The Franchise No-Poach Liability Continuum

No-poach provisions within franchise agreements prohibit franchisees from soliciting or employing the franchisor’s or other franchisees’ employees. Civil litigation regarding these provisions has exploded. The Office of the Attorney General for Washington State alone has actively investigated between 400 and 500 franchise systems since January 1, 2018 and has negotiated 225 agreements with over 100 franchisors to cease including no-poach provisions in their franchise agreements. Washington State and other plaintiffs argue that these agreements violate Section 1 of the Sherman Act and are so plainly anticompetitive that they should be assessed using a per se standard. However, a judge for the United States District Court for the Southern District of Florida (“the Court”) recently ruled that Burger King Corporation (“BKC”) is legally incapable of conspiring with its franchisees and dismissed a no-poach case against it. Plaintiffs’ per se arguments and the Court opinion regarding BKC highlight legal and economic issues arising in no-poach cases, as well as other Section 1 cases.

Washington Assistant Attorney General Rahul Rao discussed in an April 2020 ABA Antitrust Section podcast why he believes that the per se standard is the appropriate mode of analysis for franchise no-poach cases. Mr. Rao reasons that franchisees are horizontal competitors in labor markets. Thus, agreements not to solicit or employ workers are agreements that allocate workers to their current employers. Further, workers within a franchise system develop franchise-specific skills for which other employers within the franchise system besides their current employer would pay a premium. Mr. Rao thus concludes that franchise no-poach provisions are price-fixing agreements that suppress wages.

Mr. Rao also considers arguments against using a per se standard, including that a franchisor and its franchisees cooperate to produce a single, branded product and that no-poach provisions fall under the ancillary restraints doctrine. Mr. Rao argues that a franchisor and franchisee are still distinct legal entities operating independently with respect to employment decisions, notwithstanding that they produce the same branded product in output markets. Mr. Rao also argues that no-poach provisions are not ancillary restraints, because they do not promise procompetitive benefits in the relevant product markets that are affected (i.e., labor markets) and are unnecessary to achieve the broader goals of the franchise agreements. Finally, Mr. Rao makes three arguments why apparently vertical agreements between franchisors and individual franchisees concern horizontal competition. First, some franchisors own and operate establishments at the same level of commerce as franchisees. Second, franchisors that do not compete with their franchisees in output markets may still compete with them for labor. Third, a franchisor may facilitate a horizontal hub and spoke conspiracy among its franchisees.

In contrast to these arguments for a per se standard, the Court dismissed a no-poaching suit against BKC, rejecting that BKC could conspire with its franchisees. The Court focused on two key issues — the degree of control over franchise operations that the agreement vested with BKC and whether the franchises would exist absent the challenged agreement.

The Court explicitly acknowledged many of the facts and circumstances that plaintiffs have relied upon in arguing for a per se standard. BKC franchisees are independently owned and operated. Franchisees autonomously hire, fire, discipline, and promote their employees. BKC’s franchise agreement warns that the franchisee may face competition from BKC or other franchisees. Nevertheless, the Court determined that these facts were not dispositive.

The Court relied upon Supreme Court precedent for guidance in determining when legally distinct entities may be a single entity for Section 1 purposes. The Court interpreted American Needle, Inc. v. Nat’l Football League (2010) to require a “totality of the circumstances approach” to determine whether the agreement deprives the market of independent decision making. The Court found that BKC’s relationship with its franchisees is similar to the relationship that Citizens and Southern Bank Corp. had with its independently-owned, associated banks, a de facto parent subsidiary relationship as discussed in United States v. Citizens & Southern Nat. Bank (1975). Specifically, the Court found that there would be no franchises but for the challenged agreement, quoting Citizens & Southern, “because the sponsored banks were not set up to be competitors, Section 1 did not compel them to compete” and “[e]xcept for that sponsorship, they would very probably not exist.” Given the extensive operational control that BKC has over franchisees under the terms of the franchise agreement, the Court found that the “residual economic autonomy with respect to employment decisions is insufficient to convert [the franchise] into a separate economic actor.”

The Court also pointed to the paradox of treating BKC-owned restaurants differently than franchises despite their functional equivalence to BKC for interbrand competition and geographic expansion. Subjecting the relationship between BKC and its franchisees to Section 1 liability would raise BKC’s costs of expansion by franchising. This may cause BKC to forego franchising in certain circumstances in which franchising is otherwise the more efficient expansion mode, thereby hampering interbrand competition. In marginal geographical marketing areas, the effect may be to deter expansion altogether–diminishing competition in both output and labor markets.

To date, the focus in the wave of no-poach class action cases has been to achieve or survive dismissal. As franchise no-poach cases move forward, the next battleground will be class certification, especially commonality and predominance of common issues. In that regard, the same franchise agreement will govern all franchisees within a system, thus presenting some common questions of legality for all employee-class members. On the other hand, wages often are set in local labor markets in which pay for many of the jobs at issue may be determined by minimum wage statutes or by competition external to the franchise system. Additionally, no-poach provisions limit competition among employees within a system. Some class members may have lost their jobs or never been hired but for these provisions. Thus, even if a particular franchisor’s franchise agreement is found to violate Section 1, it does not mean that all workers within the franchise system were harmed by it.

EI President Jonathan L. Walker has consulted and testified regarding single-entity status, antitrust merits, and class certification respectively.