March 18, 2016

Ruling on Seattle Law Poses Big Threat to Small Businesses

Rebekah Prince and Kanysha Burton, Barnes & Thornburg LLP

Challengers of Seattle’s minimum wage ordinance were dealt a second blow in September 2015, when the U.S. Court of Appeals for the Ninth Circuit rejected their arguments that the law’s classification of franchisees violates the Dormant Commerce Clause, the Equal Protection Clause, the First Amendment, the Lanham Act, and the Washington State Constitution.

The International Franchise Association (IFA) and a handful of local Seattle franchisees sued the City of Seattle seeking to enjoin enforcement of the ordinance, but their motion was denied for failure to show a likelihood of success on the merits. Int’l Franchise Ass’n, Inc. v. City of Seattle, 2015 WL 1221490 at *5-23 (W.D. Wash Mar. 17, 2015). See also Paul D. Clement and H. Christopher Bartolomucci, IFA, Seattle Franchisees Seek to Enjoin Minimum Wage Law, The Franchise Lawyer, Winter 2015.

The group of plaintiffs fared no better on appeal to the Ninth Circuit, which upheld the district court’s findings against the IFA’s arguments on every issue. The appellate court’s opinion reflected the often negative perception of franchises and revealed a view of the franchise business model that is far different from the business reality for franchisees.

The law, which seeks to raise the minimum wage to $15 per hour, went into effect April 1, 2015. It distinguishes between small and large employers. Businesses that employ 500 or fewer employees, or “small employers,” are given seven years to implement the increase, while businesses that employ more than 500 employees, or “large employers,” must implement the increase in three years. The law classifies franchisees as “large employers”—even though they employ less than 500 employees—based on the notion that they can accommodate the increase in labor costs better than other similarly situated small businesses can.

The effects of such a classification are themselves costly, and the differences in the implementation schedules are staggering. “Large employers” must implement $2 increases every year to meet the $15 requirement by 2017, but small employers are given a much longer, more manageable timeframe, allowing for 50-cent increases every year until the $15 minimum is reached in 2021. Effectively, two small, local businesses, one a franchise and the other a non-franchise, must compete in the same market for business with strikingly different labor costs.

The ordinance seeks to justify the two implementation schedules by acknowledging that “smaller businesses and not-for-profits would face particular challenges in implementing a higher minimum wage,” (Seattle, Washington, Ord. Pr. 5; Sec. 1(9)). The Ninth Circuit concluded this statement implies that franchisees, unlike other small businesses, do not face such difficulties. But franchisees are small businesses that are formed and operate as separate entities from the franchisor, paying for rent, supplies, and payroll, in addition to fees and royalties to the franchisor; thus, the assumption of economic benefit comes solely from the franchisee’s association with the franchisor’s marks and use of the franchisor’s business model.

The IFA argued that this classification of franchisees as “large employers” is discriminatory and unconstitutional and sought to enjoin the law. The Ninth Circuit disagreed.

No Dormant Commerce Clause Violation

The IFA argued that the ordinance discriminated against out-of-state businesses because franchisees are associated with a national network of other franchisees through use of the franchisor’s trademarks. The appellate court concluded the law does not discriminate against out-of-state businesses on its face, but instead relies on neutral classifications—the number of employees of the business and the business model. Interestingly, rather than compare similarly situated franchisees to non-franchisees to prove this point, the court stated that a franchisee with a network of franchisees in Washington state was treated the same as a franchisee with a network of franchisees outside of Washington state. It is difficult to understand how...

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Rebekah Prince and Kanysha Burton, Barnes & Thornburg LLP