Finding the right franchisee can be a daunting task. Despite a franchisor’s best efforts, sometimes a franchisee just isn’t a good fit. When it’s not working out, franchisors rely on termination and non-renewal provisions in their franchise agreements to legally end the relationship.
In addition to this business reality, recent amendments to California’s Franchise Relations Act (the “Act”) make legally terminating the franchisor-franchisee relationship more difficult and more expensive for franchisors. In an unprecedented move, franchisors legally terminating or not renewing franchisees in California must now purchase certain inventory and other items from franchisees (unless an exception applies). The amendments also usher in a heightened good cause standard and extended notice and cure periods regarding termination.
Do the amendments apply to your franchise agreement?
The amendments apply to franchise agreements entered into or renewed on or after January 1, 2016, or to franchises of an indefinite duration that may be terminated by the franchisee or franchisor without cause.
The New “Good Cause” Standard
Prior to amendment, California franchisors could not terminate a franchise before the expiration of its terms except for “good cause,” which included, but was not limited to, the franchisee’s failure to comply with any lawful requirement of the franchise agreement.
Under the new regime, “good cause” is limited to a franchisee’s failure to substantially comply with the lawful requirements imposed upon the franchise by the franchise agreement.
The New Notice and Cure Periods
Originally, the Act required notice of termination and a “reasonable opportunity” to cure, which did not need to exceed 30 days.
The amended Act now requires 60 days’ notice in advance of termination and a cure period of at least 60 days from the notice. The cure period cannot exceed 75 days unless the franchisor and franchisee agree to extend the time in a separate agreement.
The Purchase Requirement
The amended Act requires franchisors to purchase certain items from a franchisee upon a lawful termination or nonrenewal of a franchisee.
- The franchisor must purchase from the franchisee all inventory, supplies, equipment, fixtures, and furnishings that the franchisee purchased from the franchisor or an approved supplier or source under the franchise agreement or other agreements (subject to carve-outs and exceptions below).
- The franchisor must pay the same amount paid by the franchisee, minus depreciation.
The amended Act contains certain carve-outs. Franchisors need not purchase items
- that are not in the franchisee’s possession or used in the business at the time of termination or nonrenewal;
- that the franchisee cannot or does not grant the franchisor clear title to and possession of;
- that are not reasonably required to conduct the operation of the franchise business in accordance with the franchise agreement (or any ancillary agreement); and
- that are sold by the franchisee between notice of termination/nonrenewal and cessation of operations.
Additionally, if a franchisee owes money to the franchisor, the franchisor may reduce the purchase price accordingly.
Exceptions to the Purchase Requirement
The amended Act contains four exceptions to the franchisor’s purchase requirement:
- The franchisee declines a bona fide offer of renewal from the franchisor;
- The franchisor does not prevent the franchisee from retaining control of the principal place of the franchise business;
- The termination or nonrenewal is due to a publicly announced and nondiscriminatory decision by the franchisor to completely withdraw from all franchise activity within the relevant geographic market area in which the franchise is located; or
- The franchisor and franchisee mutually agree in writing to terminate or not renew the franchise.
The amended Act also makes major changes to a franchisor’s ability to prohibit a transfer of the franchise, which we will cover in a follow up blog.
What do the amendments mean for California franchisors?
- Franchisors, in connection with experienced counsel, should carefully review their franchise agreements, especially provisions dealing with termination, renewal/nonrenewal, post-termination requirements, required purchases and notices.
- Franchisors should consider whether the benefits of required purchase provisions outweigh the potential costs of their repurchase obligations and how repurchase obligations could affect their balance sheets, especially in the event of a large-ticket item or termination/nonrenewal of a multi-unit franchisee.
- Franchisors should consult with experienced counsel prior to sending termination or nonrenewal notices to ensure compliance with the amended Act and to review whether an exception to their purchase obligations does or could apply.