BILL ANALYSIS Ó AB 525 Page 1 ASSEMBLY THIRD READING AB 525 (Holden, et al.) As Amended May 4, 2015 Majority vote ------------------------------------------------------------------- |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 | | ------------------------------------------------------------------- SUMMARY: Revises the rights and responsibilities of franchisors and franchisees under the California Franchise Relations Act AB 525 Page 2 (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 AB 525 Page 3 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 AB 525 Page 4 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 AB 525 Page 5 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 AB 525 Page 6 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 AB 525 Page 7 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 AB 525 Page 8 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. AB 525 Page 9 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 AB 525 Page 10 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