Amendments to California Franchise Laws Proposed

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

California has recently introduced legislation that would make numerous modifications and additions to both the Franchise Relations Act and the Franchise Investment Law.

Franchise Relations Act

The "Level Playing Field for Small Businesses Act of 2012" would amend the Franchise Relations Act to provide that good cause in a termination case consists of a substantial and material breach of the franchise agreement after the franchisee is given written notice and 60 days to cure the failure.

The bill would would be require terminations to be in accordance with the current terms and standards equally applicable to all franchisees, with limited exceptions. Exempted would be situations in which immediate termination of a franchisee was reasonable where the franchisee establishes that the event was caused in substantial manner by conduct of the franchisor.

Under the measure, immediate termination would not be permitted unless the franchisee’s noncompliance was substantial and material. The proposal would delete existing provisions regarding nonrenewals by a franchisor and instead require a franchisor to renew a franchise unless the franchisee has substantially and materially breached the franchise agreement, and would require the renewal to be under the same terms as the existing agreement, or if the franchisee elects, under the franchise terms then being offered to new franchisees.

The bill would also prohibit a franchisor, upon termination or expiration of a franchise, from enforcing against the franchisee any covenant not to compete and require the parties to a franchise agreement to deal with each other in good faith.

Franchise Investment Law

The measure would amend the Franchise Investment Law by making it unlawful for a person offering or selling a franchise to intentionally misrepresent, among other things, the prospects or chances for success of a franchise, the known required total investment for a franchise, and efforts to sell or establish more franchises than a market or market area can sustain.

Under the proposal, it would be unlawful for a franchisor to refuse to recognize and deal fairly and in good faith with an independent franchisee association. In addition, civil liability for damages would be extended to any violation of the Franchise Investment Law.

The proposal, Assembly Bill No. 2305, was introduced February 24, read the first time on February 27, and referred to Committees on the Judiciary on March 26. Text of the bill appears here on the California Legislative Information website.

Injunction Preserves McDonald’s Franchises Pending Trial of Renewal Claims

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A franchisee of several McDonald’s restaurants was reasonably likely to succeed on the merits of his claim that the franchisor had agreed to renew his three franchises with fewer than five years remaining on the agreements, a California trial court has decided. Moreover, the balance of the harms tipped strongly in favor of a preliminary injunction allowing the franchisee to continue operating the three McDonald’s franchises pending a full adjudication on his claims. Accordingly, the franchisee’s request for a preliminary injunction was granted.

A concurrent request by McDonald’s for a preliminary injunction to prevent the franchisee’s “unauthorized use” of its trademarks at the three restaurants was denied.

Offer to Extend Franchises

Shortly after purchasing seven existing restaurants from another franchisee (including the three at issue), the franchisee alleged that McDonald’s had made a written offer to extend the agreements for the three restaurants for a 20-year term and that the franchisee had mailed McDonald’s an acceptance.

A McDonald’s employee admitted that she sent a letter offering a new 20-year term for one of the franchises, but testified that she never received a response. She further alleged that she left a voicemail with the franchisee about the offer and sent a follow-up letter after the offer expired, but never received any reply.

At trial, a jury could interpret the assignment agreement by which the franchisee acquired the seven additional franchises in accordance with a broader understanding between the parties under which McDonald’s had agreed to grant the franchisee franchise extensions for those that were due to expire soon, the court determined.

In fact, the evidence indicated it would have been "extraordinary, harsh and unjust" if the franchisee had been expected to invest the $10.5 million that he invested in the acquired franchises only to have several of them expire without extension within five years.

While acknowledging that some evidence could be considered as supporting either side, the court found a reasonable likelihood that the trier of fact would accept the franchisee’s view of the evidence.

Balance of Harms

The franchisor argued that allowing the franchisor to continue operating the franchises after expiration of the franchise agreements would be “potentially damaging” to its business model, goodwill, and trademarks. However, there was no showing that the McDonald’s brand was suffering from the franchisee’s operations. The franchisee had a long history of protecting the brand and had no interest in damaging it at this point.

In contrast, there was a real possibility of serious and possibly catastrophic results for the franchisee if the three franchises were turned over to McDonald’s. Thus, the balance of harms clearly favored the franchisee, the court ruled.

The decision is Husain v. McDonald’s Corp., Superior Court, Marin County, California, CCH Business Franchise Guide ¶14,530.

Renewal of Franchises Did Not Trigger California Disclosure Obligation

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A gasoline station franchisor did not violate the California Franchise Investment Law (CFIL) by failing to make prescribed disclosures when it renewed the agreements of many of its franchisees, the federal district court in San Jose, California, has ruled.

The franchisor’s motion to dismiss the franchisees’ Franchise Investment Law claim was granted, and the franchisees were given 20 days leave to amend.

Renewal as “Offer” or “Sale”

The CFIL did not require the franchisor to make the disclosures specified in the claim when an existing franchise agreement was renewed, the court held. Franchise renewals were excluded from the statutory definitions of “offer” and “sale.”

The CFIL was enacted to ensure that prospective franchisees were adequately informed of their duties and obligations under franchise relationships before entering into them, the court observed.

The franchisees cited dicta from an unpublished decision to support their argument that disclosure obligations applied whenever a franchise agreement was renewed. The franchisor correctly noted, however, that the cited statement was dicta, the decision an unpublished one, and a subsequent decision in that same case confirmed that the CFIL did not apply to renewals of existing franchises.

Modification of Franchise Agreement

The franchisees contended that service station rent increases put into effect upon nonrenewal constituted “material modifications” of the franchise agreements under the meaning of the CFIL, triggering the disclosure requirements.

Even assuming that the rental increase was a material modification, such modification would not give rise to a suit for damages under the statute for failure to provide the comprehensive disclosures required for an offer or sale of a franchise to a prospective franchisee, the court held.

The June 2, 2010, decision is In re: ConocoPhillips Co., CCH Business Franchise Guide ¶14,397.