An Overview of State Franchise Law
Many franchise attorneys, franchise law firms, and franchisees often find the practical and theoretical connections among state laws, disclosure requirements, and the FTC rule unclear and unintuitive. This isn’t a big surprise since only a few states are adapting a complete set of franchise laws. A full set usually contains three categories of state franchise law, namely general franchise relationship laws, franchise disclosure or registration laws, and industry-specific laws.
Furthermore, they often defy reconciliation with each other and contain questions of interpretation to the adjudicating courts. When such cases arise, it is recommended that franchisees seek the assistance of a franchise law firm that can help them understand and navigate varying state laws more easily.
General Franchise Relationship Laws
Broadly speaking, state franchise laws are designed to oversee the continuing relationship between franchisors and franchisees after a franchise agreement has been made. Though these laws may vary widely from state to state, they all generally provide guidance about issues pertaining to terminations, renewals, and buy-backs.
Franchise Disclosure Laws
While the federal government has yet to enact a franchise relationship law of general application, it has formed the Franchise Disclosure Rule. State franchise disclosure or registration laws are concerned with matters between franchisors and franchisees in lieu of the execution of a franchise agreement. These laws require franchisors to disclose specific information to franchisees before the latter are allowed to sign an agreement.
Industry-specific laws, as the name suggests, regulate specific types of franchisees, which may include automobile dealers and service stations. These franchise laws are relatively well-developed examples of the general state relationship laws.
It is clear to see, then, how state franchise law can be difficult to navigate. Not only is it multi-layered but it also differs substantially from state to state. While there are 17 states now enacting franchise relationship laws, most have included general franchise relationship terms within their disclosure laws. There are also cases wherein a certain state would have a general relationship law but not a state disclosure law.
Another difficulty facing many franchise law firms is defining the term “franchise,” as this too differs from state to state. This often means that some dealers and distributorships that are normally not considered as conventional franchises may be covered under certain state laws, but might not be covered under others.
Deciding whether or not a franchisor has “good cause” to terminate a franchise agreement is one of the most heavily litigated issues under state franchise relationship laws. This “good cause” standard is different in many states. For example, Nebraska, New Jersey, Wisconsin, and Minnesota bar such terminations not made in “good faith.” Delaware, on the other hand, proscribe “unjust” terminations. Many other states defer to the definition of “good faith” as found in common law. There are categorical examples of good faith being enacted in some other states as well. These may include criminal conduct, repeated violations of the agreement, and/or loss of possession of the franchise premises.
Generally speaking, courts have been known to uphold terminations made from the franchisor’s exercise of legitimate business reasons. Franchisees have fared better in cases with “franchise withdrawal” claims, but even then, the termination would still be valid if the franchisor terminated due to a general marketing decision to withdraw from a specific market.
Even in cases where “good faith” to terminate a franchise has been established, franchise relationship laws may require the franchisor to provide notice and an opportunity to remedy the violation. Again, there is no one rule on this issue that encompasses all states. Some permit termination within the period when the franchisee is allowed to cure the violation, while others require that the opportunity to cure need only to be “reasonable.” Still others prescribe a certain number of days, typically ranging from 30 to 60.
In instances where a franchisor does not meet the notice and cure provisions, some courts have allowed them to retroactively correct the defects by reinstating franchisees, then “properly” terminating them.
Many interesting cases have arisen from franchisors that have correctly served notice to cure a breach that the franchisee cannot physically fulfill within the statutory cure period. In these instances, the franchisee has the option to stay termination as long as they make all reasonable efforts to remedy the violation that has been cited.
Refusal to Renew
Aside from termination provisions, terms prohibiting unreasonable refusals to renew are commonly found within general state relationship laws. These conditions ban nonrenewal by franchisors when they are not done in “good faith.” However, there are considerably large analytical and practical holes in nonrenewal provisions because they may sanction nonrenewal as long as the agreement explicitly states the standards for these. This means that these conditions are highly biased toward franchisors.
In the case where stipulations may seem to protect a franchisee from nonrenewal before they have been given the opportunity to obtain a fair share in their investment, some courts have manipulated the language wherein such protections no longer apply. The franchisors are also protected from wrongful nonrenewal as long as they repurchase the franchise. Surprisingly, this may only include the cost for the franchisee’s inventory. The goodwill of the business is shockingly uncompensated.
Some states, such as Indiana, permit refusals to renew as long as the franchise agreement stipulates that it is nonrenewable upon expiration. These conditions may also permit the franchisor to specify a list of prerequisites that the franchisee must fulfill in lieu of a renewal.
In Minnesota, non-renewals are only permitted after a sufficient amount of time so as to allow the franchisee to recoup its investment. However, this provision has not been tested in court and is more likely to be slowly peeled away as courts continue to interpret it.
Another approach to non-renewals involves post-term-covenants not-to-compete. In Michigan, if there are terms within a franchise agreement that allows for a post-term-covenant-not-to-compete and the franchise term is less than 5 years, then the franchisor must compensate for the business’ “value” upon renewal (though this does not include the goodwill of the business as well). Though appearing to be favorable to the franchisee, this statute can be less advantageous since it requires two prerequisites to be triggered. One of these being a franchise term of fewer than five years—an uncommon feature in many franchise agreements.
In Washington, goodwill is tied into franchise relationship laws in an effort to protect franchisees in cases of nonrenewal. Under this stipulation, the franchisor must pay for the goodwill of the business upon nonrenewal in instances where the franchisor has failed to serve a one-year notice of nonrenewal and has determined to enforce the post-term-covenant-not-to-compete.
In Wisconsin, nonrenewal provisions aim to protect franchisees from signing new and more onerous agreements in order to continue in the system. Wisconsin law states that a franchisor has no power to force a franchisee to sign a new agreement that “substantially changes the competitive circumstances of a dealership agreement without good cause.”
Remedies for violations of termination or nonrenewal statues by franchisors in franchise relationship laws vary from state to state. The most common provision requires the franchisor to repurchase the franchisee’s inventory and nothing more. Some states do require the franchisor to purchase goodwill along with remuneration for lost profits, unrecouped expenses, legal fees, damages, and other costs.
Aside from general conditions stating terms of termination and nonrenewal, there is another issue addressed in most general state relationship laws—franchisee transfers. Again, these provisions vary from state to state without a federal rule.
Some states restrain the franchisor’s ability to prolong the transfer process by setting a period of time wherein the franchisor may reject or accept the proposed transfer. Unfortunately, while there are differences in standards used to evaluate the legality of refused transfers, many include escape routes or loopholes that enable franchisors to deny transfers.
Oftentimes, this is the escape route in the franchise agreement itself. Most agreements include an explicit delineation of the requirements franchisees must meet before obtaining approval for transfers from the franchisor. As long as the criteria named by the franchisor within the agreement have some form of legitimacy, the application of these will more often than not be held to meet “good cause” standards used to deny transfer requests. This “good cause” requirement is not commonly found in most franchise relationship laws.
It is clear that there are many loopholes and traps ensconced in a state franchise law that may hurt, rather than protect, a franchisee. And facing tricky and multi-layered franchise laws may endanger a franchisee’s claim in cases of nonrenewal, termination, and transfers. In such cases, it is advised that they seek the help of a franchise law firm familiar with dealing with varying state laws as well as inconsistent and unclear standards.
Visit the Frequently Asked Questions page for more details on franchise law and how a franchise law firm can help.
For legal advice and representation, get in touch with a franchise attorney from Goldstein Law Firm today.