New California Franchise Law Will Make Franchisors Think Twice About Termination

December 7, 2015

In October, California Governor Jerry Brown signed the strongest law for protecting franchisees in the nation. While California has been leading the efforts around regulating franchising since the 1970’s, this law moves the franchisee rights forward leaps and bounds compared to other measures.

This new law, Assembly Bill No. 525, put drastic restrictions on the ability for a franchisor to terminate a franchisee. Here is the exact language:

“This bill would instead limit good cause to the failure of the franchisee to substantially comply with the lawful requirements of the franchise agreement imposed on the franchisee after being given notice at least 60 days in advance and would require that the period for a reasonable opportunity to cure the failure be no less than 60 days from the date of the notice of noncompliance.”  

In short, this law limits the items franchisors are able to terminate the agreement to “failure to substantially comply.“ Everything in this bill stacks the deck in favor of franchisees making it exceptionally difficult to terminate an agreement or block a renewal.

The bill did state a few specifics.

In reality, most of the items the bill outlines are already in your typical franchisee agreement.

Where we run into trouble is the word “substantially comply.” While there was some language outlining cut and dry actions that merited a termination further in the bill, in reality it mirrored language you typically find in the franchisee agreement. This is left largely up to interpretation. At most the word substantial is vague. In the franchising world, we will have to wait for these measures to be tested out through the court system to bring clarity. 

Not exactly the type of black and white ruling many of us desire from our legal system.

Additionally, the majority of recent regulations have been in favor of franchisees.  With that precedent, franchisors will give serious pause prior to terminating or not renewing an agreement.

Which is what the bill hopes to achieve.

The need for the law is debatable. Obviously Governor Brown feels it is warranted.

Advocates for the law have painted franchisors as heartless corporations looking to suck the financial life out of franchisees. In my regular interactions and working with franchisors, I have found this to be far from the case.

As a part owner in a franchise, I personally believe whimsically terminating and pillaging, as some of the advocates for the law have suggested, franchisees is bad for business. Like other franchisors, the best practice for the growth of the brand is to equip franchisees to succeed in the franchise. The more operators you have succeeding, the more profitable the entire organization is. When you start removing operators that reflects poorly on the entire franchise. Prospective franchisees complete due diligence prior to buying. If you have a speckled past lined with former franchisees taken advantage of, recruiting will become an impossible task.

But here’s the real kicker: 

“Upon a lawful termination or nonrenewal of a franchisee, the franchisor shall 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 terms of the franchise agreement…”

So not only have we drastically limited the ability for franchisors to terminate a bad operator, once they have the legal standing to terminate them, they must purchase all the equipment, fixtures and other required items.

By the way, that word “shall” in legalese is absolute. There is no wiggle room when a document uses the word shall.

I personally believe this section will have the most far-reaching implications in the franchise world.

Not only do you have legal roadblocks, now you have substantial financial barriers for terminating bad operators. When faced with the decision, many franchisors may choose to keep unsuitable franchisees in place rather than navigate the legal obstacle course and forfeiting the equipment costs.

Other franchisors might get creative and build a hierarchy rewarding good operators while limiting the benefits for bad apples.

We will see the most innovations around this particular section in the bill. 

The bill goes into effect on January 1st 2016. While not retroactive, it will be applied to any new franchise agreements as well as renewals following that point. If you own a franchise, it is a good time to review the FDD and tighten up your language around termination.