California’s Governor Brown Does the Right Thing

california_franchise_law_vetoThe big news in franchising last week was a nonevent.  Legislation in California that never should have become law did not become law.  The credit for this nondevelopment goes to Governor Jerry Brown, who vetoed Senate Bill 610, saying that if the legislation were to become law, it would “significantly impact California’s vast franchise industry.”  He wrote in his veto message that he needs “a better explanation of the scope of the problem” so he is “certain that the solution crafted will fix those problems and not create new ones.”

California has long regulated franchising.  The California Franchise Investment Law, passed in 1970, was the first registration and disclosure law in the U.S. governing franchise sales.  Other states followed, while some states also added laws that required good cause for termination, often called “relationship” laws.  California’s relationship law, the California Franchise Relations Act (CFRA), was enacted in 1980, making California one of only a handful of states that have laws governing both franchise sales and franchise relationships.

The proposed legislation, Senate Bill 610, would have given franchisees additional rights under the CFRA.  Notably, it would have prohibited any franchisor from terminating a franchise agreement unless the franchisee has committed a “substantial and material breach” of the franchise agreement.  The CFRA already limits termination by requiring the franchisor to have “good cause,” which is defined as conduct that includes, but is not limited to, a breach of a lawful provision of the franchise agreement.

By changing the law to allow termination solely for a substantial and material breach of the franchise agreement, franchisors likely would have engaged in detailed reviews of their franchise agreements and made these lengthy agreements even longer by including every imaginable basis for termination, each of which the agreement would explicitly define as a “substantial and material breach”.

The bill would almost certainly have also resulted in more litigation, as franchisee counsel would have sought judicial clarification of the exact meaning of a “substantial and material breach”.

It might have also damaged franchise systems by giving franchisors pause before terminating a franchise agreement when a franchisee fails to meet system standards.  A diminution of standards damages a brand.  It’s bad for other franchisees, for customers and for the business model of franchising.  If it had been enacted, this legislation might have also made franchisors less willing to expand their franchise systems into California.

In addition to raising the bar on franchise terminations, the vetoed legislation would have prohibited franchisors from arbitrarily preventing franchisees from selling their franchised businesses.  Franchisors would have been prohibited from unreasonably withholding their consent to a transfer.  The meaning of “unreasonably withheld” would certainly have been litigated and might at times have resulted in selection of inferior franchisees.

Finally, the bill would have given franchisees the statutory right to join franchisee associations, a change that appears to be uncontroversial but also unnecessary.

Tom Pitegoff

About: Tom Pitegoff

Tom Pitegoff is co-chair of the LeClairRyan franchise industry team. He is an internationally recognized leader in the franchise field. He drafts franchise agreements and disclosure documents, obtains state franchise registrations and provides ongoing franchise compliance counseling services. He represents foreign franchisors in their U.S. business and U.S. franchisors expanding abroad. View all posts by Tom Pitegoff
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