States propose revising the "relationship" between franchisors and franchisees

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In the '90s, we witnessed efforts by franchisee rights advocates to introduce federal franchise legislation to protect franchisee interests in their relationships with franchisors. In connection with the FTC reviewing and amending the FTC Rule on Franchising, similar efforts were made to add a relationship component to the amended rule. These various efforts failed and we have been through a period of relative calm with respect to proposed franchise legislation. 

However, in recent months we have seen a resurgence of legislative efforts – this time at the state level – that may change the playing field.  Whether it is due to the challenging economic environment, a perception that franchise agreements are more one-sided or other circumstances, these recent efforts seek to tilt the balance in favor of franchisees by restricting franchisor practices that are deemed unfair, protecting franchisees’ equity in their businesses and empowering collective actions by franchisee groups. 

While the proposals we are seeing at the state level vary greatly in terms of scope, they generally aim to (i) require that franchisors deal in “good faith” with their franchisees; and (ii) restrict the power of franchisors to terminate, not renew or deny consent to the transfer of franchise agreements without "good cause" (which is defined differently from state to state).  Some proposals have been withdrawn or postponed until the next legislative cycle, while others remain pending with state legislatures for review in the new year.

Given the differences between the proposed state bills and existing state franchise laws, the passage of such bills (in their current forms or in "hybrid" forms in the future) would generate a host of problems: if such bills are passed, there would be a number of resulting compliance issues, potential disputes over interpretation and required changes in current business practices of franchisors. Needless to say, any passed legislation would certainly have a significant effect on the contractual relationship between the franchisor and franchisee.

THE STATUS OF PROPOSED BILLS IN PENNSYLVANIA, MAINE, MASSACHUSETTS AND CALIFORNIA

The four states below have considered bills that would modify or add new franchise relationship laws:

1.  Pennsylvania - HB 1620

Perhaps the most significant and far-reaching of these franchise relationship bills is in Pennsylvania (HB 1620), which would add a new chapter to the Commerce and Trade title of the Pennsylvania Consolidated Statutes governing the franchisee-franchisor relationship (Responsible Franchise Practices Chapter).   In addition to fair dealing and good faith requirements, and that termination be for good cause, there are a number of unusual provisions  in the proposed bill, including: 

  • A declaration that "the franchisor and the franchisee have the need to make reasonable changes to the franchise system to incorporate new and mutually advantageous products, technologies and methods of doing business."  While there is no stated obligation, it is unclear whether this language would require a franchisor to implement changes proposed by a franchisee (or for a franchisee to refuse to make certain mandated changes)
  • An affirmative obligation to provide initial and continuing training
  • For nonrenewal, a six months' non-renewal notice must be provided by franchisor to franchisee
  • A required minimum cure period of at least 30 days (but no exception for acts that impair the goodwill of the franchised trademarks).  There is, however, an exception for a franchisee that is "sentenced for a felony which materially and adversely affects the operation, maintenance and goodwill of the franchised business" and that, "within 90 days of sentencing, does not transfer the franchise."   Thus, such a franchisee has a 90 day opportunity to sell
  • A franchisor, before granting or licensing a new franchise or opening a new channel of distribution, must give at least 120 days' written notice to all franchisees in proximity of the proposed new franchise or channel of distribution.  Any new franchise or channel is in unreasonable proximity if it will cause a reduction in gross sales of the existing franchise.
  • Atypical limitations on a franchisor's right to transfer its business, including the obligation that transferee must "assume the franchisor's obligations to the franchisee " or "renegotiate in good faith the franchisor's obligations to the franchisee"
  • A limitation on a franchisor's ability to change the franchise fee, royalty rates or other material financial terms of the franchise relationship.  But, a renewal fee (which could be interpreted as a material financial term) can be "to reimburse the franchisor for the franchisor's reasonable and actual expense directly attributable to the renewal"
  • Criminal penalties for intentional violations of the Responsible Franchise Practices Chapter (which adds to the concern that the proposed bill is overbearing and unclear in numerous respects)
  • A restriction on the franchisor from obligating (in the franchise agreement) a franchisee to mediate, arbitrate or litigate claim or controversy outside the state in which the franchised business is located.  With respect to arbitration, this provision would likely be preempted by the Federal Arbitration Act.

Status:  This bill was referred to the House's Consumer Affairs Committee in July 2013 and is anticipated to be the subject of a public hearing before year-end.

2.  Maine’s Small Business Investment Protection Act (LD 1458)

Maine’s bill would enact a new Small Business Investment Protection Act, which governs the franchisee-franchisor relationship.  The Small Business Investment Protection Act would require that franchisors engage in fair sales practices and good faith and fair dealing with franchisees, extend the time that a franchisee has to cure violations, and grant franchisees the right to join a franchisee association without retaliation from the franchisor.  

The bill includes a number of far-reaching provisions, including some that:

  • Give a franchisee the right to a uniform standard of conduct or performance (applied throughout the system of franchisees, franchisor-owned units and licensees in the same manner) rather than imposition of an ad hoc rule to penalize a specific franchisee
  • Allow franchisees to close their store between 10 pm and 6 am (even if the franchisor mandates longer hours)
  • Allow franchisees to set their own prices for their products and services (and ignore any price mandates from the franchisor)
  • Require that a franchisor allow a franchisee in good standing to renew its license without an increase in royalties or new fees
  • Require that a franchisor compensate a franchisee in the event that the franchisor establishes a new unit in a territory that has a "material adverse impact" on the gross sales or net profits of the pre-existing franchise unit (if the calculated impact on annual gross sales of the pre-existing unit, when compared to its annual gross sales for the year immediately preceding the opening of the new unit, is at least 10 percent during the first year the new unit operates).

Third parties, including the International Franchise Association (IFA), have expressed opposition to the Small Business Investment Protection Act, saying the bill is harmful to franchise systems, consumers and the Maine economy.  For example, the “non-discrimination” provision may limit the flexibility of franchisors to assist specific franchisees, which, in turn, could reduce the number of waivers granted or assistance provided to franchisees (due to the franchisors' concern of showing favoritism).   Further, the elimination of uniform pricing and hours of operation could harm not only brand reputation, but consumers by selling products at exorbitant prices and allowing franchisees to opt out of promotional campaigns that customers expect.

Status: This bill has been carried over by the Joint Committee until the next legislative term for more study (instead of voting on it).  The next term begins in January 2014.

3.  Massachusetts’ Fair Franchise Act (S73)

Massachusetts S73 would enact a new Fair Franchise Act that governs the franchisee-franchisor relationship.  Under the Fair Franchise Act, a franchisor would not be able to terminate or cancel a franchise or substantially change the competitive circumstances of a franchise agreement except for "good cause."  “Good cause” must be based upon "legitimate business reasons," including a franchisee’s refusal or failure to comply substantially with "material, reasonable and reasonably necessary express obligations of the franchise agreement."  The Act would mandate that written notice of termination or nonrenewal, along with the cause, be provided to a franchisee at least 90 days in advance (with certain exceptions).

Additionally, the new law imposes an inventory repurchase obligation on franchisors and precludes franchisors from taking various actions, including: (1) prohibiting the right of free association among franchisees; (2) imposing unreasonable standards of performance on a franchisee; and (3) failing to deal in good faith with a franchisee.  Like Maine, there are other far-reaching provisions that would:

  • Allow franchisees to close their store between 10 pm and 6 am (even if the franchisor mandates longer hours)
  • Allow franchisees discretion in pricing (such that a franchisee does not need to sell any of its products and services at a loss or otherwise not reasonably acceptable to the franchisee in its "good faith discretion").

Further, like the non-discrimination proposal in Maine, there is a similar provision preventing a franchisor from discriminating between franchises in the charges offered or made for royalties, goods, services, equipment, rentals, advertising services, or in any other business dealing, unless such discrimination is necessary for the particular franchisee to compete in the open market and does not adversely affect the business of any existing franchisee.  Also, any discrimination must be based on franchises granted at materially different times and not be arbitrary or intended to be for the benefit of the franchisor at the expense of any franchisee.

Status: There have been no notable updates to the status of this bill, other than it being referred to the Committee on Community Development and Small Businesses in January 2013.

4.  California – SB 610 and AB 1141

Each of these two bills would have amended the existing California Franchise Relations Act (CFRA) (AB 1141 would also amend the Franchise Investment Law).   These bills are relatively concise (compared to the other states).

SB 601 would have amended the CFRA by: (i) requiring franchisors to deal in "good faith" with their franchisees (defined as "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade"); (ii) prohibiting a franchisor (or subfranchisor) from restricting the right of a franchisee to join or participate in an association of franchisees, to the extent the restriction is prohibited by existing law; (iii) allowing a franchisee to sue a franchisor or subfranchisor that violates the CFRA for damages, rescission, or other relief deemed appropriate by a court; and (iv) prohibiting the mandatory waiver of franchisee's rights under the CFRA, unless done so knowingly and voluntarily.

Similarly, AB 1141 would have amended the CFRA and Franchise Investment Law by: (i) providing franchisees greater freedom to transfer their businesses; (ii) requiring automatic renewal of franchise agreements "unless the franchisee has substantially and materially breached the franchise agreement"; (iii) protecting franchisees from terminations absent "good cause" (defined as "a substantial and material breach of any lawful requirement of the franchise agreement after being given written notice thereof and 60 days to cure the failure"); (iv) requiring the parties to deal with each other in "good faith"; and (v) providing franchisees the right to assemble in trade groups without fear of retaliation.  The bill would have added a "pro-franchisee" policy statement – that franchisees lose more than their investment in a franchise if the franchise is terminated or not renewed, potentially resulting in the loss of a personal residence and other property.

Status:  SB 610 was referred to the Committee on Business, Professions & Consumer Protection in June, but pulled from consideration by the bill's sponsor and has been tabled for consideration next year.  There has been no update about AB 1141, which was assigned to be heard by the Assembly's Committee on Judiciary, which hearing was postponed as of April 16, 2013.

WHAT DOES THE FUTURE HOLD FOR THESE BILLS?

It is difficult to predict what the future holds for the above bills and, given the debate around them, whether there will be any revisions before they are reconsidered.  However, if any of the bills pass, franchisors may be cautious about entering these markets and they may be inclined to focus their development efforts on other states.

We will, of course, monitor and report back to our readers when further developments occur.

Topics:  Franchise Agreements, Franchises, Franchisors, FTC, Small Business

Published In: Antitrust & Trade Regulation Updates, General Business Updates, Franchise Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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