BILL ANALYSIS Ó
AB 525
Page 1
ASSEMBLY THIRD READING
AB
525 (Holden, et al.)
As Amended May 4, 2015
Majority vote
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|Committee |Votes |Ayes |Noes |
|----------------+------+---------------------+---------------------|
|Rules |11-0 |Gordon, Chang, | |
| | |Burke, Campos, | |
| | |Cooley, Dodd, Jones, | |
| | |Mayes, Rodriguez, | |
| | |Waldron, Wood | |
| | | | |
|----------------+------+---------------------+---------------------|
|Judiciary |7-2 |Mark Stone, Alejo, |Wagner, Maienschein |
| | |Chau, Chiu, Cristina | |
| | |Garcia, Holden, | |
| | |O'Donnell | |
| | | | |
|----------------+------+---------------------+---------------------|
|Business & |11-0 |Bonilla, Bloom, | |
|Professions | |Burke, Dodd, Eggman, | |
| | |Gatto, Holden, | |
| | |Mullin, Ting, Wilk, | |
| | |Wood | |
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SUMMARY: Revises the rights and responsibilities of franchisors
and franchisees under the California Franchise Relations Act
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(CFRA) with respect to the 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.
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 from the date
of the notice of noncompliance (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 or non-renewal of
the franchise agreement, but not transferring any equity in the
franchisor's intellectual property to the franchisee.
5)Defines "equity", for purposes of the above provision, to mean
the fair market value of the franchise and franchise assets, on
the date of the notice of termination or non-renewal, of all
investments in the franchise made by the franchisee, including
but not limited to improvements to or purchases of real
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property, equipment, inventory, advertising, and real estate, as
determined by a mutually agreed upon appraiser of business
value. Clarifies, however, that equity does not include any
initial franchise fees paid by the franchisee, and the right to
monetize equity does not apply to any franchisee terminated for
any reason for which immediate termination without opportunity
to cure is specifically allowed under Business and Professions
Code (BPC) Section 20021.
6)Provides that, notwithstanding the above definition of "equity",
should the franchisee sell, transfer, or assign any franchise
assets before a valuation is made, the sale price shall be
deemed the monetized value of the equity of that franchise
asset.
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 withheld unless
the buyer, transferee, or assignor does not meet the standards
for new franchisees.
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 any action in which the franchisor's
disapproval of a sale, assignment or transfer pursuant to this
subdivision is an issue, the reasonability of the franchisor's
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decision shall be a question of fact requiring consideration of
all existing circumstances. Clarifies that the finder of fact
may include an arbitrator as specified in the franchise
agreement and agreed upon by both the franchisor and franchisee.
10)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.
11)Authorizes a court to grant preliminary and permanent
injunctions for a violation of the CFRA.
FISCAL EFFECT: None
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. This bill revises rights and responsibilities of
franchisors and franchisees under the CFRA, primarily with respect
to the termination of franchise agreements.
Disparity in bargaining power between franchisors and franchisees.
Proponents of this 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 District), who described the dynamic as follows: "The
relationship between franchisor and franchisee is characterized by
a prevailing, although not universal, inequality of economic
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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.)
This bill is opposed by the International Franchise Association
(IFA), who contends that this 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 this bill, including franchisee
associations and organized labor, counter that this bill is simply
intended to prohibit tactics used by bad actor franchisors, while
upholding the current relationship between franchisors and
franchisees.
Substantial compliance standard for termination. BPC 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. BPC 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
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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. According to
the author, this provision ensures fairness to franchisees by
barring the termination 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." To address opposition concerns, the author has taken
amendments to remove provisions that would have applied the same
substantial compliance standard to failure of the franchisor to
renew a franchise agreement.
In response to IFA's argument that the failure to specifically
define "substantial compliance" in this bill will lead to
uncertainty and litigation, proponents counter that the
substantial compliance standard reduces, rather than increases,
ambiguity. They contend ambiguity is reduced 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. Proponents 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.") They 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
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any, were so trivial that they could have been easily fixed or
paid for." (California Civil Jury Instructions No. 312.)
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%, as compared to the 18.9%
growth rate for the other 39 states and the District of Columbia
that have neither provision in law. Of those 11 states, five
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% vs. 19.8%, 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.
Restrictions on transfer of franchise. Existing law limits the
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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 franchisor.
Opponents have contended that the transfer provisions are too
ambiguous and will lead to uncertainty and increased litigation
costs for both the franchisor and franchisee, while increasing the
burden upon our courts. To address these concerns, the author has
amended this bill to reinforce that the franchisor shall approve a
sale or transfer request without withholding consent unless the
transferee does not meet the franchisor's then-existing and
reasonable standards for approval of new franchisees. In
addition, this bill clarifies that disputes over the reasonability
of a franchisor's disapproval of a sale or transfer may be handled
by an arbitrator as agreed to by the parties pursuant to the
franchise agreement, thus lessening the burden upon the courts.
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.
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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
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 lead to increased litigation.
Recent amendments to this bill seek to address these concerns by
defining "equity" to mean the fair market value of the franchise
and franchise assets, on the date of the notice of termination or
non-renewal, of all investments in the franchise made by the
franchisee. These investments would include things such as
improvements to or purchases of real property, equipment,
inventory, and advertising, but would not include any initial
franchise fees paid by the franchisee. This bill also clarifies
that the right to monetize equity does not apply to a franchisee
terminated for any reason for which immediate termination without
opportunity to cure is allowed under BPC Section 20021, and that
if the franchisee sells, transfers, or assigns any franchise
assets before a valuation is made, the sale price shall be deemed
the monetized value of the equity of that franchise asset.
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
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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 BPC 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."
Supporters of this 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, this 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.
Analysis Prepared by:
Anthony Lew / JUD. / (916) 319-2334 FN: 0000267