On Thursday the California legislature approved a bill amending the state’s franchise laws. Pending signature by Governor Jerry Brown (almost certainly a foregone conclusion), the changes will be official.
As discussed in more detail below, the changes were made to California’s Franchise Relations Act (CFRA), and relate exclusively to the relationship between the franchisor and franchisee after the parties have signed a franchise agreement. You may be wondering what events precipitated the change to a law that has been on the books since 1980. Well, according to the legislature, changes in the law are needed to combat “the widespread use of one-sided and nonnegotiable franchise agreements [which have] created numerous problems for franchisees in California.”
Sound vague? How about this. According to the bill’s author:
[G]iven that franchisees have such a heavy investment in their small business franchises, California’s franchise laws do not sufficiently protect franchisees from potential abuse by some franchisors acting questionably or in bad faith. As a result, some small business franchisees have lost heavy sums of their own money because of what they perceive as intentionally unfair practices.
Apparently, 34 years of established law was in dire need of updating because “some franchisors” have acted “questionably,” or in ways that franchisees “perceive” to be unfair. Perceptions (and joking) aside, the legislature did cite to at least some possible abuses by franchisors, including:
- Franchisors’ imposing unfair terms for renewal, including expensive investments in facility upgrades and remodeling;
- Franchisors’ use of arguable building and equipment valuation methods which can reduce the value of a franchise when being sold back to the franchisor;
While it does not appear that there was any actual evidence of improper conduct by franchisors beyond a handful of anecdotal examples, the legislature took the proverbial ball and ran with it, passing new, rigorous standards to address the (perceived? potential? existential?) problem of franchisor overreach.
Yet some of the changes made to the law appear to be nothing more than window dressing. For example, the bill includes an amendment to CFRA section 20010, which expressly voids any provision of a franchise agreement that purports to require the franchisee to waive compliance with the statute. The amended statute will now also void any provision which purports to require a franchisee to waive compliance with the already non-waivable contractual duty of good faith and fair dealing. The effect that this change will have on existing law is best stated by the legislative history, where it was noted that since the duty of good faith is already not subject to waiver under California law, “there may be limited practical value in this bill’s non-waiver provision.”
Similarly, the law will now prohibit franchisors from restricting franchisees from joining franchisee associations. But franchisors are already prohibited from imposing such restrictions by the California Franchise Investment Act (CFIL), section 31220. Franchisees can currently sue franchisors for violations of the CFIL’s association provision, and they are entitled to recover actual damages and attorneys’ fees, and to receive injunctive relief where necessary. As CFRA has no similar provision, the addition to the statute is presumably going to have the limited effect of allowing franchisees to seek the new remedies available for wrongful termination and non-renewal as an alternative to an action for damages and injunctive relief under the CFIL.
The bill’s major substantive changes to CFRA relate to termination and assignment of existing franchises. The statute makes it unlawful for franchisors to refuse to unreasonably withhold consent to the transfer of a franchise to a “qualified” assignee, and sets up a complex procedure for the parties to follow when evaluating prospective assignees of a franchise interest. Most glaringly, the statute explicitly makes the determination of whether the franchisor has unreasonably withheld consent to be a factual question that must be decided by a jury, thereby ensuring that any disputes over franchise transfers will be lengthy and expensive affairs that cannot be resolved short of trial on the merits.
For terminations, the legislature replaced the requirement that franchise terminations be for “good cause” with a “more exacting” requirement of “substantial and material breach.” As an initial matter, although the statute appears to require that a breach be both substantial and material to warrant termination, the legislative history suggests that a “substantial and material breach” is “effectively synonymous” with the well-recognized standard for “material breach” (i.e., “an action or omission that defeats the benefit for which the parties bargained”).
In addition, for a termination to be lawful, the franchisee’s breach must remain uncured for 30 days (under the previous version of the statute, a franchisor could terminate following a reasonable opportunity to cure of no more than 30 days). Curiously, while the prior version of the statute required the franchisor to provide the franchisee with written notice of the breach, the amended version contains no reference to notice, and instead merely notes that franchisees that have been in breach for 30 days may be terminated. Despite the omission, it is likely that courts will continue to require notice of the breach.
While it does not appear that the changes to the statute were precipitated by any particular problems with the state’s regulation of franchise relationships, change is in the air, and franchisors should be prepared to give added scrutiny to assignments and terminations of franchisees in California.