California Court Applies Washington Franchise Law to California Franchise

This posting was written by John W. Arden.

A California garbage removal franchisee, bringing a wrongful termination action against its Canadian franchisor, was entitled to enforce a contractual choice of law in order to bring the action under the Washington Franchise Investment Protection Act rather than under the California Franchise Relations Act, according to a California court of appeals.

In 2003, the franchisee entered into an agreement to operate a franchise in the Los Angeles area with 1-800 Got Junk?, a franchisor headquartered in Vancouver, British Columbia.

The franchise agreement expressly provided that the contract be “construed and interpreted according to the laws of the state of Washington.” The franchisor’s Uniform Franchise Offering Circular stated that “Washington law governs this agreement, and this law may not provide the same protections and benefits as local law . . . ”

In May 2007, the franchisor terminated the franchise for failure to report some jobs and the gross revenues derived from such jobs and failure to pay a percentage of revenues to the franchisor. The franchisor maintained that the franchisee’s falsifying of reports was a material default of the franchise agreement, justifying termination of the franchise without an opportunity to cure.

The franchisee denied any wrongdoing, alleging that its drivers pocketed money from at least three jobs without reporting the payments to the franchisee or the franchisor.

The franchisee filed suit against the franchisor in Los Angeles County, charging that the franchisor terminated the agreement without cause, in violation of Section 19.100.180 of the Washington Franchise Investment Protection Act, which limits the circumstances in which a franchisor can terminate a franchise without providing notice or an opportunity to cure.

The franchisee also alleged breach of contract, breach of the implied covenant of good faith and fair dealing, tortuous interference with prospective economic advantage, defamation, and acting with a discriminatory motive under the California Fair Dealership Law.

Choice of Washington Law

In an unusual twist, the California franchisee pled application of Washington law, while the franchisor asked the California trial court to avoid its contractual choice of law in order to apply California law. The franchisor argued that the choice of law provision in its franchise agreement was unenforceable because there was no reasonable basis for application of Washington law.

Nevertheless, the trial court enforced the contractual provision, stating that there was a reasonable basis for the franchisor to designate Washington as the law governing the agreement, since Washington is the state closest to the franchisor’s Vancouver headquarters. The trial court found it puzzling that the franchisor’s founder and president said he did not know why Washington law was selected, since he was in a position to know.

“The objective facts are that it is reasonable for a company doing business in many states to designate the laws of one state in a contract that will be used in many states,” the trial court judge said. “If the company’s lawyers are already familiar with the laws of that one state and find them favorable, they will not have to spend so much time and energy learning the law of remaining states . . . “

The franchisor then sought a writ of mandate to vacate the trial court ruling.

The court of appeal found that there were two issues presented: (1) whether a reasonable basis existed for the parties’ choice of Washington law and (2) whether enforcement of the choice of law is barred by the California Franchise Relations Act.

Under California law, a contractual choice of law is enforceable unless either (a) the chosen state has no substantial relationship to the to the parties or the transaction and there is no other reasonable basis for the parties’ choice or (b) application of the law of the chose state would be contrary to a fundamental policy of a state that has a materially greater interest than the chosen state.

Reasonable Basis

Even though there was no substantial relationship between the franchisee or the transaction and the State of Washington, the franchisee satisfied the alternative prong of the test—that there was a reasonable basis for the selection of Washington law.

There is a benefit to a franchisor and franchise system in having a single set of rules to apply to all franchisees—a benefit that has been recognized by many courts examining choice of law issues, the court found. Further, the State of Washington is the closest U.S. jurisdiction to the franchisor’s headquarters in Vancouver.

Fundamental Public Policy

Moreover, the franchisor failed to establish that the application of Washington law contravened the fundamental public policy embodied in the California Franchise Relations Act.

The Franchise Relations Act serves to protect California franchisees from abuses by franchisors in connection with the termination and nonrenewal of franchises. The statutory scheme generally prohibits termination of a franchise prior to the expiration of its term except for good cause, which is defined as the failure to comply with any lawful requirement of the franchise agreement after being given at least 30 days notice and a reasonable opportunity to cure the failure. There are specific grounds for immediate notice of termination.

The Act includes an antiwaiver provision that “{a]ny condition, stipulation or provision purporting to bind any person to waive compliance with any provision of this law is contrary to public policy and void.”

Waiver of Compliance

The antiwaiver provision does not categorically prohibit choice of law provisions, the court held. It only voids choice of law provisions that require a franchisee to waive compliance with the protections of the Franchise Relations Act. Thus, the critical inequity is whether the enforcement of the choice of law provision in this case would diminish the franchisee’s rights under the Franchise Relations Act.

“A comparison of the CFRA and the WFIPA shows that Washington affords a franchisee far greater protection from summary termination of a franchise,” the court ruled.

While the California statute contained 11 grounds for immediate termination, without notice or right to cure, the Washington statute authorized such termination in only four situations: (1) the franchisee’s bankruptcy or insolvency, (2) the franchisee’s assignment for the benefit of creditors, (3) the franchisee’s voluntary abandonment of the franchise, and (4) the franchisee’s conviction or plea of no contest to a charge of violating any law relating to the franchise business.

Providing superior protection from summary termination is not a waiver of compliance with the California Franchise Relations Act, in the court’s view. “California public policy is not offended if the franchisor contractually obligates itself to give notice and an opportunity to cure in situations where the CFRA would permit immediate termination of a franchise.”

Accordingly, the enforcement of the choice of law provision was not barred by the antiwaiver provision of the California Franchise Relations Act, the court concluded.

The decision is 1-800-Got Junk? LLC v. Superior Court of Los Angeles County, B221636, filed October 21, 2010. It will appear in the CCH Business Franchise Guide.