BILL ANALYSIS Ó
AB 525
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Date of Hearing: April 21, 2015
ASSEMBLY COMMITTEE ON JUDICIARY
Mark Stone, Chair
AB 525
(Holden and Atkins) - As Amended April 6, 2015
SUBJECT: FRANCHISE RELATIONS: RENEWAL AND TERMINATION
KEY ISSUE: SHOULD CALIFORNIA FRANCHISE LAW BE REVISED TO
STRENGTHEN KEY PROTECTIONS FOR SMALL BUSINESS FRANCHISEES,
INCLUDING, AMONG OTHER THINGS, PROHIBITING TERMINATION AND
NONRENEWAL OF FRANCHISEES WHO ARE IN SUBSTANTIAL COMPLIANCE WITH
THEir FRANCHISE AGREEMENTs?
SYNOPSIS
Proponents of this bill, including associations of franchisee
business owners and organized labor groups, contend that greater
measures are needed to protect the investment and wellbeing of
franchisees against unfair practices by franchisors-practices
made easier by the inherently one-sided nature of the franchise
relationship and the typically unequal bargaining power between
franchisors and franchisees. To establish such protections,
this bill, sponsored by the Coalition of Franchisee
Associations, proposes a number of changes to state franchise
law, including, among other things: (1) allowing franchisors to
terminate or fail to renew a franchisee for good cause only
where the franchisee has failed to substantially comply with
terms of the franchise agreement; (2) extending the period of
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notice and opportunity to cure a breach from 30 days to 60 days;
(3) protecting franchisees' ability to pass their businesses on
to their family and heirs; and (4) ensuring that franchisees can
monetize the equity they may have invested in the business prior
to termination of the agreement, as specified.
The bill is opposed by the International Franchise Association,
representing franchisors, who contend generally that parties
have the right to freely contract as they wish, and that this
bill will hurt business in California by interfering in
contracting between consenting parties, and increasing
litigation over ambiguities created by the bill. Opponents also
contend that the substantial compliance and extended opportunity
to cure provisions are burdensome and make it difficult for
existing franchisors to conduct business in this state,
rendering it an unattractive place to open new franchises.
Proponents counter that economic data from states that employ
the substantial compliance standard and/or a 60-day notice
before termination do not support this contention. Should the
bill be approved by this Committee, it will be referred to the
Assembly Business and Professions Committee.
SUMMARY: Revises the rights and responsibilities of franchisors
and franchisees with respect to the rules under the California
Franchise Relations Act (CFRA) governing the renewal and
termination of franchise agreements. Specifically, this bill:
1)Revises the definition of "good cause," for the purpose of
authorizing termination of a franchise agreement prior to the
end of its term, to mean the failure of the franchisee to
substantially comply with any lawful requirement of the
franchise agreement after being given notice and a reasonable
opportunity to cure the failure.
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2)Further specifies that the above notice shall be given at
least 60 days in advance, and that a reasonable opportunity to
cure the failure shall in no event be less than 60 days
(rather than 30 days provided under existing law.)
3)Clarifies that the franchisee's failure to comply with any
federal, state or local laws or regulations including, but not
limited to all health, safety, building and labor laws or
regulations applicable to operation of the franchise shall
constitute grounds for immediate termination of the franchise
agreement by the franchisor.
4)Provides that a franchisee shall have the opportunity to
monetize any equity the franchisee may have developed in the
franchised business prior to the termination of the franchise
agreement, but not transferring any equity in the franchisor's
intellectual property to the franchisee.
5)Prohibits a franchisor from failing to renew a franchise
unless the franchisee has failed to substantially comply with
the franchise agreement. Further provides that if the
franchisee is in substantial compliance with the franchise
agreement at the time of the expiration of the franchise
agreement, the franchisee may renew for the same duration as
provided in the expiring franchise agreement and the renewal
shall be under the franchise agreement terms that are being
offered to new franchises.
6)Requires the franchisor to provide written notice to the
franchisee of its intention not to renew at least 180 days
prior to the termination of the existing franchise agreement
if the franchisor has legitimate grounds not to renew the
franchise.
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7)Makes it unlawful for a franchise agreement to prevent a
franchisee from selling or transferring a franchise or a part
of an interest of a franchise to another person, provided that
the person is qualified under the franchisor's then-existing
and reasonable standards for approval of new franchisees,
except that a franchisee shall not have the right to sell,
transfer, or assign the franchise, or any right thereunder,
without the written consent of the franchisor but not to be
unreasonably withheld.
8)Establishes a process and timeline for the franchisee to
notify the franchisor of a decision to sell or transfer the
franchise, and for the franchisor to subsequently notify the
franchisee of his or her approval or disapproval of the sale
or transfer, as specified.
9)Provides that in the event a franchisor terminates or fails to
allow the renewal, sale, assignment, or transfer of a
franchise other than in accordance with the CFRA, the
franchisor must reinstate the franchisee under the same terms
as the existing franchise agreement and pay all damages caused
thereby, or at the election of the franchisee, pay the
franchisee the fair market value of the franchise and
franchise assets.
10)Authorizes a court to grant preliminary and permanent
injunctions for a violation of the CFRA.
EXISTING LAW, under the California Franchise Relations Act:
1)Defines a franchise as a contract between two or more persons
by which: (1) a franchisee is granted the right to offer, sell
or distribute goods or services under the plan or system of
the franchisor; (2) operation of the business is substantially
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associated with franchisor's trademark, advertising or other
symbol; and (3) a franchise fee is paid by the franchisee.
(Business & Professions Code Section 20001. All further
references are to this code unless otherwise stated.)
2)Prohibits termination of a franchise agreement prior to the
end of the term, except for good cause, where good cause
includes failure to comply with any lawful requirement of the
franchise agreement after written notice and a reasonable
opportunity to cure the failure, which need not be more than
30 days. (Section 20020.)
3)Specifies a number of circumstances that justify immediate
notice of termination of a franchise agreement without an
opportunity to cure, including, among other things: (1)
bankruptcy of the franchisee; (2) abandonment of the
franchise; (3) mutual written agreement to terminate the
franchise; (4) the franchisee is convicted of a felony or
other crime relevant to operation of the franchise; (5)
operation of the franchise poses an imminent danger to public
health or safety; and (6) the franchisee fails, for 10 days
after notification of noncompliance to comply with any
federal, state or local laws or regulations applicable to
operation of the franchise. (Section 20021.)
4)Requires a franchisor to notify the franchisee of the
intention not to renew a contract at least 180 days prior to
the expiration of the franchise, during which time the
franchisee may attempt to find a buyer acceptable to the
franchisor. (Section 20025.)
5)Prohibits a franchisor from denying the surviving spouse,
heirs, or estate of a deceased franchisee or the majority
shareholder of the franchisee the opportunity to participate
in the ownership of the franchise under a valid franchise
agreement for a reasonable time after the death of the
franchisee or majority shareholder of the franchisee. Further
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provides that during that time, the surviving spouse, or heirs
of the deceased shall either satisfy all of the then current
qualifications for a purchaser of a franchise, or sell,
transfer, or assign the franchise to a person who satisfies
the franchisor's then current standards for new franchisees.
(Section 20027.)
6)Requires a franchisor that terminates or fails to renew a
franchise without complying with the CFRA to offer to
repurchase the franchisee's resalable current inventory at the
lower of the fair wholesale market value or the price paid by
the franchisee. (Section 20035.)
FISCAL EFFECT: As currently in print this bill is keyed
non-fiscal.
COMMENTS: This bill, sponsored by the Coalition of Franchisee
Associations, proposes a number of changes to California
franchise law that, according to the author, seek to protect the
investment and wellbeing of franchisees against unfair practices
by franchisors. The bill revises rights and responsibilities of
franchisors and franchisees under the California Franchise
Relations Act (CFRA), primarily with respect to the renewal and
termination of franchise agreements. The author explains the
need for the bill as follows:
The California Franchise Relations Act provides
franchisees with fewer rights than nearly every other
form of contract law in California, especially as they
pertain to termination, breach and damages. Franchise
agreements are frequently one-sided contracts that
strongly favor the franchisor over the small business
owners who operate franchises. AB 525 restores
fairness to franchise agreements by applying
traditional contract law standards, giving franchisees
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the right to transfer the business, ensuring
franchisees can recover their equity when a franchise
relationship end, all while protecting the
franchisor's rights to terminate the worst actors,
including those who break laws, cannot make required
payments or operate in direct defiance of the contract
terms.
Disparity in bargaining power between franchisors and
franchisees. Proponents of the bill assert that the franchise
business relationship is inherently one-sided in favor of
franchisors, often to the great detriment of small business
franchisees. This view has been supported by, among others, the
California Court of Appeal (2nd Dist.), who described the
dynamic as follows:
The relationship between franchisor and franchisee is
characterized by a prevailing, although not universal,
inequality of economic resources between the
contracting parties. Franchisees typically, but not
always, are small businessmen or businesswomen or
people seeking to make the transition from being wage
earners and for whom the franchise is their very first
business. Franchisors typically, but not always, are
large corporations. The agreements themselves tend to
reflect this gross bargaining disparity. Usually they
are form contracts the franchisor prepared and offered
to franchisees on a take-it-or-leave-it basis.
(Emerson, Franchising and the Collective Rights of
Franchisees (1990) 43 V and. L. Rev. 1503, 1509 & fn.
21.) . . . Some courts and commentators have stressed
the bargaining disparity between franchisors and
franchisees is so great that franchise agreements
exhibit many of the attributes of an adhesion contract
and some of the terms of those contracts may be
unconscionable. (Postal Instant Press v. Sealy, 43
Cal. App. 4th 1704, 1715-1717 (1996).)
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This bill is opposed by the International Franchise Association
(IFA), who contends that the bill creates ambiguity in the
enforcement of franchise contracts and will promote litigation
between franchisees and franchisors, which will result in
sub-standard services and products being delivered to California
consumers. IFA argues that franchisors and franchisees have the
right to freely contract as they wish, and that this bill will
hurt business in California by interfering in contracts between
consenting parties that are needed to freely develop new
franchise businesses. Proponents of the bill, including
franchisee associations and organized labor, counter that the
bill is simply intended to prohibit tactics used by bad actor
franchisors, while upholding the current relationship between
franchisors and franchisees.
Substantial compliance standard applied to termination and
renewal. Business and Professions Code Section 20020 currently
allows premature termination of a franchise agreement for good
cause, which includes failure to comply with any lawful
requirement of the franchise agreement after written notice and
a reasonable opportunity to cure the breach of at least 30 days.
Section 20025 allows the franchisor to fail to renew a
franchise agreement simply by providing the franchisee with 180
days written notice of its intent not to renew the agreement.
According to the author, these standards unfortunately allow
some franchisors to unfairly take advantage of franchisees by
using the contract to punish franchisees by taking their
business away and to avoid their legal obligations to give
franchisees another chance.
Accordingly, this bill would allow termination of franchise
agreement for good cause only upon the failure of the franchisee
to substantially comply with any lawful requirement of the
franchise agreement, and give the franchisee advance notice and
an opportunity of at least 60 days to cure the breach. In
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addition, the bill would also prohibit a franchisor from failing
to renew a franchise unless the franchisee has failed to
substantially comply with the franchise agreement. According to
the author, this provision ensures fairness to franchisees by
barring the termination or nonrenewal of any franchisee that is
in substantial compliance with the franchise agreement, instead
of allowing termination much more broadly for failure to comply,
in the case of terminations, "with any lawful requirement of the
franchise agreement."
In opposition to the bill, IFA contends that the failure to
define "substantial compliance" in the bill will lead to
uncertainty and litigation. They note, for example, that this
provision would allow a franchisee to be renewed who only
becomes substantially compliant in the last year of their
contract, even though there may not have been substantial
compliance throughout the entire franchise term.
Proponents of the bill counter, rather convincingly, that the
"substantial compliance" standard reduces, rather than
increases, ambiguity because the term is well-defined,
historically accepted, and is a central tenet of contract law
used by many other states to regulate franchise agreements and
contracts, generally. They note that California courts have
been interpreting substantial performance of contracts dating
back to at least the early 1900s (see, e.g., Thomas Haverty Co.
v. Jones, 185 Cal. 285 (1921), holding that substantial
performance was achieved when the non-breaching party still "is
enjoying the fruits of the . . . work in performance of the
contract.") Proponents also note that current California jury
instructions provide for a simple two-part test to determine the
existence of substantial performance. First, the breaching
party must show they "made a good faith effort to comply with
the contract," and second, "[the non-breaching party] received
essentially what the contract called for because?failures, if
any, were so trivial that they could have been easily fixed or
paid for." (CACI No. 312.)
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60-day opportunity to cure breach. Supporters also report that
franchisees are often given as little as five days to cure
noncompliance-an unreasonable amount of time depending on the
nature of the cure needed-and therefore providing 60 days to
cure is a reasonable solution common to many other commercial
transactions. Opponents contend that this change is
anti-consumer because it will allow sub-standard franchise
outlets to offer inferior products and services to consumers
that are not up to par with high standards necessary to protect
the brand's reputation. They also contend generally that the
substantial compliance and extended opportunity to cure
provisions are burdensome and make it difficult for existing
franchisors to conduct business in California, rendering it an
unattractive place to open new franchises.
Proponents counter that economic data derived from states that
employ the substantial compliance standard, a 60-day notice
before termination, or both, do not support this last
contention. Instead, they report that between 2003 and 2013,
the eleven states that have one or both of these provisions had
an average franchised unit growth rate of 23.2 percent, as
compared to the 18.9 percent growth rate for the other 39 states
and the District of Columbia that have neither provision in law.
Of those eleven states, five (Arkansas, Nebraska, New Jersey,
Rhode Island and Wisconsin) employ both the "substantial
compliance" standard and require at least 60 days' notice before
termination. The same data show that the franchise growth rate
for those five states is essentially identical to the growth
rate as compared to the other 45 states and the District of
Columbia (19.4 percent vs. 19.8 percent, respectively.) In
short, proponents contend that "substantial compliance"
standards have resulted in greater certainty and investment
protection, not less, for franchisees in those states that
employ such standards.
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Terms of renewal. As previously mentioned, this bill seeks to
prohibit the franchisor from failing to renew a franchise unless
the franchisee has failed to substantially comply with the
franchise agreement. If the franchisee is in substantial
compliance with the franchise agreement at the time of the
expiration of the franchise agreement, the bill permits the
franchisee to renew for the same duration as provided in the
expiring franchise agreement, and requires the renewal to be
under the same terms that are being offered to new franchisees.
This is needed, supporters contend, because at the time of
renewal, the franchisor often uses its superior bargaining power
to obtain new terms that may not be as favorable to the
franchisee as the terms that persuaded him or her to enter the
initial contract. Having invested so much in the new franchise,
they contend, the franchisee is placed in an unfair and
unworkable position. On the other hand, opponents contend that
the bill appears to mandate renewal even if the franchise
agreement does not grant a renewal right, and even though the
parties understood at the inception of their relationship that
there would be no contractual renewal right. Opponents assert
that the bill fails to account for franchisors that may no
longer wish to have franchises in the area currently being
served, and that the bill unnecessarily changes a
well-established law that has operated for over forty years,
with the possible consequence of disrupting thousands of
contracts already in place.
Restrictions on transfer of franchise. Existing law limits the
transfer of franchises to family members of a deceased
franchisee as long as those family members meet criteria for
owning a franchise as determined by the franchisor. Similarly,
current law also provides the deceased franchisee's family the
opportunity to sell or transfer the franchise to a third party
that meets the franchisor's criteria for owning a franchise, as
specified. According to the author, this bill seeks to
establish a streamlined process and timeline for the sale or
transfer of a franchise without decreasing the advance notice
period of 180 days that franchisees must provide to the
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franchisor. The bill requires the franchisor to approve the
sale or transfer request without unreasonably withholding
consent.
Opponents contend again that the bill is too ambiguous because,
for example, while the bill states that the transfer of a
franchise must be to a person "qualified under the contract," it
also requires that approval must be based upon a "reasonable
standard," without defining this term. Because the bill also
requires the trier of fact to make this determination, opponents
contend the transfer provisions will lead to uncertainty and
increased litigation costs for both the franchisor and
franchisee while increasing the burden upon our courts.
Proponents contend that the bill does not increase uncertainty,
but in fact reinforces provisions already contained in franchise
agreements by requiring new franchisees to meet the franchisor's
then existing and reasonable standards for approval.
Monetization of franchise equity. Unlike other types of
contract law in California, the CFRA only entitles franchisees
to recover the cost of any existing inventory remaining upon
dissolution of the franchise. Current law that allows the
franchisor to essentially take all equity, personal capital, and
goodwill a franchisee has developed upon franchise dissolution
is particularly unfair to small business franchisees, contends
the author, given that franchisees invest a large amount of
their own money in the business and continue to pay for upgrades
and changes in response to the market. Even if the franchisor
breaches the franchise contract, the franchisee is limited by
the original franchisee agreement in what contract damages they
can claim.
According to the author, this bill seeks to adopt the IFA's own
"Statement of Guiding Principles" by codifying a franchisee's
right to "monetize any equity" they have developed in their
business while offering strong protections to the franchisor's
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intellectual property. Proponents contend this provision is
needed to ensure that franchisees receive the full equity they
put into a business in cases of termination. In addition, in
the event that the franchisor breaches the franchise agreement
or violates state law, this bill would provide franchisees the
opportunity to seek all contract damages provided for every
other contract relationship by common law but not to franchisees
under current franchise law. Opponents contend that it is
uncertain as to how such "monetized equity" would be assessed
and be determined by the franchisee or evaluated by the
franchisor. They contend this language is unprecedented in any
franchise statute and again will likely lead to litigation in
California.
Violation of local health and safety laws; grounds for immediate
termination. Existing law provides for a number of
circumstances that justify immediate notice of termination of a
franchise agreement without an opportunity to cure. These
circumstances are considered so serious that they threaten to
damage the brand reputation of the franchise and are thus
grounds for immediate termination-for example, when a franchisee
is convicted of a felony, goes bankrupt, or the franchise
operation poses an imminent danger to public health. One set of
circumstances listed in Section 20021 calls for immediate
termination when "the franchisee fails, for a period of 10 days
after notification of noncompliance, to comply with any federal,
state or local law or regulation applicable to the operation of
the franchise." (Section 20021(e).) Supporters of the bill
contend that, like the provision that allows early termination
"for any lawful requirement of the franchise agreement," this
particular set of circumstances justifying immediate termination
should be clarified to avoid an unnecessarily broad
interpretation. Accordingly, the bill clarifies that violations
of state and local "health, safety, building and labor" laws and
regulations are grounds for immediate termination, but not
violations not falling outside of those important categories of
laws.
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Previous related legislation. SB 610 (Jackson) of 2013 would
have explicitly required franchisors and franchisees to
negotiate in good faith, and would have permitted termination of
a franchisee only in instances of a "substantial and material"
breach of the franchise agreement. SB 610 was vetoed by
Governor Brown, who characterized the "substantial and material
breach" standard as unknown and untested. To remedy the
Governor's concerns on this point, this bill instead applies the
"substantial compliance" standard, rooted in well-established
case law dealing with "substantial performance" of contracts.
Additionally, as the author notes, substantial compliance is the
standard used in franchise law in five other states, with the
first such state adopting this standard back in the early
1970's.
AB 2305 (Huffman) of 2012 would have enacted several reforms to
the CFRA, as well as the California Franchise Investment Law,
among them requiring "substantial and material" breach to
terminate early; prohibiting provisions restricting venue for
resolution of disputes solely to a forum outside of this state;
and requiring good faith in the performance and enforcement of
franchise agreements. AB 2305 failed in Assembly Business and
Professions Committee after passing this Committee.
ARGUMENTS IN SUPPORT: The bill is supported by associations of
franchisee business owners and organized labor. In addition to
many of the arguments discussed above, these organizations
support the bill because of its potential benefits to the
working-class employees of mostly small-business franchisees.
For example, SEIU writes in support:
This bill will impact over 83,000 franchised
establishments that employ more than 925,700 workers
in California. Fast food restaurants are the biggest
employers in the franchise sector, and fast food
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workers and franchisees share a common problem-the
unchecked power of big corporations. AB 52 protects
franchisees against franchisor abuse, giving
franchisees the opportunity to grow profitable
businesses, achieve financial security and pass some
of their gains to their workers in the form of higher
wages and benefits.
ARGUMENTS IN OPPOSITION: This bill is opposed by the
International Franchise Association (IFA), representing
franchisors. In addition to the arguments discussed previously,
IFA also contends that existing California law and the Federal
Trade Commission (FTC) already require extensive disclosure
documents to ensure that both parties know what is expected from
the other before they enter into a franchise agreement. Among
other reasons for their opposition, IFA writes:
Franchisors impose standards and expectations on all
franchisees to protect the brand's reputation for
other franchise owners nearby, and, ultimately, the
general public - their collective customer. This bill
would result in allowing sub-standard franchise
outlets to continue offering inferior products and
services to consumers.
[In addition] during a period of stagnant growth
globally, franchisors, like many other businesses, are
being extremely judicious with their investment
capital, yet according to IHS Global Insight and ADP,
franchise businesses have been expanding at a greater
rate than non-franchised for the five years since the
Recession. Passing burdensome legislation as AB 525
would undoubtedly force franchisors to look to other
states to expand their brands - taking jobs and new
businesses with them.
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REGISTERED SUPPORT / OPPOSITION:
Support
Coalition of Franchisee Associations (sponsor)
ARCO Travel Zone Center
California Labor Federation
Coalition of Franchisee Associations (CFA)
Independent Organization of Little Caesar Franchisees (IOLCF)
Lagarias Law Offices
Pacific Management Consulting Group
Plumbing-Heating-Cooling Contractors Association of California
(CAPHCC)
Service Employees International Union (SEIU)
Small Business Majority
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Small Business California
Numerous individuals
Opposition
International Franchise Association (IFA)
Analysis Prepared by:Anthony Lew / JUD. / (916) 319-2334