Labor Ruling Could Prompt Banks to Second-Guess Franchise Lending

To borrow a famous phrase by former Fed Chairman William McChesney Martin, the National Labor Relations Board is threatening to "take away the punch bowl" from banks that lend to franchises.

The governmental agency, charged with handling alleged violations of the National Labor Relations Act, ruled in a 3-2 vote this summer that multiple entities – such as franchisors and franchisees — can be considered joint employers if they share matters "governing essential terms and conditions of employment." As a result, each can be held accountable for labor-law violations.

The ruling has been viewed primarily as a labor relations issue, but industry experts said expanded legal exposure for franchisors could end up spooking some lenders that have been keen to lend to that business model. The timing of the decision, meanwhile, comes as many banks have been ramping up lending to franchisors.

The ruling "absolutely exasperates and flummoxes people," said Michael Layman, vice president for regulatory affairs at the International Franchise Association.

"We had a meaningful, successful standard based on direct control of employee practices," Layman said. "This … introduces a boatload of uncertainty. No one can be sure that they won't run afoul of the standard since no one knows what it means."

The prior standard for joint employment was more accommodating to franchisors, applying only to entities that exercised actual control of key workplace functions such as hiring, firing, discipline and supervision. Few, if any, franchisors exerted that much control over franchisees.

The labor board, however, decided that the pre-existing definition was too narrow. "If otherwise sufficient, control exercised indirectly — such as through an intermediary — may establish joint-employer status," the board determined.

While the original case involved a waste-management firm, the AFL-CIO quickly asserted that the decision could cover other franchise relationships. "It means more working people can engage in meaningful collective bargaining by bringing all parties who control their wages and other conditions of employment to the table," said Richard Trumka, the labor union's president.

So franchisors are now exposed to potentially wide-ranging legal difficulties. The labor board, for instance, is investigating more than 155 allegations of unfair labor practices at fast-food chain McDonalds.

The franchise industry is wringing its hands over the decision, fearing that small franchisors and people looking to employ a franchise model could find it challenging to start businesses or expand, with access to credit serving as a key hurdle.

"The extreme lack of clarity is problematic," Darrell Johnson, chief executive of Arlington, Va., research firm FRANdata, said. "Where else is the government going and how intrusive is it going to be on the subject of franchisor-franchisee relations?"

Lenders might ultimately be forced to make some hard choices, Layman said. Given the decision, "why would anyone take a chance on an aspiring franchise or a single-unit operator seeking to grow?" he said.

Franchisors have recently enjoyed a "proliferation" of interest from banks, said Dennis Monroe, a lawyer at Monroe Moxness Berg in Minneapolis who specializes in franchise finance.

"We get calls a couple of times a month," Monroe added. "Most of the major banks and even the regionals are playing in the [franchise] space."

More than 2,000 banks subscribe to a FRANdata service that provides credit information about franchises, Johnson said.

Smaller banks have also made efforts to boost franchise lending.

Pacific Premier Bancorp in Irvine, Calif., had nearly $300 million in franchise loans on its books at the end of the third quarter. First Financial Bancorp in Cincinnati held $514 million of franchise loans on June 30.

Atlantic Capital Bancshares in Atlanta, which formed a franchise lending group last year, is concerned about the ruling, said Douglas Williams, the company's president and chief executive.

"It's a potential threat to the franchise business model and to franchisees in particular," Williams said. "It could have a wide-ranging effect on small businesses and job creation."

Pacific Premier's chief executive, Steven Gardner, declined to comment. Efforts to reach First Financial were unsuccessful.

Banks are attracted to franchise lending because it often creates multiple credit opportunities," Monroe said. "They all need to remodel or add more units," he added.

The International Franchise Association has formed a special action group to push back against the ruling. The group recently managed to get a bill introduced in the House of Representatives that would restore the previous joint-employer definition.