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The Sound and Fury Over California SB 610

After months of debate, California SB 610, intended to protect the rights of franchise owners, sits on the governor’s desk, awaiting signature. The editorial board of The Los Angeles Times has urged the governor to veto it, describing it as a measure that somehow simultaneously restates existing law and invites courts to re-write contracts for reasons of public policy. Others view the measure as pro-small business, since these businesses are likely the franchisees. Some see it as improving the ability of fast-food workers to negotiate for higher wages.  Or perhaps it’s about brand standards and economic discrimination in lower income communities. It seems quite a burden of significance for some relatively straight forward legal language.

SB 610 limits what can be provided in the contract between the corporate parent (franchisor) and the local operator (franchisee) and it limits the franchisor’s rights on termination or non-renewal of a franchise. The significance of these limits has yet to play out, but it is not clear that it would necessarily lead to any of the consequences foreseen by proponents or opponents.

 What SB 610 Changes

If signed by the governor, the following four things could no longer be included in the franchise agreement:

  • Neither party can require the other to waive the requirement of good faith and fair dealing. This requirement arguably already exists.
  • The franchisee cannot be prevented from joining or participating in an association of franchisees.
  • The contract may not prevent a franchisee from selling the franchise or an interest in it to someone else.
  • However, the agreement may require the franchisee to give notice to the franchisor and obtain the franchisor’s consent to the transfer.

In addition, the franchisor’s actions are limited in two ways:

  • A franchisor may not terminate a franchise agreement before the expiration of its term unless the franchisee breaches the agreement in substantial and material ways. This is a change from current law, which just requires “good cause,” and the occurrence of specified events. It appears to offer greater protections to franchisees.
  • If the franchisor terminates the franchise or does not consent to its sale, the franchisee may, at the franchisee’s choice, either be reinstated with damages, or paid the fair market value of the franchise and franchise assets. This change also appears to expand the franchisee’s currently existing right to require the franchisor to repurchase salable inventory.

 What Does This Mean for Franchisors?

It is not clear that, as feared, this would make it more difficult to terminate the franchise of an under-performing or substandard franchise. Those reasons would simply have to be cast as “substantial and material” breaches of the agreement. This suggests that franchise contracts will become far more specific in outlining economic and operating standards. It could become far more expensive for a franchisor to refuse a request to sell the franchise or an interest in it to another party. The franchisor could end up in a contractual relationship with an entity that it would not otherwise have chosen to do business with. It could, and probably will, be argued that this interferes with franchisor’s freedom of contract.

 What Does This Mean for Franchisees?

It is not clear what a new-found freedom to associate with other franchisees would mean. Trade groups perform any number of roles, including the development of best practices, industry self-regulation and lobbying activities. It is clear, however, that these changes could be very meaningful in protecting the value of a franchisee’s investment in the franchise. The apparent relaxation of restrictions on the sale of the franchise turns it into a far more liquid asset. It would not be surprising to see more disputes about how to calculate the fair market value of a franchise. More litigation focusing on the meaning of “substantial and material breach,” or the circumstances under which a franchisor might reasonably refuse to consent to the sale of the franchise or interest may also be in the offing.

What Does It Mean for Workers?

The Service Employees International Union of California has supported the bill, as a measure for fairness for franchisees. Except for the fact that employees might find themselves negotiating more directly with owners of potentially more valuable franchises, it is not clear  what effect it would have on wages. They seem unlikely to go down, but going up is far more dependent on overall economic conditions and changes in minimum wage laws.

What Does It Mean for Consumers?

Will the product or the service in fast-food restaurants and muffler shops suddenly get worse?  It seems that concern about operating standards will simply shift from the franchisor to the franchisee.  It is conceivable that this might lead to less standardization, although, that is not necessarily the same as a decline in quality.  As with wage concerns, this seems more likely to be the product of economic conditions or managerial talent than contract provisions.

And so we wait, with bated breath, to see if Governor Jerry Brown will sign SB 610. Owning a franchise is often the first step for entrepreneurs. It can set a small businessperson up for bigger and better things, or it can flame out ignominiously.  The law appears to tip the balance slightly in favor of the franchisee.  Franchisors and, to a lesser extent, workers and consumers also have a stake in this, however.

Nasir Pasha, Esq.

Post by:

Managing attorney and co-host of podcast Legally Sound | Smart Business

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