In response to perceived overreaching and abuse by franchisors, the California legislature amended the Franchise Relations Act (CFRA) strengthen franchisees’ rights regarding terminations, non-renewals, and franchise transfers. The changes are effective January 1, 2016.
Termination Rights
Franchisors retain the right to terminate franchisees without providing a right to “cure”, for reasons such as the abandonment of the business, non-payment of fees for more than 5 days after notice, misrepresentation, misuse of brand license, unauthorized transfers, and repeated breaches of the agreement.
For other types of franchisee defaults, the amendments allow termination only for “good cause” (failure to “substantially comply” with any lawful provision) and provide a 60-day cure period. In the future, in performance disputes, the issue will be whether the franchisee’s performance “substantially complied” with the franchisor’s sales metrics.
A franchisor which terminates or non-renews without “good cause” is liable for the fair market value of the franchise plus other, demonstrable damages.
Buyback Rights
Notably, under the new CFRA amendments, if a franchisor lawfully terminates or refuses to renew a franchise but continues to control the franchise premises, the franchisor is obliged to pay the former franchisee its original cost less depreciation of all inventory, supplies, equipment, fixtures, and furnishings purchased by the franchisee. The franchisor does have set-off rights for amounts owed by the franchisee. This new buyback provision does not apply: (i) if the parties agree to terminate or not renew the franchise; or (ii) if the ex-franchisee cannot not transfer clear title and possession of the franchise assets to the franchisor.
Transfers
Previously, a franchisor could refuse a franchisee’s request to sell its business or forbid a franchisor from refusing to consent to a transfer without offering a reason. Under the new CFRA amendments, a franchisor may not prevent a franchisee from selling or transferring the franchise to a buyer who meets the franchisor’s standards for new franchisee sales or transfers. The CFRA amendment overrides express contract provisions that purport to give franchisors discretion to reject buyers for any reason but does not prevent franchisors from exercising a first purchase right.
Conclusion
The new CFRA provisions increase franchisors’ uncertainty and risk, which will likely be reflected in higher franchisee fees. And apart from the many legal questions raised by the amendments, it remains to be seen what effect the new “substantial compliance” standard will have on consumer brand expectations, and consistent product and service quality