BILL ANALYSIS                                                                                                                                                                                                    Ó



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          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  








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          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.










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          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.










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          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  








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            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  








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            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  








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               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).)   








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          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  








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          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.)








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          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.










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          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  








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          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  








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          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.









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          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  








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               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.









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          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









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          Small Business California


          Numerous individuals




          Opposition


          International Franchise Association (IFA)




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