New California Franchise Law Provides More Rights to Franchisees, Burdens for Franchisors

May 22nd, 2016

by David L. Cahn and Jordan M. Halle

Effective for franchise agreements entered into or renewed this year, new amendments to the California Franchise Relations Act impose significant restrictions on franchisor’s termination or refusal to renew franchise agreements, increase franchisor’s post-termination obligations, and bolster franchisees’ rights to sell their franchised business. These changes make California a somewhat more risky state in which to use franchising as a growth strategy, while arguably bolstering the security of franchisees’ investments in mature brands.

Restrictions on Termination:  a franchisor must have “good cause” to terminate a franchise, and “good cause” for termination is limited to a franchisee’s failure to “substantially” comply with the lawful requirements of the parties’ franchise agreement.  Generally franchisors must provide at least 60 days, but not more than 75 days, to cure a material default.  Franchisors may still terminate for certain “serious” defaults with less than 10 days’ notice, such as failure to pay fees, abandonment, and repeated defaults.  New sanctions available to franchisees terminated or refused renewal without good cause include damages in the amount of the fair market value of the franchised business and assets, and preliminary and injunctive relief for a franchisor’s violation of the statute.  Expect plenty of litigation over whether there was “substantial” noncompliance and a “material” default by a terminated franchisee.

Post-termination repurchase obligation: California always has been a state where franchisors had to approach a decision to terminate with caution, because of a California statute that prohibits enforcement of covenants not to compete as well as case law making it difficult to collect lost future profit damages from terminated franchisees.  Now, absent certain exceptions, a franchisor must buy from the terminated franchisee all inventory, supplies, equipment, fixtures and furnishings that the franchisee had purchased due to a franchise agreement requirement – even if termination is due to the franchisee’s material default.  Any money owed by the franchisee to the franchisor may be offset against the repurchase price for such items.  Notable exceptions to the repurchase requirement are if the franchisee declined the franchisor’s renewal offer, or if the franchisor permits the former franchisee to retain control of the business location after termination.

Right to Transfer:  Franchisors now may not prevent a franchisee from selling the business’s assets or an interest in the business, except if the buyer does not meet the franchisor’s standards for new franchisees or if the franchisee and buyer fail to comply with other reasonable requirements of transfer in the franchise agreement.  The franchisor must provide the franchisee and prospective buyer with written standards by which it determines whether a prospective franchisee is acceptable, and if denying transfer approval on the basis of non-suitability must explain why the proposed buyer does not meet one or more of the standards.  Franchisors may enforce right of first refusal provisions in the franchise agreement, provided that the franchisor pays equal to or greater than the price offered by the prospective buyer.

Conclusion: The new California laws generate issues with the franchise agreement, franchisor operations, and franchisor/franchisee relations that any franchisor selling franchises in California should have reviewed and addressed by an attorney.  Please contact us for further information and advice.