California AB525 - What Has Been Achieved

09/09/2015
There was a lot of hand-wringing over AB525, the amendment to California’s franchise relationship law, when it was first proposed. Without a doubt, the version of AB525 being presented to Governor Brown for his signature is a significant improvement over the bill that Assembly Member Holden originally advanced. Both the IFA and the CFA should be applauded for their effort in working together to find a workable solution.

Despite the efforts of SEIU to fragment the franchise relationship, through AB 525, as a solution to their dire need to rapidly organize new pools of labor, the collaboration between the CFA and IFA on this measure is likely a setback to those efforts.
On its surface, AB525 may appear to be a victory for franchisees and others that fought for its adoption.
Advancing a decidedly franchisor-centric point of view, AB525:
Requires a franchisor to wait up to 75 days, and maybe longer, before taking any effective action against a franchisee in many situations;
Effectively puts the rights of franchisees that violate franchise agreements ahead of children and their family’s health and safety;
Potentially rewards a franchisee even if they intentionally decide to violate the terms of their contract in a way meant to force the franchisor to terminate the franchise agreement; and
Attempts to force a franchisor to grant to a franchisee additional terms to their agreement even if the terms of the existing agreement do not provide for those rights.
I can certainly lament that the current political climate in California does not lend itself to Governor Brown vetoing AB525 as he did SB610 last October, as nothing really has changed.
If not for the strength of the vote for AB525 I expect he still might veto AB525, since it is more than likely going to move some of the routine disputes between franchisors and franchisees that were generally settled without litigation into California’s already overburdened court system, and possibly reduce the opportunity for business ownership by potential franchisees.
Those will be unfortunate but unavoidable results, as some of the language contained in the bill is unclear even at this late date despite everyone’s efforts.
But because of negotiations between franchisors and franchisees with some exceptions, AB525 likely will not cause any significant harm to franchisors, but will also not result in many tangible benefits to franchisees. On balance, I believe franchisors may have come away strengthened in California and if anything, while franchisees may have achieved many of their goals, they may actually have lost more than they gained. Having franchisees lose equity because of what I anticipate will be a decline in the resale value of their businesses is not good for either the franchisor or franchisee, and is precisely why I am generally opposed to legislative fixes that would be better served by advancing natural market forces. As we learned in Iowa, which after more than fifteen years still has the lowest per capita penetration by franchised brands in the country, franchisors react when they perceive legislation as being unfair.
For franchise systems as a whole, I am most alarmed at the inability of franchisors under AB525 to quickly and effectively bring out-of-compliance franchisees into compliance should they violate the terms of their franchise agreement. Regardless of the reasons, when consumers determine that brand consistency cannot be relied upon, whether in a franchise or any other form of business, they generally choose to find more reliable sources to obtain their products and services. For most franchisees, having their livelihoods put in jeopardy by the minority of franchisees that are out of compliance is not fair. However, if brand consistency at a franchisee’s location does become an issue it will be short-lived, as AB525 provides franchisors with ample recourse to deal with this concern.
The proponents of AB525 expended a considerable amount of effort in certain areas, and I was pleased that they agreed to retain the statutory language allowing franchisors to terminate franchisees, without cure period, in some very important areas. I suspect that they understood the risk to most franchisees of what Assembly Member Holden was proposing and needed to better protect the majority of franchisees from the potential bad acts of a few, and I applaud Keith Miller from the CFA for apparently coming to that conclusion.
At the same time, quite a bit of effort was focused on protecting franchisee equity and trying to force franchisors to renew expired franchise agreements by imposing on them a penalty should they decide not to renew the relationship or find the need to terminate a franchisee lawfully. I applaud the decision of the proponents in giving franchisors the right to purchase a franchisee’s assets at depreciated book value instead of an appraised value if they wanted to retain the location as their penalty of choice. This penalty, in effect, enables the franchisor to evaluate the asset purchase more easily. An appraisal after the decision to terminate or not grant a franchisee a successor term might have resulted in an inflated price for the assets sold by the franchisee. It was a good choice that is reasonably fair to both franchisees and franchisors should the franchisor decide to end the relationship but wishes to retain the location, as it is more precise and argumentatively better values the franchisees equity in their business, at that time.
I am distressed that the law most likely will result in a change in the way some franchisors will need to manage their relationship with franchisees going forward. Because of the way the bill is languaged, routine defaults that in the past were simply matters of discussion will likely be noticed as defaults by franchisors. In order to enforce brand standards as a way to protect both the franchise system and the majority of compliant franchisees under the law, many former “technical” defaults will now need to be recorded by the franchisor. In addition, franchise agreements offered in California will likely change somewhat, and some franchisors may consider imposing modified fees in California to deal with any perceived additional costs and risks. Imperfect laws generally result in imperfect solutions, and franchisors, like any other business owner, will naturally determine their best course of action to deal with these kinds of issues when they arise. All of these changes will unfortunately combine to have a negative effect on both the franchise relationship and on the equity earned by franchisees, because it may result in a lowering of the resale value of their businesses should they decide to retire from the system. I wish Assembly Member Holden had given that more thought.
At the same time, I don't see a realistic possibility that franchisors will abandon the California market, as some franchisors have claimed might happen. It is too important a consumer market for any brand. Franchises will still be offered, even if not in the same way or in the same quantity as they might have been without the law. For those franchisors with the necessary resources, I expect more company-owned locations might be developed instead. Because AB525 allows franchisors to know their cost of a franchisee’s assets in advance, some may take advantage of the penalty clause and choose to purchase a franchisee’s assets at depreciated book value rather than extend the relationship if the economics are favorable.
The political climate in California was certainly difficult, and I applaud the efforts and the results achieved by the IFA staff and its General Counsel Stuart Hershman in collaborating with Keith Miller, the head of the Coalition of Franchisee Associations, in coming to a consensus on AB525.
For full disclosure, the decision of the IFA’s Board of Directors to negotiate AB525 was not unanimous and as the sole holdout for lobbying against the bill in its entirety, given the results of the IFA/CFA collaboration, I regret that decision. Still, at the beginning of our board discussion I found it troubling that Assembly Member Holden chose to cherry-pick, out of context, one of the principles contained in the IFA’s Statement of Guiding Principles and give it a meaning that was never intended when I drafted it as part of the IFA’s Statement of Guiding Principles. Had his intent been to benefit franchisees, he could have instead elected to replace AB525 with the twelve Guiding Principles in their entirety. The IFA’s Statement of Guiding Principles can be found at http://emarket.franchise.org/StatementGuidingPrinciples.pdf. These were the principles unanimously adopted by the IFA’s Board of Directors after lengthy collaboration between franchisors and franchisees. Franchisors, franchisees, and consumers in California would have been better served had Assembly Member Holden simply done that.

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