BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 2305
                                                                  Page  1

          Date of Hearing:   April 17, 2012

                           ASSEMBLY COMMITTEE ON JUDICIARY
                                  Mike Feuer, Chair
                AB 2305 (Huffman) - As Introduced:  February 24, 2012
           
          SUBJECT  :  FRANCHISES:  THE LEVEL PLAYING FIELD FOR SMALL 
          BUSINESS ACT OF 2012

           KEY ISSUE:   SHOULD CALIFORNIA'S FRANCHISE LAW BE REVISED TO 
          STRENGTHEN PROTECTIONS FOR SMALL BUSINESS FRANCHISEES AND HELP 
          EQUALIZE BARGAINING POWER IN THE FRANCHISEE-FRANCHISOR 
          RELATIONSHIP?

           FISCAL EFFECT  :  As currently in print this bill is keyed fiscal.

                                      SYNOPSIS
          
          As indicated by the name of this legislation, The Level Playing 
          Field for Small Businesses Act of 2012, the author and bill 
          proponents strongly believe that the franchise business 
          relationship is inherently one-sided in favor of franchisors, 
          potentially to the great detriment of small business 
          franchisees.  They contend that greater protections are needed 
          to protect franchisees against unfair practices-made easier by 
          the inherent one-sidedness of the franchise relationship--that 
          unfortunately arise in some cases and threaten the financial 
          livelihood of these small businessmen and women who form the 
          economic backbone of our state.  To establish such protections, 
          this bill, sponsored by the American Franchisee Association, 
          proposes a number of changes to state franchise law, including, 
          among other things: (1) allowing franchise termination for good 
          cause only where there has been a substantial and material 
          breach of the franchise agreement, as well as 60 days to cure 
          the breach; (2) prohibiting any provision in a franchise 
          agreement that restricts venue for resolution of disputes solely 
          to a forum outside of California; (3) requiring good faith in 
          the performance and enforcement of the franchise agreement, and 
          requiring a duty of competence to franchisees, as specified.  
          The bill is strongly opposed by franchisors, retailers, and 
          large business interests, who contend generally that parties 
          have the right to freely contract as they wish, and that this 
          bill will hurt business in California by interfering in 
          contracting between consenting parties needed to freely develop 
          new franchise businesses.  These opponents also contend that 








                                                                  AB 2305
                                                                  Page  2

          existing California law already scrutinizes franchise agreements 
          closely, and generally protects residents from unreasonable 
          contract provisions, making many of the components of this bill 
          unnecessary. The analysis below highlights the arguments made 
          for and against a number of the key policy changes proposed by 
          this bill.  This bill is double referred to the Business and 
          Professions Committee.

           SUMMARY  :  Enacts The Level Playing Field for Small Businesses 
          Act of 2012 to revise the rights and responsibilities of 
          franchisors and franchisees as well as the rules that govern the 
          franchise relationship in California.  Specifically,  this bill  , 
          among other things:   

          1)Requires the franchisee and franchisor to deal with each other 
            in good faith in the performance and enforcement of the 
            franchise agreement. 

          2)Prohibits franchisors from restricting franchisees from 
            associating with other franchisees or from participating in a 
            trade association.

          3)Declares void as a matter of law any provision in a franchise 
            agreement that restricts venue for resolution of disputes 
            solely to a forum outside California, and prohibits the 
            Commissioner of Corporations from registering any franchise 
            offer that contains a provision restricting venue in such a 
            manner.

          4)Requires franchisors to establish good cause as a condition of 
            terminating or failing to renew a franchise agreement, where 
            good cause means a substantial and material breach of the 
            franchise agreement, or be required to reinstate the 
            franchisee and pay resulting damages.

          5)Allows franchisees 60 days after written notice to cure 
            defects that result in noncompliance with terms of the 
            franchise agreement.

          6)Allows a franchisee to select vendors that meet standards 
            established by the franchisor without specifically limiting 
            the use of particular vendors.

          7)Provides an existing franchisee with a limited cause of action 
            for damages when a franchisor develops a new franchise 








                                                                  AB 2305
                                                                  Page  3

            location by a different franchisee that is in unreasonable 
            proximity to an existing location and that results in a 6% 
            decline in annual gross sales to the existing franchisee.

          8)Requires franchisors to owe a duty of competence to 
            franchisees.

          9)Allows surviving spouses and heirs to meet reasonable 
            qualifications and standards for assuming responsibility for 
            the decedent's franchise rights.

          10)Requires franchisors to show cause for the denial of a 
            transfer of the franchise from one franchisee to another.

          11)Eliminates requirements for scienter and reasonable reliance 
            for recovery on claims of fraud, deceit, misrepresentation, or 
            omission.

          12)Allows the prevailing plaintiff in a claim for violation of 
            these provisions to be awarded costs and reasonable attorneys' 
            fees.

           EXISTING LAW  , the California Franchise Relations Act (CFRA), 
          among other things: 

          1)Defines a franchise as a contract between two or more persons 
            by which: (a) a franchisee is granted the right to offer, sell 
            or distribute goods or services under the plan or system of 
            the franchisor; (b) operation of the business is substantially 
            associated with franchisor's trademark, advertising or other 
            symbol; and (c) a franchise fee is paid by the franchisee.  
            (Bus. & Prof. Code Section 20001.)

          2)Provides that any condition, stipulation or provision waiving 
            compliance with the CFRA is contrary to public policy and 
            void.  (Bus. & Prof. Code Section 20010.)

          3)Prohibits termination of a franchise agreement prior to the 
            end of the term, except for good cause, where good cause 
            includes failure to comply with any lawful requirement of the 
            franchise agreement after written notice and a reasonable 
            opportunity to cure.  (Bus. & Prof. Code Section 20020.)

          4)Requires a franchisor to notify the franchisee of their 
            intention not to renew a contract at least 180 days prior to 








                                                                  AB 2305
                                                                  Page  4

            the expiration of the franchise, during which time the 
            franchisee may attempt to find a buyer acceptable to the 
            franchisor.  (Bus. & Prof. Code Section 20025.)

          5)Requires the surviving spouse or heirs of deceased 
            franchisees, wishing to participate in the ownership of the 
            franchise, to meet all franchisor requirements for standards 
            for new franchise purchase.  (Bus. & Prof. Code Section 
            20027.)

          6)Requires a franchisor that terminates or fails to renew a 
            franchise without complying with the CFRA to offer to 
            repurchase the franchisee's resalable current inventory at the 
            lower of the fair wholesale market value or the price paid by 
            the franchisee.  (Bus. & Prof. Code Section 20035.) 

           EXISTING LAW  , the California Franchise Investment Law (CFIL), 
          among other things:

          1)Imposes civil liability upon the franchisor for false 
            statements or omissions of material fact in connection with 
            the purchase or sale of a franchise, but only if there is 
            scienter on the part of the franchisor and reasonable reliance 
            by the franchisee. (Corporations Code Sections 31201 and 
            31301.)

          2)Provides that, except as explicitly provided by the CFIL, no 
            civil liability shall arise against any person for violation 
            of any provision of the CFIL or any rule or order hereunder. 
            (Corporations Code Section 31306.)

           COMMENTS  :  This bill, sponsored by the American Franchisee 
          Association, proposes a number of changes to California 
          franchise law that, according to proponents, seek to "level the 
          playing field and provide for fair relationships with 
          franchisors (to help) small businesses throughout California 
          avoid bankruptcy and continue creating jobs in our communities."

           Disparity in bargaining power between franchisors and 
          franchisees.   As indicated by the name of this legislation (The 
          Level Playing Field for Small Businesses Act), proponents 
          strongly believe that the franchise business relationship is 
          inherently one-sided in favor of franchisors, potentially to the 
          great detriment of small business franchisees.  This view has 
          been supported by, among others, the California Court of Appeal 








                                                                  AB 2305
                                                                  Page  5

          (2nd Dist.), who described the dynamic as follows:

             The relationship between franchisor and franchisee is 
             characterized by a prevailing, although not universal, 
             inequality of economic 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.) . . . Some courts and 
             commentators have stressed the bargaining disparity between 
             franchisors and franchisees is so great that franchise 
             agreements exhibit many of the attributes of an adhesion 
             contract and some of the terms of those contracts may be 
             unconscionable.  Postal Instant Press v. Sealy, 43 Cal. App. 
             4th 1704, 1715-1717 (1996.)   

          Franchisors who oppose the bill contend generally that parties 
          have the right to freely contract as they wish, and that this 
          bill will hurt business in California by interfering in 
          contracting between consenting parties needed to freely develop 
          new franchise businesses.  These opponents also contend that 
          existing California law already scrutinizes franchise agreements 
          closely and generally protects residents from unreasonable 
          contract provisions, making many of the components of this bill 
          unnecessary. 

          According to the author, this bill seeks to "respect the 
          importance and rights of franchisors who have a responsibility 
          to the overall brand and their other franchisees," but also 
          establish needed protections for franchisees against unfair 
          practices-made easier by the inherent one-sidedness of the 
          franchise relationship--that unfortunately arise in some cases 
          and threaten the financial livelihood of these small 
          businesspeople.  For reasons of brevity, this analysis discusses 
          only five of the key policy changes proposed by this bill.
           
          1.) Termination for good cause; opportunity to cure breach.   BPC 
          Section 20020 currently allows premature termination of a 
          franchise for failure to comply with any lawful requirement of 








                                                                  AB 2305
                                                                  Page  6

          the franchise agreement, after written notice and a reasonable 
          opportunity to cure "which in no event need be more than 30 
          days."  This bill would instead allow termination for good cause 
          only where there has been a substantial and material breach of 
          the franchise agreement, and would allow the franchisee 60 days 
          to cure the breach.  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.  Supporters of the bill counter that 
          only a substantial and material breach-for example, endangering 
          public health or safety-should be grounds for early termination, 
          and that failure to comply with  any  lawful requirement of the 
          agreement (e.g. a missing light bulb; walls painted red, not 
          blue) is simply unwarranted.  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 allowing 60 days to cure 
          is a reasonable solution common to many other commercial 
          transactions.
           
          2.) Choice of law and forum selection clauses.   This bill 
          declares void any provision in a franchise agreement that 
          restricts venue for resolution of disputes solely to a forum 
          outside of California.  Supporters contend that the ability of 
          franchisors to enforce out-of-state forum-selection clauses 
          against California franchisees encourages franchisors to pursue 
          frivolous claims and discourages franchisees from asserting 
          their legal rights.  In addition, they note that it is often 
          prohibitively expensive for a franchisee to have to travel 
          across the country to defend himself in an arbitration seeking 
          franchise termination.  Opponents, including CJAC, counter that 
          this bill will prevent judges from allowing choice of law or 
          forum selection clauses when appropriate, for example, when the 
          location of the forum may make sense due to the nature of the 
          contract.  They contend that courts can and should be able to 
          exercise their discretion, in a particular case, as to whether 
          the clause is reasonable or not.  Because of the unequal burden 
          placed on franchisees who must travel to the franchisor's chosen 
          state,  the Committee may nevertheless conclude that  it is 
          reasonable that franchisors who wish to benefit from the robust 
          California marketplace should be prohibited from excluding 
          California as a forum for resolving disputes with California 
          franchisees.









                                                                  AB 2305
                                                                  Page  7

           3.) Good faith requirement and duty of competence.   The bill 
          seeks to require the parties to deal with each other in good 
          faith in the performance and enforcement of the franchise 
          agreement, and also provides that franchisors shall owe a duty 
          of competence to franchisees.  According to the author, given 
          that franchisees have such a heavy investment in their small 
          business franchises, California's franchise laws do not 
          sufficiently protect the franchisee from abuse by some 
          unscrupulous or mismanaged franchisors.  As a result, some small 
          business franchisees "have lost everything trying to fight 
          honest battles against intentionally unfair practices."  
          Opponents contend that "good faith" and "duty of competence" are 
          so broadly defined or undefined to require judicial involvement 
          to resolve minor disputes and contractual uncertainties, at 
          great expense to both parties as well as consumers who would 
          have to absorb the costs.  

          Supporters respond that the bill would not require contractual 
          terms to be examined under a "good faith" standard, but rather 
          the conduct of either party to the franchise agreement.  They 
          note that franchisors are apparently having no problem selling 
          franchises in Washington where state law also requires the 
          parties "to deal with each other in good faith", and point out 
          that Congress has included the term "good faith" over 900 times 
          in the Internal Revenue Code.  Finally, supporters contend that 
          a duty of competence does not handicap honest franchisors that 
          do not mislead franchisees in order to develop business, and 
          that if such claims are made in selling the franchise, they 
          should not be insulated from responsibility if untrue.

           4.) Right to renewal.   This bill seeks to provide franchisees 
          with a statutory right to renewal of the franchise agreement 
          that "shall be under the same terms as the existing franchise 
          agreement" or at the franchisee's election, under terms then 
          being offered to new franchisees.  Supporters contend that all 
          too often, when it comes time for a franchisee to renew the 
          agreement, the franchisor uses its superior bargaining power to 
          obtain new terms that may not be as favorable to the franchisee 
          as the terms that persuaded him to enter the initial contract.  
          Having invested so much in the new franchise, they contend, the 
          franchisee is placed in an unfair and unworkable position.  On 
          the other hand, opponents contend that the current language of 
          the bill essentially requires the franchise agreement to last in 
          perpetuity (assuming no substantial or material breach), and is 
          so inflexible that it prevents the original contract from being 








                                                                  AB 2305
                                                                  Page  8

          modified to even add new products or services or require 
          technological improvements.

          Because the Committee may conclude that the current version of 
          the bill may potentially allow insufficient flexibility to 
          modify the contract in ways that might benefit both parties,  the 
          Committee may wish to discuss with the author his openness to 
          continuing to work with stakeholders to increase flexibility in 
          the renewal process  , perhaps by requiring only certain key terms 
          to be preserved, or by providing more than 180 days of notice of 
          intent not to renew so the franchisee has more time to 
          renegotiate or locate a buyer.

           5.) Private right of action and attorneys' fees.   Existing law, 
          the CFIL, already provides a private right of action, but this 
          bill seeks to strengthen the damages remedies and provide 
          attorneys' fees for prevailing plaintiffs.  Opponents contend 
          that by allowing treble damages and a one-sided attorney's fee 
          award, this bill creates significant incentives for plaintiffs 
          to bring meritless lawsuits alleging breach of franchise law.  
          Supporters counter that the private right of action under the 
          CFIL is extremely important because California authorities have 
          limited resources and cannot sufficiently enforce the statute.  

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          American Franchisee Association (co-sponsor)
          California Small Business Association (co-sponsor)
          American Association of Franchisees & Dealers (AAFD)
          Asian American Hotel Owners Association (AAHOA)
          Association of Certified Family Law Specialists
          Consumer Attorneys of California (CAOC)
          Coalition of Franchisee Associations (CFA)
          Independent Coalition of Franchise Owners
          Dozens of letters from individual franchisees in California, 
          including:
             7-Eleven franchise store owners
             Arco AM/PM franchise store owners
             UPS franchise store owners
             Subway franchise store owners
             Big O Tires franchise store owners 
          Several private individuals and out-of-state franchisees









                                                                  AB 2305
                                                                  Page  9

           Opposition 
           
          California Chamber of Commerce
          California Retailers Association (CRA)
          Civil Justice Association of California (CJAC)
          International Franchise Association (IFA)

           
          Analysis Prepared by  :    Anthony Lew / JUD. / (916) 319-2334