BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Hannah-Beth Jackson, Chair
2015-2016 Regular Session
AB 2637 (Wilk)
Version: June 16, 2016
Hearing Date: June 28, 2016
Fiscal: Yes
Urgency: No
RD
SUBJECT
Franchise investments: offer and sale of registered franchises:
registration exemption
DESCRIPTION
This bill would revise an exemption to the California Franchise
Investment Law's general requirement that a franchisor
re-register its franchise disclosure document with the
Department of Business Oversight each time it negotiates changes
to the franchise agreement described in that disclosure document
with a franchisee, as specified.
BACKGROUND
The California Franchise Investment Law (CFIL) regulates
franchise investment opportunities by subjecting franchise
offers and various other aspects of the franchise relationship
to filing, review, and oversight by the Department of Business
Oversight (DBO). The CFIL seeks to provide prospective
franchisees with the information necessary to make an
intelligent decision regarding franchise offers, and to prohibit
the sale of franchises where they would lead to fraud or a
likelihood that a franchisor's promises would not be fulfilled.
In 2004, AB 2921 (Cox, Ch. 458, Stats. 2004) was brought by the
Franchise Law Committee of the State Bar's Business Law Section,
the same sponsor of this bill, to create additional exemptions
in situations where the sponsor argued regulatory intervention
is unnecessary and/or not cost efficient. In doing so, AB 2921
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enacted Section 31109.1 of the Corporations Code, the subject of
this bill, to exempt re-registration of agreements after
subsequent negotiations with franchisees which result in
material changes to the final agreement.
This bill, sponsored by the Franchise Law Committee of the State
Bar's Business Law Section, now seeks to remove many of the
conditions that must be met to be exempt from re-registration
under Section 31109.1.
This bill was heard in the Senate Banking & Financial
Institutions Committee on June 15, 2016, and passed out on a
vote of 7-0.
CHANGES TO EXISTING LAW
Existing law , the California Franchise Investment Law (CFIL),
generally requires any offers and sales of franchises in
California to be registered with the Department of Business
Oversight (DBO), unless it otherwise qualifies for an exemption,
as specified. (Corp. Code Sec. 31000 et seq.) Specifically,
existing law provides that it shall be unlawful for any person
to offer or sell any franchise in this state unless the offer of
the franchise has been registered under this part or exempted
under specified laws. (Corp. Code Sec. 31110.)
Existing law , the CFIL, generally defines a franchise as a
contract or agreement, either expressed or implied, whether oral
or written, between two or more persons, by which all of the
following occur:
a franchisee is granted the right to engage in the business
of offering, selling or distributing goods or services under
a marketing plan or system prescribed in substantial part by
a franchisor;
the operation of the franchisee's business pursuant to such
plan or system is substantially associated with the
franchisor's trademark, service mark, trade name, logotype,
advertising or other commercial symbol designating the
franchisor or its affiliate; and
the franchisee is required to pay, directly or indirectly,
a franchise fee. (Corp. Code Sec. 31005(a).)
Existing law requires franchisors subject to the CFIL to
register their offerings by submitting an application
accompanied by a proposed franchise disclosure document to DBO
containing specified material information about their businesses
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and the franchises they are offering. Existing law requires
franchisors to provide a copy of that disclosure document,
together with copies of all proposed agreements pertaining to
the sale of the franchise, to a prospective franchisee at least
14 calendar days before entering into any contract with or
receiving any payment from a prospective franchisee (whichever
occurs first). (Corp. Code Secs. 31114, 31119.)
Existing law requires a franchisor to promptly notify DBO in
writing, by an application to amend the registration, of any
material change in the information contained in the application
as originally submitted, amended or renewed. The commissioner
may by rule further define what shall be considered a material
change for such purposes, and the circumstances under which a
revised offering prospectus must accompany such application.
(Corp. Code Sec. 31123.)
Existing law requires that material modifications to a franchise
agreement be registered with DBO pursuant to a specified
application, except as otherwise provided. Existing law
provides that, except as otherwise provided, it is unlawful to
solicit the agreement of a franchisee to a proposed material
modification of an existing franchise without first delivering
to the franchisee a written disclosure, in a form and containing
information as the commissioner may by rule or order require,
identifying the proposed modification, either five business days
prior to the execution of any binding agreement by the
franchisee to the modification or containing a statement that
the franchisee may, by written notice mailed or delivered to the
franchisor or a specified agent of the franchisor within not
less than five business days following the execution of the
agreement, rescind the agreement to the material modification.
(Corp. Code Sec. 31125.)
Existing law , among other things, exempts from the above, any
modification of a franchise agreement with an existing franchise
of a franchisee if the modification is offered on a voluntary
basis and does not substantially and adversely impact the
franchisee's rights, benefits, privileges, duties, obligations,
or responsibilities under the franchise agreement. (Corp. Code
Sec. 31125(d).)
Existing law , Section 31109.1 of the Corporations Code, exempts
a franchisor from the requirement to re-register its franchise
disclosure document with DBO, every time it negotiates an
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amendment to a franchise agreement described in that disclosure
document, as long as all of the following requirements are met:
the initial franchise offer was registered, as specified;
each prospective franchisee is provided with all of the
following in a separate written appendix to the franchise
disclosure document:
o a summary description of each material negotiated term
that was negotiated by the franchisor for a California
franchise during the 12-month period ending in the calendar
month immediately preceding the month in which the
negotiated offer or sale was made;
o a statement indicating that copies of the negotiated
terms are available upon written request; and
o the name, telephone number, and address of the
franchisor [from] whom requests for a copy of the
negotiated terms may be obtained.
the franchisor certifies or declares in an appendix to its
application for renewal that it has complied with the
requirements of the exemption; and
the negotiated terms of the amended franchise agreement, on
the whole, confer additional benefits on the franchisee.
(Corp. Code Sec. 31109.1(a).)
Existing law requires the franchisor to also:
provide a copy of the negotiated terms to a prospective
franchisee within five business days of request by the
prospective franchisee; and
maintain copies of all material negotiated terms for a period
of five years from the effective date of the first agreement
containing the relevant negotiated term and makes these copies
available to the commissioner upon request. (Corp. Code Sec.
31109.1(b), (c).)
Existing law defines "material" to mean that a reasonable
franchisee would view the terms as important in negotiating the
franchise. (Corp. Code Sec. 31109.1(d).)
This bill would strike many of the existing requirements of the
Section 31109.1 exemption and, instead, require that a
franchisor meet all of the following to avoid re-registration of
terms different from the terms of the registered offer:
the initial franchise offer was registered, as specified;
the cover page, a state cover page, or a state addendum of the
disclosure document setting for a specific statement relating
to the ability of the franchisor and franchisee to negotiate
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changes to the franchise agreement; and
the franchisor certifies or declares in an appendix to its
application for renewal that it has complied with the
requirements of the exemption.
This bill would repeal the requirement that a franchisor provide
a copy of the negotiated terms to a prospective franchisee
within five business days of a request by a prospective
franchisee, and would revise the existing requirement that the
franchisor maintain copies of all material negotiated terms for
which this exemption is claimed for a period of five years from
the effective date of the first agreement containing the
relevant negotiated term. Instead, the franchisor would have to
maintain copies for a period of five years from the effective
date of the agreement containing the relevant negotiated term.
COMMENT
1. Stated need for the bill
According to the author:
The idea behind enacting [Corporations Code Section] 31109.1
was that full disclosure should promote fairness among
franchises. The reasoning was that where one franchisee is
savvy enough to negotiate the terms of her or his agreement,
notice of the additional benefits and protections of the
negotiated agreement should be made available to subsequent
franchisees.
While it was well-intentioned, Cal. Corp. Code [Sec.] 31109.1
creates a significant practical problem for franchisors and
franchisees in California. Even though virtually all
franchisors are willing to negotiate with some prospective
franchisees under some circumstances, [Sec.] 31109.1 actually
serves to decrease the number of situations in which most
franchisors are willing to negotiate with franchisees in
California. Many franchisors are concerned that requiring
disclosure of past negotiated terms to subsequent franchisees
will cause the negotiated changes to become a "new normal,"
with future franchisees expecting to get not only every change
that was negotiated in the past (whether or not they present
circumstances similar to those that led the franchisor to
negotiate before), but additional changes as well. Other
franchisors are concerned that not all franchisees are
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similarly situated to one another, and the circumstances that
led to the franchisor's willingness to negotiate with one
franchisee may not be the same for another franchisee. To
avoid this consequence, many franchisors refuse to negotiate
any changes in California-even under circumstances in which
they otherwise would be willing to negotiate with a
similarly-situated franchisee in another state. [ . . . ] In
other words, instead of protecting franchisees, [Sec.] 31109.1
has actually caused more harm to them by creating impediments
to negotiating deals.
Assembly Bill 2637 proposes to amend Corporations Code Section
31109.1 to address the existing unintended consequences caused
by 31109.1. Under the proposed revision, franchisors would be
permitted to negotiate changes to the franchise agreement
provided the franchisor has made certain additional
disclosures in its [franchise disclosure document (FDD)] that
would provide prospective franchisees with more information
about the negotiation and sales process. [ . . .]
AB 2637 will also require a franchisor who claims the
exemption under [Sec.] 31109.1 to certify in any application
for renewal of its registration with the DBO that it has
complied with the statute. Finally, the franchisor will be
required to maintain copies of all material negotiated terms
claimed under the exemption for a period of five years, and
make them available to the DBO for review upon request. These
amendments will help facilitate the negotiation process
between parties and, as a result, help improve operation of
franchises within California.
2. Bill reduces disclosure obligations of franchisors seeking
exemption from re-registration of modified franchise
agreements
The CFIL seeks to protect California investors from flimsy or
fraudulent franchise investments by setting forth a general rule
that all franchise offers must be reviewed by the Department of
Business Oversight (DBO) to ensure that they are valid and
accurate. Accordingly, the CFIL prohibits a person from
offering or selling any franchise in this state unless the
franchise offer has been registered or is explicitly exempt from
registration. The DBO reviews registered offers for financial
soundness and misrepresentations, and also conducts a background
check on franchisor principals. The DBO also reviews
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modifications to franchise agreements, and pursues legal action
against individuals for fraudulent or unlawful conduct in
connection with a franchise offer. (Corp. Code Sec. 31000 et
seq.)
Over the years, however, the CFIL has been amended to exempt
various franchise offers in situations where the Legislature
believed the risk to California investors was not significant
enough to warrant regulatory intrusion. For example, franchise
offers by large and well-established franchisors are exempt from
review. Similarly, franchise agreements where a franchisee has
significant experience in a substantially similar business are
exempt from review. Underlying such exemptions is a recognition
that unlike "ordinary" investing, franchise investing sometimes
bears more resemblance to a transaction between businesses than
the usual business-to-consumer or business-to-investor situation
where the law often seeks to protect the less knowledgeable or
sophisticated consumer/investor.
As noted in the Background, in 2004, AB 2921 (Cox, Ch. 458,
Stats. 2004) was enacted to add additional exemptions from
registration (or re-registration, in this case) in situations
where the sponsor of that bill, the Franchise Law Committee of
the State Bar's Business Law Section, argued regulatory
intervention is unnecessary/not cost efficient. At the time it
was heard, this Committee's analysis of AB 2921 acknowledged
that re-registration could be burdensome, but suggested also
that the proposed exemption potentially went too far:
The bill's supporters argue that this re-registration is
unnecessary and burdensome [ . . . and] deters franchisors
from negotiating changes to the registered offer, which
sometimes hurts franchisees who are seeking better terms.
However, in recognition of the fact that subsequent changes
could also operate unfairly on franchisees, the bill provides
that this exception would apply only if the franchisee was
provided with a summary of, and an opportunity to review in
detail, other material departures from the registered offer
negotiated by the franchisor in this state. The bill's
supporters argue that this information will help protect
franchisees from outlandish modifications by providing them
with information on what other franchisees had agreed to.
While Committee staff realizes that re-registration can often
be redundant and burdensome, it also has some concerns over
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the breadth of this exception. If franchisors are allowed to
significantly depart from the registered offer, what is the
point of requiring registration in the first place? Also,
there would seem to be considerable risk that unscrupulous
franchisors could use this exception to evade detection by the
Department. Finally, Committee staff is not convinced that
franchisees are protected when they are provided with
information on other changes agreed to by other franchisees.
This information would not protect franchisees if many other
franchisees had agreed to (or been duped into) unfair terms;
nor would the information protect early franchisees, who would
be provided little information. [ . . . ] (Sen. Judiciary Com.
analysis of AB 2921 (2003-2004 Reg. Session) Jun. 29, 2004,
pp. 6-7.)
With this bill, the sponsors are now seeking to reduce the
obligations placed on the franchisors who wish to avoid
re-registration under the AB 2921 exemption. Seemingly, because
AB 2921 required that each prospective franchisee be provided a
summary description of each material negotiated term that was
negotiated by the franchisor for a California franchise during
the 12-month period immediately preceding the month in which the
negotiated offer or sale was made, proponents assert that
franchisors have been less willing to negotiate agreements with
franchisees as a result.
Accordingly, the bill would strike various existing
requirements, including that a prospective franchisee receive,
among other things: (1) a summary description of each material
negotiated term that was negotiated by the franchisor for a
California franchise during the 12-month period ending in the
calendar month immediately preceding the month in which the
negotiated offer or sale is made under this section; and (2) a
statement indicating that copies of the negotiated terms are
available upon written request. Along these lines, this bill
would also repeal the requirement that the franchisor provide a
copy of the negotiated terms to the prospective franchisee
within five business days following the request of the
franchisee. Instead, the bill would require that the cover
page, a state cover page, or a state addendum of the disclosure
document specifically state to the prospective franchisee that:
"You and the franchisor may agree to sign the forms of franchise
agreement and other agreements attached to this disclosure
document. However, California law does not prohibit you and the
franchisor from negotiating changes to the franchise agreement
and other agreements, nor does it require you or the franchisor
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to negotiate any changes."
By revising the law such that a franchisor would have to inform
franchisees that negotiations are permitted, but not have to
disclose the terms of prior negotiations, the sponsor believes
this bill would reverse the reported "chilling effects" of
Section 31109.1 and encourage more negotiations. The
International Franchise Association (IFA) writes in support of
the bill, arguing that the bill will encourage franchise growth
in California and lead to more entrepreneurs opening businesses
and providing more jobs and revenue to California.
Support : International Franchise Association
Opposition : None Known
HISTORY
Source : Franchise Law Committee of the Business Law Section of
the State Bar
Related Pending Legislation : None Known
Prior Legislation : AB 2921 (Cox, Ch. 458, Stats. 2004) See
Background and Comment 2.
Prior Vote :
Senate Banking and Financial Institutions Committee (Ayes 7,
Noes 0)
Assembly Floor (Ayes 79, Noes 0)
Assembly Appropriations Committee (Ayes 20, Noes 0)
Assembly Banking and Finance Committee (Ayes 12, Noes 0)
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