Executive Summary:  The recent criminal prosecution of several 7-Eleven franchisees, which arose out of a criminal alien employment investigation, as well as efforts by government agencies to treat franchisors and franchisees as joint employers for the purposes of liability under federal labor and wage and hour laws, highlights the need for franchisors to take proactive steps to ensure they and their franchisees are in compliance with applicable labor, immigration and employment laws.

7-Eleven Franchisees Indicted as Part of Ongoing Investigation

On June 17, 2013, the U.S. Attorney for the Eastern District of New York issued a press release trumpeting the arrest and indictment of nine individuals and the lock-down of seven 7-Eleven franchise stores in connection with an alleged multi-state conspiracy to conceal systemic employment of illegal immigrants, exploit immigrant employees, and steal identities. The defendants owned ten 7-Eleven franchise stores located in Long Island, New York and coastal Virginia. U.S. v. Farrukh Baig et al., Case # 2:13-cr-00351 (E.D.N.Y.)

According to the indictment, the defendants signed multiple original and renewal franchise agreements authorizing 7-Eleven, Inc. (SEI) to terminate franchise rights and take over store operations if the franchisees failed to comply with all applicable laws and regulations, including employment and immigration laws. Despite SEI’s lengthy franchise relationship with the defendants, the indictment notes that SEI failed to uncover defendants’ illegal conduct and take legal action to terminate their franchises.

The U.S. Attorney’s June 2013 press release noted that the government’s criminal investigation of 7-Eleven franchisees is ongoing and that federal agents are in the process of executing search and seizure warrants to inspect approximately 30 other franchise stores nationwide. The results of the broadened investigation have yet to be disclosed.

7-Eleven Inc. Sued by Franchise Operators for Wage and Hour Violations

In a related development, in October 2013, SEI was sued by four Indian franchise operators in New Jersey for alleged violations of state and federal minimum wage and overtime laws. Plaintiffs claim that SEI improperly classified them as independent contractors based on the degree of control SEI exercised over store operations, including regulation of vendors and product supply; franchisee payroll processing; control over franchisee bookkeeping and accounting; and alleged “intense” daily oversight by SEI market and zone managers. On August 5, 2014, U.S. District Court Judge Rene Bumb denied SEI’s motion to dismiss the plaintiffs’ wage claims, ruling that the allegations contained in the complaint, if proved, would entitle plaintiffs to relief under the Fair Labor Standards Act and the New Jersey Wage and Hour Law based on their status as “employees.” Naik v. 7-Eleven, Inc., 2014 WL 3844792 (D.N.J. Aug. 5, 2014).

7-Eleven Franchise Operators Plead Guilty to Federal Criminal Charges

The latest development in the criminal case occurred on September 22, 2014, when five of the 7-Eleven operators charged in the June 2013 indictment agreed to plead guilty to the criminal harboring and wire fraud counts and to forfeit their homes and franchise ownership rights to the government. They also face additional criminal fines and up to 20 years imprisonment at sentencing, scheduled for February 18, 2015.

The details of the plea agreement have not been disclosed, including whether the defendants have agreed to cooperate with prosecutors in their ongoing investigation. SEI sued the individual franchisees in October 2013 seeking to terminate their franchise agreements and take over store operations. On April 30, 2014, defendants Farrukh and Bushra Baig denied liability to SEI and asserted that SEI’s claims for relief were barred by fraud, discriminatory business practices, culpability, unclean hands, unjust enrichment, self-dealing, violation of the covenant of good faith and fair dealing, waiver, equitable estoppel, and unfair and deceptive trade practices, among other affirmative defenses. Now that ownership of defendants’ franchise and property rights has passed to the government, it appears SEI has a far different fight on its hands to recover ownership and control.

The Implications for Other Franchisors

The SEI experience should serve as a wake up call to U.S. chain store operators and other franchisors to consider whether they need to do more to audit and enforce the employment and immigration compliance provisions of their franchise agreements. Indeed, any corporate franchisor exercising similar degrees of control over franchise operations needs to consider the potential for its own criminal liability under the anti-harboring statute, 8 U.S.C. § 1324. Section 1324(a)(1) makes it a crime to conceal, harbor or shield an alien from detection in any place, including any building or any means of transportation, knowing, or in reckless disregard of the fact, that the alien entered or remains in the United States in violation of law, or to engage in any conspiracy to do so, or to aid and abet such violations.

Forms I-9 and payroll records are among the categories of documents and things typically listed in criminal search and seizure warrants in harboring cases. An employer’s failure to prepare and retain I-9s in accordance with the law and regulations is cited by prosecutors as circumstantial evidence of reckless disregard of the employment of undocumented workers. Likewise, evidence of complicity in document fraud has been held to constitute “concealment” under the harboring statute.

Undocumented alien workers at the location named in the warrant constitute “contraband” and typically are arrested, detained, and interrogated by government agents regarding the employer’s knowledge of their immigration status as well as the employer’s compliance with wage and hour and health and safety laws. Wage theft, passport seizure, and threats of deportation for reporting the employer serve as aggravating factors under the harboring statute and may also be used to build a case for the separate crime of human trafficking. Employee victims can qualify for work permits by cooperating in the investigation and successful prosecution of offending employers.

Where the line between independent contractors and employees is blurred vis-à-vis a franchisor and its franchisees, as alleged by the operators in the Naik complaint, a franchisor may find itself exposed to liability for the franchisee operator’s failure to comply with the I-9 requirements or otherwise to ensure that the documents used in the employment verification process were not obtained fraudulently with the assistance of the operator. Likewise, the franchisor may find itself named as a defendant in lawsuits filed by employees of the franchisee for wage and hour and other labor protective statute violations.

The Bottom Line:

To limit their exposure to civil and criminal liability for franchisee and subcontractor violations, many franchisors and government contractors have implemented labor and immigration compliance policies that require franchisees and subcontractors to engage independent auditors, at the franchisee/subcontractor’s expense, to review their I-9, payroll, and personnel records and practices, and to certify annually that they are in compliance with all wage and immigration recordkeeping requirements. Alternatively, or in addition to requiring independent compliance audits and certification, some franchisors and prime contractors have created their own wage and immigration compliance teams or have hired outside counsel to conduct wage and immigration compliance audits. If violations are found, franchisees and subcontractors are required to take prompt corrective action or face termination.

For franchisors and government contractors that are publicly held, implementing similar controls and procedures is fast becoming a “best practice” – and highly recommended by regulators, risk managers, and insurers.