A San Andreas Fault for Franchising

“California’s falling into the ocean!” Growing up in Southern California I heard that every time we had an earthquake. Usually, though, all I had to do was stand in a door jamb and wait until the shaking stopped (now not the recommended response). Franchising in California is experiencing its own series of earthquakes and aftershocks, and standing in a door jamb isn’t the answer. In fact, the antidote is far from clear.

The epicenters of California’s franchise earthquakes include the FAST Act and AB-5, the law that codified the ABC employment definition articulated in the Dynamex Operations West v. Superior Court of Los Angeles in 2018. These quakes rattle existing fault lines that include a virtual ban on post-termination non-competes. Like building on a bluff in Malibu, nurturing a vibrant, successful franchise in California has become increasingly challenging over the years. In my next several blog posts, I’ll briefly discuss each of these fault lines and their potential effect on the franchise industry in California.

These recent cracks in the firmament should be considered against the already fissured earth of the Golden State. For instance, California has been inhospitable to post-term non-competes for as long as I have been practicing law. The California Business & Professional Code Section 16600 (enacted in 1976) voids, with few exceptions, “every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind . . . .” The only statutory exceptions are non-competes in conjunction with the sale of a business (§16601), the dissolution of a partnership (§16602) or a limited liability company (§16602.5). A judicially created exception for the protection of trade secrets renders post-termination non-competes “not invalid,” if the enforcer can demonstrate the need protection via a reasonable and narrow non-compete. As recently as 2020, California courts have permitted some flexibility in the scope of Code Section 16600, but its application to post-termination restrictive covenants in franchise agreements still unclear.              

Some may also suggest that California’s extensive regulatory mandates for franchisors and franchise brokers present additional challenges. Surely they do, but franchisors who do business in California have successfully traversed those challenges for decades, despite the perceived burdens of the system. Proponents of the regulatory structure will persuasively argue that its enforcement has protected investors – and well-run franchisors – from the harm that some bad actors could inflict on the system. But do California’s ABC joint employment rules and the recently-adopted FAST Act protect Californians or simply make it nearly impossible for the franchisors and franchisees to thrive in the world’s fifth largest economy that is California?

Next: Part 2 – The Joint Employment Conundrum