Two state laws govern franchising in California: the California Franchise Investment Law (Cal Corp Code 31000 et seq), which governs the offer and sale of franchises in California; and the California Franchise Relations Act (Cal Bus & Prof Code 20000 et seq), which governs the termination and non-renewal of franchises. Both laws are in flux: pro-franchisee amendments to the California Franchise Relations Act were passed in late 2015 and pro-franchisor amendments to the California Franchise Investment Law are pending.

California Franchise Relations Act amendments

In October 2015 California Governor Jerry Brown signed AB 525,(1) which substantially amended the California Franchise Relations Act. The final version of AB 525 resulted from a compromise between the International Franchise Association and the Coalition of Franchisee Associations after a more onerous version was originally proposed. The modified act applies to franchise agreements entered into or renewed on or after January 1 2016, and to any franchise agreement of indefinite duration that may be terminated without cause. It does not apply to franchise agreements executed before January 1 2016, even if the relevant termination, non-renewal or transfer occurs in 2016 or later.

Termination

The California Franchise Relations Act prohibits a franchisor from terminating a franchise agreement prior to the expiration of its term unless it can articulate 'good cause' for early termination. Under the prior version of the law, 'good cause' included a franchisee's failure to comply with any lawful requirement of the franchise agreement after being given notice and a reasonable opportunity to cure the failure within 30 days. The amended act limits 'good cause' to a franchisee's failure to 'substantially comply' with the lawful requirements of the franchise agreement and requires franchisors to give franchisees at least 60 days to cure the breach. Franchisors may continue to terminate franchisees upon 10 or fewer days' notice for certain egregious material defaults (eg, failure to timely pay amounts due to the franchisor, abandonment or unauthorised transfers).

Transfer

Under the amended California Franchise Relations Act, a franchisor may not prevent a franchisee from selling or transferring the franchise, all or a substantial part of the assets of the franchised business or an interest in the franchised business or franchisee entity to a person that otherwise meets the franchisor's then-current standards for new or renewal franchisees. The revised law requires the franchisee to notify its franchisor in writing of its intent to sell, transfer or assign and to provide certain information about the proposed buyer. Within 60 days of the franchisee's request, the franchisor must inform the franchisee in writing of its approval or disapproval of the sale. A franchisee's proposed sale, assignment or transfer is deemed approved unless the franchisor identifies reasonable grounds to disapprove such request within the 60-day deadline.

Franchisor obligations on lawful termination or non-renewal

The most significant changes to the California Franchise Relations Act concern a franchisor's obligations, and a franchisee's rights, when a franchisor terminates or fails to renew. Prior to the 2015 amendments, the act required a franchisor that improperly terminated or failed to renew a franchise to offer to repurchase the franchisee's resalable current inventory. The amended act goes much further. Subject to a few exceptions, a franchisor, on lawful termination or non-renewal of a franchisee, must purchase from the franchisee at the value of price paid, minus depreciation, "all inventory, supplies, equipment, fixtures, and furnishings" purchased or paid for under the franchise agreement for which the franchisee can provide clear title and possession. The franchisor may offset any amounts owed by the franchisee to the franchisor from the purchase price.

Remedies for wrongful termination or non-renewal

Under the revised California Franchise Relations Act, if a franchisor terminates or fails to renew a franchisee in violation of the act, the franchisee may recover "the fair market value of the franchised business and franchise assets" and any other damages caused by the franchisor's violation. In addition, a court may enjoin violations or threatened violations of the act.

Proposed California Franchise Investment Law amendments

Passed in 1970, the California Franchise Investment Law generally requires franchisors to register with the California Department of Business Oversight (DBO) before offering and selling franchises in California. The law also requires franchisors to make certain pre-sale disclosures to prospective franchisees. Two bills currently pending before the California legislature would ease some of the law's more onerous restrictions on franchisors.

AB 1782 would create a new exemption to the law that would permit a franchisor or prospective franchisor to exhibit at a franchise trade show in California without first having to register with the DBO. Under the proposed exemption, exhibiting at a trade show alone would not constitute an "offer to sell".(2) To take advantage of the exemption, a franchisor or prospective franchisor would be required to:

  • file an exemption form with the DBO at least 14 days before the trade show; and
  • post a notice at its trade show booth explaining that
    • the franchisor is not offering a franchise for sale in California;
    • the franchisor cannot legally offer a franchise for sale in California; and
    • any attempt by the franchisor to offer a franchise for sale or solicit a purchase in California should be reported.

AB 2637 would amend the law's requirements regarding disclosure of negotiated sales.(3) The law currently requires a franchisor to make certain disclosures to prospective franchisees regarding terms that were negotiated with prior California franchisees that modified the standard franchise agreement contained in the registered franchise disclosure document. AB 2637 would delete this requirement and would allow franchisors to negotiate freely with California prospects if the franchisor:

  • includes a statement in its franchise disclosure document that California law does not prohibit a franchisor from negotiating, or require a franchisor to negotiate, its standard franchise agreement or related agreements;
  • retains copies of material negotiated terms for five years; and
  • certifies its compliance in its annual renewal application.

AB 1782 and AB 2637 both passed in the California Assembly in April 2016. They now move on to the California Senate. If passed by the California legislature, the bills will proceed to the California governor for signature.

For further information on this topic please contact Jess A Dance at Gardere Wynne Sewell LLP by telephone (+1 720 437 2011) or email (jdance@gardere.com). The Gardere Wynne Sewell LLP website can be accessed at www.gardere.com.

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