iStock_000017765581XSmallCalifornia recently made new amendments to its franchise law, California Franchise Relations Act (“CFRA”) (Cal. Bus. & Prof. Code §20000 et seq.), which regulates franchisee-franchisor relationships. These amendments, which will affect franchise agreements entered into or renewed after January 1, 2016, substantially change the laws in that state dealing with franchise terminations and renewals. The changes are summarized below.

Franchise Terminations

The revised CFRA creates substantial new limits on a franchisor’s ability to terminate its franchisees, as follows:

             ‘Good Cause’ Restricted to Substantial Compliance.  Under the CFRA, a franchisor must have “good cause” to terminate its franchisees prior to the expiration of the franchise term. The new law states that “good cause” is now limited to a franchisee’s failure to substantially comply with the lawful requirements of the parties’ franchise agreement. This is less open-ended than the former version of the law, which stated that “good cause” included (but notably is not limited to) the failure of a franchisee to comply with any lawful requirement of the franchise agreement after being given notice and an opportunity to cure the failure.

            60-Day Cure Period.  The previous version of the CFRA did not set any minimum number of days that a franchisor was required to provide a franchisee to cure a default before a franchise agreement was terminated. The amended law now requires the franchisor to provide a minimum of 60 days advance notice for a franchisee to cure a material default, measured from the date the franchisee is notified of the noncompliance.

Importantly, the 60-day cure period in the new law will not apply to every type of default.  A franchisor may continue to terminate franchisees upon ten or fewer days advance notice for certain types of time-sensitive material defaults, including those where the franchisee:

  • Fails to timely pay amounts due to the franchisor or its affiliate
  • Abandons the business
  • Engages in conduct that reflects materially and unfavorably upon the franchise system
  • Fails to comply with laws or regulations
  • Commits repeated defaults

Franchisor’s Obligations After Termination or Refusal to Renew

A franchisor now has new obligations to a franchisee that will affect the franchisor’s actions after terminating or refusing to renew a franchisee. These new obligations include:

            Obligation to Repurchase Assets. Where a franchisee is lawfully terminated or not renewed, the franchisor will now have the obligation to purchase from the franchisee “all inventory, supplies, equipment, fixtures, and furnishings purchased or paid for” by the franchisee if those purchases were made in accordance with the requirements of the franchise agreement. This repurchase requirement will not apply, however, where:

  • The assets to be purchased were not “reasonably required to conduct the operation of the franchise business;”
  • The franchisee is unable to give the franchisor clear title and possession to the assets;
  • The franchisee declined an offer from the franchisor to renew the agreement;
  • The franchisor does not prevent the franchisee from retaining control of the franchise business location after the termination or nonrenewal;
  • The franchisor’s termination or nonrenewal is based on a publicly-announced, nondiscriminatory decision to completely withdraw its franchise activity from the geographic market area where the franchisee is located; or
  • The parties mutually agree in writing to terminate or to not renew the franchise.

Again, this repurchase requirement applies to a termination or refusal to renew even where the franchisor terminated the franchisee for good cause. Critically, however, the franchisor is permitted to offset the purchase price of the assets against the money that the franchisee owes to the company.

            Damages for Failure to Comply with the CFRA. The new version of Section 20035 adds sharp new teeth for a franchisee claiming a CFRA violation. Under the new law, if a franchise company terminates or fails to renew a franchisee in violation of the CFRA, the aggrieved franchisee will be entitled to receive from the franchisor “the fair market value of the franchised business and franchise assets,” as well as any other damages caused by the franchisor’s violation of the CFRA.

Franchisee’s Right to Sell

Finally, AB 525 has created a new framework enabling franchisees to sell or transfer their businesses.  Specifically, the CFRA now requires the following:

            Right of Sale. Under the new law, a franchisor may not prevent a franchisee from selling: the franchise; all or substantially all of the assets of the franchise business; or an interest in the franchise business or franchisee business entity (whether controlling or noncontrolling) to another person, with limited exceptions.

            Required Notice. The revised CFRA will now require a franchisee to notify its franchisor, in writing, of its intention to sell all or substantially all of the franchise, the form of which is detailed under the new law.

            Notification Period. The franchisor must inform the selling franchisee of its approval or disapproval of a sale in writing within 60 days of its receiving from the franchisee all of the required documentation. If the franchisor does not approve the sale, it must inform the franchisee in writing of the reasons for its disapproval. Any failure by the franchisor to disapprove the sale within 60 days will result in the sale being deemed approved.

This new law significantly changes the landscape for franchisee-franchisor relations in California. Franchisors and prospective franchisees will need to be mindful of the January 1, 2016 implementation date and how the law will affect their relationships going forward.