Franchise Systems Attacked by Slew of Antitrust No-Poach Class Actions

Antitrust Law Update

Date: November 14, 2018

Key Notes:

  • A spate of recent antitrust class actions should be cause for concern among franchisors in every industry.
  • These lawsuits are based on “no-poach” or non-solicitation clauses in franchisee agreements, which franchisors believe have lawful business purposes but antitrust plaintiffs characterize as simple wage price-fixing.
  • Franchisors and franchisees should consult with counsel to determine their risk and possible level of exposure to this kind of suit.

The latest trend in copycat antitrust class actions are lawsuits based on so-called “no-poach” provisions in franchisee agreements. A typical no-poach or non-solicitation clause prohibits or limits one franchisee from recruiting or hiring the employees of another franchisee.

Franchisors defend these provisions as a means of preserving the integrity of the overall franchise system, preventing franchisees from getting into wasteful disputes with each other, and encouraging franchisees to train and invest in employees, especially managers and other key team members, in industries with often high employee turnover. Antitrust plaintiffs, however, characterize them as simple wage price fixing that stabilizes or lowers the market price for employee services.

While the current set of cases focuses on the fast food industry, any franchise system that has or had any such provision in its franchise agreement could be at risk, and both the franchisor and each franchisee should review the agreements and consult with counsel on these potential antitrust issues.

The Market for Labor

Most people think of antitrust as protecting the sales of goods and services, especially to consumers. But the sale of labor can also be thought of as a market, subject to antitrust protection.

A high-profile example is the Department of Justice’s civil actions against the California high-tech giants, including Apple, Intel, and Google. The technology industry has high-value and highly compensated employees, such as software engineers, who often have knowledge of trade secrets or other business intellectual property. Because California law disfavors restrictive covenants in employment agreements, these companies sought an alternative way to prevent their competitors from recruiting their high-value people – a mutual no-poach agreement. DoJ’s Antitrust Division investigated and prosecuted the companies, arguing there was no economic justification for their agreement to not solicit the others’ employees. Each company settled and, after civil class actions were filed, they collectively paid hundreds of millions of dollars in settlements.

DoJ later published new no-poach policy guidelines and has threatened to prosecute criminally any companies or individuals who enter into so-called naked no-poach agreements, i.e., agreements which are not reasonably necessary to any separate, legitimate business collaboration between the employers.

Franchise Agreements in the Antitrust Crosshairs

Given that no-poach clauses are apparently very common in franchise agreements, they have become the newest target. In January 2018, the Washington Attorney General began a wide-ranging investigation of the use of such clauses by fast food franchises operating in the state. The AG’s position, similar to that expressed by DoJ, was that such agreements were just a form of price fixing and thus a per se violation of the Sherman Antitrust Act.

But franchise systems are different than firms that are just each other’s competitors. In the 1970s, antitrust law often treated the horizontal aspects of franchise agreements with great scrutiny, and some cases held certain franchise provisions to be per se illegal if they impacted competition among franchisees. However, after the Supreme Court recognized that most vertical relationships had efficiency-enhancing aspects and should be judged under the more lenient rule-of-reason approach, the modern view has been to assess intra-franchisee restrictions for their actual economic effects.

The Washington AG takes the outdated approach. Nonetheless, the AG investigation has resulted in over 30 fast food chains agreeing to discontinue the use and enforcement of the provisions, and a government enforcement action was filed against Jersey Mike’s, which refused to settle. Similar investigations subsequently have been opened in 10 other states as part of the state attorneys’ general joint investigation.

Fries with that Class Action?

As was the case after the DoJ’s action against the tech companies, follow-on civil litigation has ensued across the country with class actions filed against several nationwide fast food chains. Currently there are at least 10 distinct sets of cases targeting the franchisors of McDonald’s, Burger King, Domino’s, Little Caesar’s, Dunkin Donuts, Auntie Anne’s, Carl’s Jr., Cinnabon, Jimmy John’s, and IHOP. Several of the cases also name individual franchisees.

The follow-on class actions seek monetary damages on behalf of all the chains’ employees and injunctive relief. The complaints follow a similar template, arguing that the franchisor-franchisee no-hire agreements are per se violations that restrain competition for labor and depress wages. The lawsuits lay out the franchise model for the particular defendants and then cite statistics and policy papers relating to fast food workers’ low wages and the potential impact of no-hire agreements on employee mobility and wages. The plaintiffs allege that because of a no-poach/no-hire agreement, the named plaintiff was denied the opportunity to transfer or obtain employment at a different franchisee that offered superior pay or benefits, and the putative class members experienced similarly depressed wages and benefits because of the direct and/or cumulative effect of such agreements.

Although many of these lawsuits were filed only recently, franchisors have begun to respond. For example, McDonald’s, in a motion to dismiss, argued that their provisions are legitimate vertical restraints between franchisor and franchisee and not simple price fixing. While the district court did not dismiss the case, it did find that the agreements were ancillary to the overall franchise agreements, which had a procompetitive effect of allowing for “increased output of burgers and fries.” Therefore, the court found that the agreement was not per se illegal, but could be considered under the quick-look analysis. Defendants in other cases have begun to raise similar arguments, which have yet to be ruled upon. Plaintiffs also appear to have drafted their more recent lawsuits to pre-emptively rebut these arguments by including additional allegations relating to the quick-look analysis and the allegedly anti-competitive effects.

Who is at Risk?

So far, the litigation has been limited to fast food chains. That is likely to change in the near future. The Washington AG has expanded its investigation into other industries that rely on the franchise model, including hotels, gyms, retailers, automobile repair shops, and other service providers. Additionally, Senators Cory Booker and Elizabeth Warren have opened an investigation into the practice and sent letters to almost 100 businesses, across a variety of industries, urging them to end the use of no-poach/no-hire agreements and requesting information as to each company’s practices on the matter.

As a result, it will be easier to target companies for class actions as research has been published that identifies companies that do and do not include no-hire/no-poach provisions in their franchise agreements.

What Should You Do If You Might Be Next?

The threat of potential litigation highlights the importance of evaluating the risk of including no-poach/no-hire provisions in any agreement. It more broadly shows the need to have adequate antitrust compliance in place, including conducting antitrust diligence when adopting any contractual provision that arguably affects competition. For firms with such provisions in place, they should consult antitrust counsel and be prepared should a governmental investigation begin or civil lawsuit be filed.

FOR MORE INFORMATION

For more information, please contact:

Daniel Ferrel McInnis
Partner, Antitrust, Competition & Trade Regulation Practice Group
202.263.4110
Dan.McInnis@ThompsonHine.com

Jennifer L. Maffett-Nickelman
Franchise Practice Leader
937.443.6804
Jennifer.Maffett-Nickelman@ThompsonHine.com

Joe Smith
202.263.4145
Joe.Smith@ThompsonHine.com

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