Where is the win-win in franchising? It is right in front of us. According to a report furnished by PricewaterhouseCoopers for the International Franchise Association, almost 30,000 franchise businesses in Pennsylvania employ 318,600 workers in franchised restaurants, hotels, retail outlets and service franchises. Service franchises include businesses that support personal, business, commercial and residential real estate needs and automotive categories. Pennsylvania prospers because the franchise model works as it does.
But does it work for the franchisees? HB 1620 was introduced in Harrisburg on June 24 and hearings are being conducted. The bill intends to establish "responsible franchise practices" and level the playing field for franchisees. The assumption is that franchisees are subject to unfair treatment by franchisors in the sale and operation of their businesses. The bill creates penalties and remedies, and would confer powers and duties upon the Department of Community and Economic Development.
Pennsylvania courts have been dealing with franchise issues for decades. The collaborative relationship between franchisors and franchisees exists and flourishes because when the franchisee grows, the franchisor grows. Their business interests are generally aligned because a franchisor cannot grow unless its franchise outlets grow through successful franchises. The tensions in the business relationship generally arise from branding issues. Franchisees want less competition from other franchisees in the same system. Franchisors want more outlets and better brand penetration so their customers have many convenient outlets to choose. Franchisees want all of those customers to themselves. Franchisors just want the customers to be happy and the franchisees to be profitable. Franchisees want to innovate. Franchisors want franchisees to follow the system. Franchisees do not want to spend money for refurbishing if it is not a good investment. Franchisors do not want their older locations looking like museums. Their tensions are the subject of proper and legitimate business discussions, and sometimes even develop into lawsuits.
Court decisions have refined the concepts of good faith and fair dealing to help adjust these tensions. Good faith is implied in all contracts falling under the Uniform Commercial Code and now has developed so that it is implied in almost all contracts. Good faith under the UCC means honesty in fact and objective honesty under the circumstances. But when coupled with the "fair dealing," good faith is modified to imply that not only honesty is required, but also fairness. Courts have been interpreting what good faith and fair dealing means for decades, and through constant refinement, have created a substantial body of law.
Nevertheless, HB 1620 seeks to impose a legislative overlay upon decades of court decisions. The bill seeks to rewrite existing franchise agreements by inserting non-negotiable provisions. All franchise agreements would be perpetually renewable, so that unless "good cause" exists, such as the franchisee committing a material breach, it would enjoy an evergreen arrangement. Franchisors are worried because "good cause" is undefined. This provision of the bill would undermine a franchisor's decision whether to renew or require a transfer of the franchise because the franchisee was underperforming. From the franchisor's point of view, this impinges on the ability to allow fresh blood into the franchise system with energy and ideas that can improve the brand. Franchisors oppose this permanent tenure for franchisees. It would allow franchisees to hold the franchise brand hostage by having franchisees drag their feet on improvements to their business knowing that it is difficult to compel their compliance through the renewal protocols and processes.
Similar to the changes in renewal, good cause will also be required for franchise terminations. No one knows if good cause in this context will be mere uncured breaches of contract or whether material breach will be required. If the franchisee misses five months of payments, will that be sufficient for it to lose its livelihood, especially if the franchisor is an industry giant? On the other hand, why should noncompliant franchisees have a free ride and enjoy rights to a contract no other industry would allow?
The bill also would reduce the requirements of franchisees on transfer. This is a double-edged sword. The ability to readily transfer franchises increases their resale value, which is good for existing franchisees and good for the franchisor. Increased franchise unit values helps sell new franchises. But the bill may undermine protections to the brand on transfer and the ability to improve the quality of the franchisee. As franchise systems mature, so can the quality of their franchisees. Rather than sell to the highest bidder, the franchisor wants to have a veto right over the transfer to ensure it goes to both the highest and most responsible bidder. This bill will impair that practice and increase risks to the brand by liberalizing transfer requirements.
The offer and sale of franchises is regulated by the Federal Trade Commission. Pennsylvania currently does not have a law that regulates the relationship in franchising and has been satisfied to allow court decisions to adjust the relationship. This franchise bill would change the legal landscape and would impose legislative dictates on franchise contracts in Pennsylvania that exist in no other state. We will see if this bill survives the hearings on the franchise relationships in Pennsylvania.
First published in The Legal Intelligencer.