California Franchise Relations Act – Are Your Franchise Transfer Standards Ready to Hand to Franchisees?
In the last issue of this newsletter, Henry Pfutzenreuter wrote a detailed article outlining the recent Amendments to the California Franchise Relations Act (the “CFRA”). The Amendments addressed issues that were already covered in the franchise relationship laws of several other state statutes. Thus, when we went through the franchise filing renewal season, the only change we needed to make to our clients’ Disclosure Documents was to expand the language of the California addenda to confirm our clients would comply with the transfer provisions of the amended law, since the existing version of the CFRA had not addressed transfers. However, as we look to the future, there is one requirement of the CFRA transfer provision that is already keeping franchisors awake at night, and you want to get ahead of the issue.
Consistent with laws in other states, the CFRA prohibits franchisors from unreasonably withholding consent to the transfer of a franchise. The CFRA does this by tying the approval requirements to the standards set by the franchisor “for the approval of new or renewing franchisees.” However, unlike other state statutes, the CFRA makes it impossible for franchisors to set these standards “on the fly,” taking into account individual circumstances, by providing that the standards are “to be made available to the franchisee” on just 15 calendar days’ notice. Based on that requirement, franchisors should today be reviewing their policies regarding the grant of new franchises, and the renewal of existing franchises. If those standards are not in writing, franchisors with franchisees in California need to put them in writing so that they can be provided to those franchisees on relatively short notice.
Preparing standards for the award of a franchise is not a simple process. The first time we ran into the issue, we had a client who had a standard that required new franchisees to have a net worth of $1 million, and liquid assets of $250,000. That made sense for a new franchise, which required an initial investment of just under $1 million. However, if that is your written standard, then arguably, under the amendments to the CFRA, when a franchisee proposes to sell its ten outlets for $15 million to someone with a net worth of $1 million and liquid assets of only $250,000, you may be hard pressed to reject the transaction without running afoul of the CFRA. We revised our client’s standard to provide that the franchisee must have a net worth equal to the cost of the investment in the franchise, with liquid assets of at least 25% of that investment. With that revision, the standard was applicable to both new franchisees and those purchasing an existing franchise. Certainly, other examples can come to mind. The point, however, is that franchisors need to consider their standards for new and renewing franchisees, be certain they are broad enough to cover not only a single unit purchase, but a multiple unit purchase, and document the standards in writing so they can be made available to California franchisees in order to comply with the requirements of the CFRA.