State Franchise Laws
Franchise Law Overview
Only a minority of states have enacted a full set of franchise laws. Franchise attorneys generally view these state laws as fitting into one of three categories: general franchise relationship laws, franchise disclosure/registration laws, and industry-specific franchise laws. The federal government has never enacted a franchise relationship law of general application, although it has enacted the Franchise Disclosure Rule.
Although the myriad of state franchise relationship laws have significant differences, their thrust is directed toward the ongoing relationship between franchisors and franchisees after the parties have signed a franchise agreement. These laws provide guidance to issues such as terminations, renewals, and buy-backs. In contrast, franchise disclosure/registration laws concern matters between franchisors and franchisees before a franchise agreement has been executed. Franchise disclosure/registration laws require franchisors to make specific disclosures to potential franchisees before permitting the franchisee to sign an agreement. Finally, industry-specific laws regulate very specific types of franchises, including service stations and automobile dealers. These industry specific laws are relatively well-developed instances of general state relationship laws.
Franchise attorneys, franchise law firms, and franchisees learn quickly that the practical and theoretical connections between state laws, disclosure requirements and the FTC Rule are neither clear nor intuitive. Frequently, they defy reconciliation with each other and present difficult questions of interpretation to the adjudicating courts.
Franchise law can prove difficult to navigate. It is multilayered and differs significantly from state to state. For example, while seventeen states have enacted franchise relationship laws, many have included general franchise relationship provisions within their state disclosure laws. Moreover, not every state that has enacted a general state relationship law has a state disclosure law. Making matters even more complex is that states’ definitions of the term “franchise” differ from each other even when they use the same terminology. Thus, while certain dealers and distributorships not normally considered to be traditional franchises would be covered under some state franchise laws, they will not be covered under other state laws.
Terminations
One of the most heavily litigated issues under state franchise relationship laws is whether the franchisor had “good cause” to terminate a franchise agreement. The “good cause” standard differs from state to state. For example, Minnesota, Nebraska, New Jersey and Wisconsin bar bad faith terminations or terminations not made in “good faith.” Others, such as Delaware, proscribe franchise terminations that are “unjust.” Still other states do not define a specific permissible standard and instead rely upon definitions of “good faith” found in common law. Some states have attempted to streamline the process by creating categorical examples of good-faith terminations. These include voluntary abandonment of the franchise, bankruptcy, loss of possession of the franchise premises, criminal conduct, or repeated violations of the franchise agreement.
Generally, courts have upheld terminations resulting from the franchisor’s exercise of valid or legitimate business reasons. However, in cases involving “franchise withdrawal” claims, franchisees have fared better – but even then, so long as the franchisor terminates a franchisee pursuant to a general marketing decision to withdraw from a particular market, the termination would be valid.
Even assuming that a franchisor has “good cause” to terminate a franchise, certain franchise relationship laws require that a terminating franchisor provide notice and an opportunity to cure the alleged violation underlying the termination. Not surprisingly, the statutory permutations on this issue are numerous: some states permit termination within the period allowed to cure while others direct that the opportunity merely need be “reasonable.” Others states set forth a specific number of days for the franchisee to cure, ranging from 30 to 60 days. Finally, some states unexplainably avoid setting any number of days for notice and cure periods.
Where a franchisor runs afoul of procedural notice and cure provisions, some courts have allowed the franchisor to retroactively “correct” the defects by reinstating the franchisee and then “properly” terminating him. The most interesting aspect of these procedural cases occurs when a franchisor has properly served notice to cure to a franchisee for a breach that the franchisee is physically incapable of fully curing within the statutory cure period. In such cases a franchisee may turn to another legal theory – one that is not commonly embraced – that prevents a termination so long as the franchisee makes all reasonable efforts to cure the breach.
Refusals to Renew
In addition to the termination provisions discussed above, provisions prohibiting unreasonable refusals to renew are frequently found in general state relationship laws. These statutes prohibit nonrenewals by franchisors when they are not made in “good faith.” However, unlike the termination proscriptions above, the nonrenewal provisions uniformly have gaping analytical and practical holes that almost always favor the franchisor’s nonrenewal.
In essence, these provisions sanction nonrenewals so long as the franchise agreements explicitly state the standards for nonrenewal. Even where the statutory provisions appear to bar nonrenewals until the franchisee has been permitted a full opportunity to obtain a fair return on his investment in the franchise, courts have manipulated the language to the extent that it no longer provides the anticipated protection to the franchisee. Moreover, the franchisor will be protected by a statute for a wrongful nonrenewal so long as he repurchases the franchise, which, incredibly, includes only the franchisee’s inventory. The goodwill of the business, the value of the business built up by the franchisee’s blood, sweat and tears, is shockingly and unjustifiably uncompensated.
States that have enacted franchise relationship laws, such as Indiana, permit refusals to renew so long as the franchise agreement states that it is nonrenewable upon expiration. These statutes also permit the franchisor to specify in the franchise agreement a list of prerequisites that the franchisee must achieve before a renewal is considered. Minnesota has taken a maverick approach by permitting nonrenewals only if the franchisee has been allowed to operate for a sufficient time to recoup its investment. This provision has not been tested in the courts to allow its parameters to be explored; suffice it to say, however, that it is likely that the protections appearing on the face of this statute will be slowly peeled away as the courts continue to interpret it.
The statutory provisions in some states also create an interesting dynamic between nonrenewals and post-term-covenants not-to-compete. For instance, in Michigan if a franchise agreement contains a post-term-covenant-not-to-compete and the franchise term is for fewer than 5 years, the franchisor must compensate the franchisee for the “value” of the business upon renewal (which does not include the goodwill of the business). This provision, although appearing to be more favorable to franchisees than nonrenewal statutes, is actually less advantageous to the franchisee because it requires two prerequisites to be triggered – one of which is a franchise term of fewer than 5 years. Franchise agreements that run less than five years are very uncommon.
Washington’s franchise relations laws provide protection to the franchisee in a nonrenewal context by tying in the concept of goodwill. Under that statute, the franchisor must pay for the goodwill of the franchisee’s business upon nonrenewal when the franchisor fails to provide a one-year notice of nonrenewal and also determines to enforce the post-term covenant not-to-compete.
Wisconsin’s non-renewal statute strives to prohibit a franchisor from demanding the franchisee to sign a new and significantly more onerous agreement in order to continue in the system. Specifically, the Wisconsin law states that a franchisor may not force a franchisee to sign a new franchise agreement that “substantially change[s] the competitive circumstances of a dealership agreement without good cause.”
Remedies
Remedies for violations by franchisors of state franchise relationship laws of the termination or nonrenewal provisions are inconsistent from state to state. The most prevalent provision merely requires the franchisor to repurchase the franchisee’s inventory. Others require the franchisor to purchase goodwill, as well as remunerate the franchisee for damages, lost profits, unrecouped expenses and other legal costs and fees.
Transfers
In addition to the general provisions regarding termination and nonrenewal, another significant issue addressed in general state relationship laws concerns franchisee transfers. Some states restrain the franchisor's ability to prolong the transfer process by imposing a set period of time in which the franchisor may reject or approve the proposed transfer. Other states do not specify a time limitation. Although the varying state statutes establish differing standards to evaluate the legality of a refused transfer request, each of them includes many escape routes for franchisors who wish to deny a transfer. The most common is the franchise agreement itself. Almost every franchise agreement includes an explicit delineation of the "prerequisites" that the franchisee must meet in order to obtain approval from the franchisor for a transfer. So long as the criteria included by the franchisor in the franchise agreement have some apparent legitimacy, the franchisor's application of these criteria will almost always be held to meet the "good cause" standard for the denial of a requested transfer. The "good cause" requirement itself is included in very few of the franchise relationship statutes.