No Joy For Franchising in CA: AB-5 Exemption Rejected

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As if COVID, wildfires, and heat weren’t enough, California franchisors and franchisees suffered another gut punch when the legislature rejected a proposed franchise exemption to AB-5.

When AB-5 was enacted in 2019, to the horror of the franchise industry, it appeared to create a presumption that the franchise business model created an employment relationship between franchisor and franchisee and franchisee’s employees. The Bill’s sponsors in the Assembly disclaimed any intent to interfere with positive business relationships that allow small businesses, including franchised outlets, to continue and pledged to address the issue in future amendments to the law. The apologetic statement, promising amendments, temporarily calmed the waters.

Then COVID attacked, and the industry focused on survival in the wake of quarantine orders and massive unemployment. Now, just as the world adjusts to a new reality, word emerges from the California legislature that there will be no franchise exemption to AB-5. An early draft of AB-5 amendments included a franchise exemption, but the provision died as amending legislation wended its way to enactment. Amplifying the AB-5 adversity is the risk that the Dynamex case, which presaged AB-5, will be applied retroactively, exposing those considered employers under the test codified in AB-5 to years of prior year employment tax exposure.

Commentators blame/credit unions for the exemption’s demise, but the source hardly matters. What does matter is that franchisors and franchisees will need to again reassess their approach to franchising in California’s AB-5 environment. The lure of access to the fifth largest economy in the world enhances the risks inherent in making the wrong decision.

In a 2019 alert, “New California Law Imperils Franchise Model,” my colleague Elle Gerhards and I noted a few possible actions by franchisors and franchisees in the wake of AB-5, none of them palatable. Franchisors and franchisees need to reconsider frankly discouraging choices: (a) bow to pressure and change to an employment model; (b) cling to the franchise model, but redefine obligations and change the financial model; (c) withdraw from California. There is a raft of nearly-impossible steps that would be required to implement significant changes to the franchise business model, not the least of which are the contractual underpinnings of the franchise relationship.

Now, with no apparent hope that a franchise business model and AB-5 can co-exist, will franchisors begin the agony of decision-making? What is the future of the thousands of California franchisees and their tens of thousands of employees in the process? Millions are unemployed in the wake of COVID; is now the time to add thousands more to the ranks?

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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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