7 key questions from S.B. 610 debate

With noise surrounding Senate Bill 610, passed last week by the California Assembly and scheduled to be debated this week in the state Senate, amplifying arguments on both sides of the debate, it can be difficult to keep track of what is at stake for the Golden State’s franchisors and franchisees. 1851 Magazine asked players from both sides of the issue to weigh in on the most pressing questions surrounding S.B. 610. When could this be decided? Supporters and opponents started arriving in Sacramento Tuesday, and several contacted by 1851 Magazine thought debate and a vote on the legislation could occur Wednesday in the California Senate. The bill’s proponents were confident they had the votes — 21 senators need to vote “aye”— to get it passed. What does the bill say? • According to a synopsis of the bill from the legislative counsel (see here), existing California law prohibits a franchisor from terminating a franchise agreement prior to its expiration date except for “good cause.” S.B. 610 would amend that standard, prohibiting a franchise agreement to be terminated early unless there is a “substantial and material breach on the part of the franchisee of a lawful requirement of the franchise agreement.” • Also, existing law requires a franchisor to offer to repurchase the franchisees resalable inventory when that franchisee’s contract is terminated or not renewed. Under S.B. 610, if a franchisor terminates an agreement or fails to allow the sale or transfer of a franchise “other than in accordance with the law,” that franchisor must, “at the election of the franchisee, either reinstate the franchisee and pay specified damages or pay to the franchisee the fair-market value of the franchise and franchise assets.” • Any stipulation in a franchise agreement asking any person to waive the implied covenant of good faith and fair dealing is void. • It is unlawful for a franchise agreement to: 1) Restrict the right of a franchisee to join an association of franchisees for collective lobbying. 2) Prevent a franchisee from selling or transferring a franchise to another person, provided the new operator is qualified, so long as the current franchisee receives consent from the franchisor. So which points are the most contentious? Franchisee supporters of the bill said elevating the standard for termination to a “substantial and material breach” in a franchise agreement is the biggest sticking point for owner-operators, followed by getting “fair-market value” for their businesses rather than being compensated only with the cost of their outstanding inventory. However, the International Franchise Association has lobbied against S.B. 610, arguing that the “substantial and material” language sets a bar for termination that is undefined but also much higher than for “good cause,” said Dean Heyl, the IFA’s vice president of state government relations and public policy. “No other state has adopted this standard,” Heyl said. “If a franchise agreement says the franchisee must clean a restaurant 10 times per day, but the franchisee only wants to clean it five times, is that a material breach? … Everything would have to be litigated. This bill creates so much ambiguity.” Are franchise agreements terminated unfairly that often? It depends on whom you ask. Heyl of the IFA argued that terminations are rare, because franchisors seek to avoid early terminations as much as franchisees do. “A termination is a black spot on a franchisor’s FDD,” he said. “There’s also nothing worse than a dead store, so it’s in the best interests of both parties to work these disputes out. … I understand if there’s a franchisee that wants to move on and get full market value for the business, and the franchisor wants to work with them to get maximum value as well. But this bill does not do that.” But supporters of the bill contend differently. “[Termination] happens a lot, or at least enough so that S.B. 610 has gone forward,” said John Gordon, principal of San Diego-based Pacific Management Consulting Group and a supporter of the bill. “Where it seems to be the worst is at some brands where the asset protection departments — which are really there to go after fraud and prevent injuries — are treated like a revenue center. That’s a bad incentive.” How is S.B. 610 supposed to address the termination issue? Supporters, like California-based McDonald’s franchisee Kathryn Slater-Carter, believe requiring franchisors to compensate franchisees the “fair-market value” of their businesses will keep both sides more honest, providing a disincentive to brands to terminate too quickly. She countered the IFA’s oft-repeated argument that S.B. 610 would make it harder for franchisors to uphold brand standards through requirements in the agreements. “This bill promotes brand standards because it ties the value of somebody’s franchise to market value,” Slater-Carter said, “and the way you maintain market value is by keeping the standards of the franchisor.” But that is a cynical way of looking at franchising, Heyl said, and S.B. 610’s new requirements add an unnecessary layer of red tape to the process. “With that line of thinking, you presuppose that there will be a termination,” he said. “Most parties entering into an agreement don’t expect it to go south. We would say, everybody should stick to the ‘good cause’ standard and lay out the items needed to meet it.” Will this make franchising more litigious in California? That’s the concern of the IFA and franchisors who oppose the bill. Gordon, a supporter, said: “We think this will cut down on litigation net-net … if you lay out ‘fair-business value’ in the legislation. The vast majority of litigation is currently initiated by franchisors.” He added that Gov. Jerry Brown’s support for the bill hinges on whether it would lead to increased lawsuits in California courts. Will Gov. Brown sign the bill into law? Neither side knows for sure. The Democrat has expressed concerns to both bill supporters and opponents that California is already considered to be over-regulated. He would have until the end of September to sign or veto the bill. “Jerry is Jerry,” Gordon said. “He’s a unique character, and he doesn’t need anybody in this fight. He’ll do what he thinks is right for California.”