted the right to open a specified number of franchised outlets within a given territory according to a specified schedule. The Commentary affirms the way in which most franchisors have disclosed information related to their area development program in their FDD, including that the area development program can be disclosed in the same FDD as a single-unit franchise program. The Commentary also confirms that there should not be separate tables in Item 20 listing the number of area development arrangements in place. Instead, the list of current and former franchisees should identify outlets opened (or closed) by an area developer by use of footnotes. In short, for most franchise systems, the Commentary does not alter the disclosures they were already making for their area development program.

Subfranchising

A subfranchise arrangement involves the franchisor granting rights to another (the subfranchisor) that permit the subfranchisor to enter into unit franchise agreements with third parties (the subfranchisees) in a specified territory. The subfranchisor essentially acts as the franchisor in the territory, and is therefore soliciting subfranchisees and providing training and other support services that the franchisor commits to provide in a unit franchise agreement. The master franchisor and subfranchisor usually share fees paid by the subfranchisees. As with the area development guidance, the Commentary confirms, rather than alters, the typical disclosure procedures that most franchisors already implement in their FDD.

Subfranchising requires separate FDDs. The separate FDDs will, however, have certain disclosures that overlap, such as the disclosure in the subfranchisor’s FDD to subfranchisees of litigation and bankruptcy of both the master franchisor and the subfranchisor, and the disclosure in the subfranchisor’s FDD of the unit outlets of both the subfranchisor and of the system as a whole. One exclusion from these overlapping disclosure obligations, however, is that a master franchisor should not disclose in the FDD for its subfranchising program the Item 20 information about single-unit franchises that are opened or closed. In other words, a master franchisor should not disclose to its prospective subfranchisors the number of unit outlets that are opened or closed.

The above describes some of the Commentary’s new requirements on multi-unit franchise programs. The full text of the adopted Commentary is available here.

Franchisors should review their multi-unit offerings to determine if their FDD incorporates the new NASAA Multi-Unit Commentary before renewing in the several franchise registration states.

In a closely watched case with far-reaching implications, the California Supreme Court determined that Domino’s Pizza, the franchisor, should not be held liable for the alleged sexual harassment by an employee of one of its franchisees. The lengthy, well-reasoned decision gave great weight to the contemporary realities of the franchise business model and the unique nature of franchising. Noting how franchising has become such an important and thriving part of our economy, the Court followed the modern, enlightened view and rejected the reasoning of the old line of cases that found a franchisor vicariously liable for acts of its franchisees based on the degree of control they exercised over their franchisees.

Among the important factors that the Court considered in determining that Domino’s was not the employer of the franchisee’s employees were that the franchisee: (a) implemented day-to-day operational standards for the business: (b) hired, fired, and disciplined its employees; (c) regulated workplace behavior; and (d) was a completely different company from the franchisor. The Court also looked to the franchise agreement that described the parties as independent contractors and stated that Domino’s was not liable for damages arising out of the operation of the store.

The Court recognized how important it is for franchisors to impose comprehensive, uniform standards in order to effectively market their brand and protect their trademarks. Since these controls benefit both parties by building customer trust with consistency and uniformity, the Court reasoned that they should not be used to automatically saddle the franchisor with responsibility for employees of the franchisee.

The stature of the California Supreme Court as one of the nation’s most influential and innovative state courts may well influence judges throughout the country. Other courts should take notice in recognizing that franchising is unique and that holding franchisors liable for the wrongful acts of franchisees and their employees can have a profoundly negative impact on the franchise industry and the economy.

Patterson v. Domino’s Pizza, LLC, et. al, S20543, Ct. App. 2/6 B235099 (August 28, 2014)

In a decision that could have far-reaching legal implications for franchisors, on July 29, 2014, the General Counsel of the National Labor Relations Board (“NLRB”) ruled that McDonald’s was a joint employer of its franchisees’ employees. This decision stems from allegations that McDonald’s and its franchisees violated employees’ rights following protests pertaining to wages and working conditions.

Under long-standing NLRB precedent, a joint employer relationship may be found where one company possesses control over another company’s employees. Typically, the NLRB looks for evidence showing that the joint employer meaningfully affects employment matters such as decisions regarding hiring, firing, discipline, supervision or direction of another employer’s employees. Because the General Counsel’s reasoning for his decision is not published, the specific basis of the General Counsel’s decision remains unknown; however, factors such as a franchisor requiring (or strongly recommending) franchisees to maintain common policies, dress code, work rules and/or performance standards are among those that might be considered by the NLRB in deciding joint employer status.

The NLRB’s decision is troubling; however it is likely merely the opening salvo in an undoubtedly lengthy legal battle. The General Counsel’s decision authorizes the NLRB to proceed with unfair labor practice charges against McDonald’s and its franchises. Initial proceedings would be conducted before an NLRB Administrative Law Judge (“ALJ”). Any decision by the ALJ is subject to appeal to a three-member panel of the NLRB (the NLRB could, and in this case may be likely to, opt to have the entire Board participate in the decision), and any ruling by the NLRB may be appealed to a federal circuit court of appeals.

This is not the first time the question of joint employer status of franchisors and franchisees has been raised. Over the last several years, several state courts have examined the issue. Those decisions, however, have dealt with more limited state law issues. Ultimate success by the NLRB in treating McDonald’s as a joint employer with its franchisees could have far-reaching consequences for the franchise model in the U.S. Today’s franchise relationships are a balance between franchisors imposing enough control over their franchisees’ business to ensure a uniform experience for customers and the franchisees controlling day-to-day operations of their businesses. The franchise model is often attractive to franchisors because it enables them to grow their brand with less financial outlay than opening its own locations and is attractive to franchisees because they get to open their own business with the safety net that the franchisor provides through systems and support. Treating franchisors and franchisees as joint employers may force franchisors to reconsider their relationships with their franchisees in fundamental ways that will impact the desirability of franchising to both parties.

John Baer and his co-authors, Anders Fernlund – NOVA, Susan Grueneberg – Snell & Wilmer, LLP, and Jane LaFranchi – Marriott International, Inc., discuss the challenges a non-U.S. franchisor will face in entering the U.S. Market in the article, “Taking the Leap: Bringing a Foreign Brand to the United States,” published by the International Journal of Franchising Law. Read the article.

On Monday, May 5, 2014, Doug Neville will be presenting, “The Affordable Care Act and Immigration: What Every Franchise Lawyer Needs to Know,” at the 47th Annual IFA Legal Symposium in Chicago, Illinois. Doug and his co-presenters will discuss what affect the Affordable Care Act (ACA) will have on franchisors and franchisees, best practices franchisors and franchisees should follow to comply with, and to reduce liability under the ACA, and how franchisors can help franchisees achieve their immigration objectives.

Also during the IFA Legal Symposium, on Tuesday, May 6, 2014, Beata Krakus will be facilitating a roundtable addressing social media policies in franchising. During the roundtable session entitled, “Social Media Policies in Franchising: Structuring, Protecting the Brands and Enforcing Long Term,” attendees will have the chance to share challenges, questions and solutions surrounding the topic.

Other Greensfelder attorneys attending the 47th Annual IFA Legal Symposium include John Baer, Leonard Vines and Dawn Johnson.