In late June, the California Assembly Business, Professions and Consumer Protection Committee passed Senate Bill 610, the Small Business Investment & Protection Act. An earlier version of this Bill died in the California legislature last year, but this year’s version now moves to the full California Assembly. Many are predicting passage. The Bill is supported by the Service Employees International Union (they seem to be involved with everything franchising recently), and the Asian American Hotel Owners Association. It is franchisee-friendly. If adopted, the Bill would amend the California Franchise Relations Act in several respects, but the most significant changes would be to impose new requirements pertaining to franchise terminations and franchise transfers.

With respect to franchise terminations, the legislation provides that a franchise can be terminated only if there has been “a substantial and material breach…of a lawful requirement of the franchise [agreement].” And then only if the franchisee has failed to cure the breach within 30 days after notice. This would be a change in the current statute that authorizes termination for “good cause,” which is defined as conduct that includes, but is not limited to, any breach of a lawful provision of a franchise agreement. The current Act also provides that a franchisor need only give “reasonable notice” before termination, which need not be longer than 30 days. The amendment also authorizes an action for injunctive relief and damages for a wrongful termination. Specifically, a franchisee improperly terminated would be entitled to reinstatement as a franchisee and damages or, at the election of the franchisee, the fair market value of the franchise and franchise assets.

With respect to franchise transfers, the amendment would grant franchisees a statutory right to transfer or assign all or part of their franchise to a qualified prospective franchisee. The amendment confirms a franchisor’s right to approve a transfer, but would make it a violation of the statute to unreasonably withhold consent. Further, the question of whether a franchisor’s refusal to consent to a transfer was reasonable “is a question of fact requiring consideration of all the existing circumstances.” The amendment would also require a franchisor to act on a franchise transfer request within 60 days. If a franchisor fails to approve a transfer within the 60 period, then the transfer would be deemed to have been accepted. And if the franchisor should refuse to consent, it must do so in written notice to the franchisee setting forth the basis for denial. The Bill also authorizes injunctive relieve for violations of the provisions relating to franchise transfers, and authorizes damages actions similar to those provided for wrongful termination.

If adopted, SB 610 will be a bonanza for lawyers in California. In the first instance, because termination can only be based on a breach of the franchise, it will put a premium on contract drafting of the franchise that anticipates all termination worthy behavior. The proposed amendments to the Act may also result in more litigation, since it leaves judges and juries to decide whether a franchisee’s breach of the franchise was “substantial” and “material” and whether a franchisor’s refusal to consent to a requested franchise transfer was unreasonable.

There is, or course, a real downside to the legislation. A franchisor must be able to reliably and consistently enforce system standards to maintain the integrity of its brand. This is important to the franchisor, but it is also important to most franchisees who play by the rules and to consumers who rely upon the brand when they purchase goods or services from a franchised outlet. The fact is that the threat of termination is a powerful tool to discourage free-riding by franchisees. But legislation such as SB 610 significantly deters franchisors from using this tool.

As a rational franchisor, would you risk having to spend tens of thousands (if not hundreds of thousands) of dollars defending a termination based operation of a restaurant that did not meet in some respects the franchisor’s brand standards for cleanliness? Maybe not, and as a result, and over time, standards are eroded, and as standards are eroded, so too is the value of the franchisor’s brand and the value of a franchisee’s business. Legislation such as SB 610 would be understandable if there was real evidence of a persistent, widespread, problem of arbitrary terminations and refusals to consent to franchise transfers by franchisors, but I am aware of no such evidence. Let’s hope that the California Assembly asks to see that evidence before passing SB 610.