BILL ANALYSIS Ó AB 525 Page 1 Date of Hearing: April 21, 2015 ASSEMBLY COMMITTEE ON JUDICIARY Mark Stone, Chair AB 525 (Holden and Atkins) - As Amended April 6, 2015 SUBJECT: FRANCHISE RELATIONS: RENEWAL AND TERMINATION KEY ISSUE: SHOULD CALIFORNIA FRANCHISE LAW BE REVISED TO STRENGTHEN KEY PROTECTIONS FOR SMALL BUSINESS FRANCHISEES, INCLUDING, AMONG OTHER THINGS, PROHIBITING TERMINATION AND NONRENEWAL OF FRANCHISEES WHO ARE IN SUBSTANTIAL COMPLIANCE WITH THEir FRANCHISE AGREEMENTs? SYNOPSIS Proponents of this bill, including associations of franchisee business owners and organized labor groups, contend that greater measures are needed to protect the investment and wellbeing of franchisees against unfair practices by franchisors-practices made easier by the inherently one-sided nature of the franchise relationship and the typically unequal bargaining power between franchisors and franchisees. To establish such protections, this bill, sponsored by the Coalition of Franchisee Associations, proposes a number of changes to state franchise law, including, among other things: (1) allowing franchisors to terminate or fail to renew a franchisee for good cause only where the franchisee has failed to substantially comply with terms of the franchise agreement; (2) extending the period of AB 525 Page 2 notice and opportunity to cure a breach from 30 days to 60 days; (3) protecting franchisees' ability to pass their businesses on to their family and heirs; and (4) ensuring that franchisees can monetize the equity they may have invested in the business prior to termination of the agreement, as specified. The bill is opposed by the International Franchise Association, representing franchisors, 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, and increasing litigation over ambiguities created by the bill. Opponents also contend that the substantial compliance and extended opportunity to cure provisions are burdensome and make it difficult for existing franchisors to conduct business in this state, rendering it an unattractive place to open new franchises. Proponents counter that economic data from states that employ the substantial compliance standard and/or a 60-day notice before termination do not support this contention. Should the bill be approved by this Committee, it will be referred to the Assembly Business and Professions Committee. SUMMARY: Revises the rights and responsibilities of franchisors and franchisees with respect to the rules under the California Franchise Relations Act (CFRA) governing the renewal and 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. AB 525 Page 3 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 (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 of the franchise agreement, but not transferring any equity in the franchisor's intellectual property to the franchisee. 5)Prohibits a franchisor from failing to renew a franchise unless the franchisee has failed to substantially comply with the franchise agreement. Further provides that if the franchisee is in substantial compliance with the franchise agreement at the time of the expiration of the franchise agreement, the franchisee may renew for the same duration as provided in the expiring franchise agreement and the renewal shall be under the franchise agreement terms that are being offered to new franchises. 6)Requires the franchisor to provide written notice to the franchisee of its intention not to renew at least 180 days prior to the termination of the existing franchise agreement if the franchisor has legitimate grounds not to renew the franchise. AB 525 Page 4 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 unreasonably withheld. 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 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. 10)Authorizes a court to grant preliminary and permanent injunctions for a violation of the CFRA. EXISTING LAW, under the California Franchise Relations Act: 1)Defines a franchise as a contract between two or more persons by which: (1) a franchisee is granted the right to offer, sell or distribute goods or services under the plan or system of the franchisor; (2) operation of the business is substantially AB 525 Page 5 associated with franchisor's trademark, advertising or other symbol; and (3) a franchise fee is paid by the franchisee. (Business & Professions Code Section 20001. All further references are to this code unless otherwise stated.) 2)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 the failure, which need not be more than 30 days. (Section 20020.) 3)Specifies a number of circumstances that justify immediate notice of termination of a franchise agreement without an opportunity to cure, including, among other things: (1) bankruptcy of the franchisee; (2) abandonment of the franchise; (3) mutual written agreement to terminate the franchise; (4) the franchisee is convicted of a felony or other crime relevant to operation of the franchise; (5) operation of the franchise poses an imminent danger to public health or safety; and (6) the franchisee fails, for 10 days after notification of noncompliance to comply with any federal, state or local laws or regulations applicable to operation of the franchise. (Section 20021.) 4)Requires a franchisor to notify the franchisee of the intention not to renew a contract at least 180 days prior to the expiration of the franchise, during which time the franchisee may attempt to find a buyer acceptable to the franchisor. (Section 20025.) 5)Prohibits a franchisor from denying the surviving spouse, heirs, or estate of a deceased franchisee or the majority shareholder of the franchisee the opportunity to participate in the ownership of the franchise under a valid franchise agreement for a reasonable time after the death of the franchisee or majority shareholder of the franchisee. Further AB 525 Page 6 provides that during that time, the surviving spouse, or heirs of the deceased shall either satisfy all of the then current qualifications for a purchaser of a franchise, or sell, transfer, or assign the franchise to a person who satisfies the franchisor's then current standards for new franchisees. (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. (Section 20035.) FISCAL EFFECT: As currently in print this bill is keyed non-fiscal. 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. The bill revises rights and responsibilities of franchisors and franchisees under the California Franchise Relations Act (CFRA), primarily with respect to the renewal and termination of franchise agreements. The author explains the need for the bill as follows: The California Franchise Relations Act provides franchisees with fewer rights than nearly every other form of contract law in California, especially as they pertain to termination, breach and damages. Franchise agreements are frequently one-sided contracts that strongly favor the franchisor over the small business owners who operate franchises. AB 525 restores fairness to franchise agreements by applying traditional contract law standards, giving franchisees AB 525 Page 7 the right to transfer the business, ensuring franchisees can recover their equity when a franchise relationship end, all while protecting the franchisor's rights to terminate the worst actors, including those who break laws, cannot make required payments or operate in direct defiance of the contract terms. Disparity in bargaining power between franchisors and franchisees. Proponents of the 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 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).) AB 525 Page 8 This bill is opposed by the International Franchise Association (IFA), who contends that the 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 the bill, including franchisee associations and organized labor, counter that the bill is simply intended to prohibit tactics used by bad actor franchisors, while upholding the current relationship between franchisors and franchisees. Substantial compliance standard applied to termination and renewal. Business and Professions Code 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. 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 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. In AB 525 Page 9 addition, the bill would also prohibit a franchisor from failing to renew a franchise unless the franchisee has failed to substantially comply with the franchise agreement. According to the author, this provision ensures fairness to franchisees by barring the termination or nonrenewal 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." In opposition to the bill, IFA contends that the failure to define "substantial compliance" in the bill will lead to uncertainty and litigation. They note, for example, that this provision would allow a franchisee to be renewed who only becomes substantially compliant in the last year of their contract, even though there may not have been substantial compliance throughout the entire franchise term. Proponents of the bill counter, rather convincingly, that the "substantial compliance" standard reduces, rather than increases, ambiguity 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. They 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.") Proponents 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 any, were so trivial that they could have been easily fixed or paid for." (CACI No. 312.) AB 525 Page 10 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 percent, as compared to the 18.9 percent growth rate for the other 39 states and the District of Columbia that have neither provision in law. Of those eleven states, five (Arkansas, Nebraska, New Jersey, Rhode Island and Wisconsin) 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 percent vs. 19.8 percent, 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. AB 525 Page 11 Terms of renewal. As previously mentioned, this bill seeks to prohibit the franchisor from failing to renew a franchise unless the franchisee has failed to substantially comply with the franchise agreement. If the franchisee is in substantial compliance with the franchise agreement at the time of the expiration of the franchise agreement, the bill permits the franchisee to renew for the same duration as provided in the expiring franchise agreement, and requires the renewal to be under the same terms that are being offered to new franchisees. This is needed, supporters contend, because at the time of renewal, the franchisor often uses its superior bargaining power to obtain new terms that may not be as favorable to the franchisee as the terms that persuaded him or her 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 bill appears to mandate renewal even if the franchise agreement does not grant a renewal right, and even though the parties understood at the inception of their relationship that there would be no contractual renewal right. Opponents assert that the bill fails to account for franchisors that may no longer wish to have franchises in the area currently being served, and that the bill unnecessarily changes a well-established law that has operated for over forty years, with the possible consequence of disrupting thousands of contracts already in place. Restrictions on transfer of franchise. Existing law limits the 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 AB 525 Page 12 franchisor. The bill requires the franchisor to approve the sale or transfer request without unreasonably withholding consent. Opponents contend again that the bill is too ambiguous because, for example, while the bill states that the transfer of a franchise must be to a person "qualified under the contract," it also requires that approval must be based upon a "reasonable standard," without defining this term. Because the bill also requires the trier of fact to make this determination, opponents contend the transfer provisions will lead to uncertainty and increased litigation costs for both the franchisor and franchisee while increasing the burden upon our courts. Proponents contend that the bill does not increase uncertainty, but in fact reinforces provisions already contained in franchise agreements by requiring new franchisees to meet the franchisor's then existing and reasonable standards for approval. 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. 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 AB 525 Page 13 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 likely lead to litigation in California. 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 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 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." (Section 20021(e).) Supporters of the 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, the 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. AB 525 Page 14 Previous related legislation. SB 610 (Jackson) of 2013 would have explicitly required franchisors and franchisees to negotiate in good faith, and would have permitted termination of a franchisee only in instances of a "substantial and material" breach of the franchise agreement. SB 610 was vetoed by Governor Brown, who characterized the "substantial and material breach" standard as unknown and untested. To remedy the Governor's concerns on this point, this bill instead applies the "substantial compliance" standard, rooted in well-established case law dealing with "substantial performance" of contracts. Additionally, as the author notes, substantial compliance is the standard used in franchise law in five other states, with the first such state adopting this standard back in the early 1970's. AB 2305 (Huffman) of 2012 would have enacted several reforms to the CFRA, as well as the California Franchise Investment Law, among them requiring "substantial and material" breach to terminate early; prohibiting provisions restricting venue for resolution of disputes solely to a forum outside of this state; and requiring good faith in the performance and enforcement of franchise agreements. AB 2305 failed in Assembly Business and Professions Committee after passing this Committee. ARGUMENTS IN SUPPORT: The bill is supported by associations of franchisee business owners and organized labor. In addition to many of the arguments discussed above, these organizations support the bill because of its potential benefits to the working-class employees of mostly small-business franchisees. For example, SEIU writes in support: This bill will impact over 83,000 franchised establishments that employ more than 925,700 workers in California. Fast food restaurants are the biggest employers in the franchise sector, and fast food AB 525 Page 15 workers and franchisees share a common problem-the unchecked power of big corporations. AB 52 protects franchisees against franchisor abuse, giving franchisees the opportunity to grow profitable businesses, achieve financial security and pass some of their gains to their workers in the form of higher wages and benefits. ARGUMENTS IN OPPOSITION: This bill is opposed by the International Franchise Association (IFA), representing franchisors. In addition to the arguments discussed previously, IFA also contends that existing California law and the Federal Trade Commission (FTC) already require extensive disclosure documents to ensure that both parties know what is expected from the other before they enter into a franchise agreement. Among other reasons for their opposition, IFA writes: Franchisors impose standards and expectations on all franchisees to protect the brand's reputation for other franchise owners nearby, and, ultimately, the general public - their collective customer. This bill would result in allowing sub-standard franchise outlets to continue offering inferior products and services to consumers. [In addition] during a period of stagnant growth globally, franchisors, like many other businesses, are being extremely judicious with their investment capital, yet according to IHS Global Insight and ADP, franchise businesses have been expanding at a greater rate than non-franchised for the five years since the Recession. Passing burdensome legislation as AB 525 would undoubtedly force franchisors to look to other states to expand their brands - taking jobs and new businesses with them. AB 525 Page 16 REGISTERED SUPPORT / OPPOSITION: Support Coalition of Franchisee Associations (sponsor) ARCO Travel Zone Center California Labor Federation Coalition of Franchisee Associations (CFA) Independent Organization of Little Caesar Franchisees (IOLCF) Lagarias Law Offices Pacific Management Consulting Group Plumbing-Heating-Cooling Contractors Association of California (CAPHCC) Service Employees International Union (SEIU) Small Business Majority AB 525 Page 17 Small Business California Numerous individuals Opposition International Franchise Association (IFA) Analysis Prepared by:Anthony Lew / JUD. / (916) 319-2334