With every new legislative session, California’s business community awaits with dread the Legislature’s next effort to grow the big government regulatory state. Reflecting this dread, Chief Executive magazine’s annual CEO survey on business friendliness recently ranked California the worst state for business in America for the 11th year in a row.
It’s not that any individual new bill or new regulation debilitates economic growth. Rather, it’s the cumulative effect of government overreach that discourages new businesses from opening and encourages existing ones to close.
Already this year, the Assembly has passed a slightly revised version of a bill that was so threatening to business Gov. Jerry Brown vetoed it last year. Misleadingly called the “Franchise Bill of Rights,” Assembly Bill 525 would prevent franchisors from terminating contracts with franchise operators without “good cause,” meaning that the franchisee has failed “to substantially comply with the franchise agreement” after having had 60 days to cure the breach.
As with much of California’s ever-expanding regulatory puzzle, this bill ignores the realities of the underlying business relationships and will hurt people it’s intended to protect.
Let’s look at a typical quick-service restaurant franchise. The franchisor owns, represents and licenses the brand (for example, Carl’s Jr.), but the franchisee actually owns and operates each restaurant.
The franchisor is contractually empowered to protect its brand by setting standards the franchisees must meet to ensure consistency throughout the system. If you’re a franchisee, you want to be absolutely sure the franchisor is protecting your investment by requiring each of your fellow franchisees to adhere to standards on, for example, cleanliness, customer service and food quality. Even one bad restaurant can hurt the brand’s image, reducing sales throughout the system.
Imagine that you’re a small-business owner trying to build security for your family, create jobs in your community and make a profit. You’ve invested your savings and borrowed some money to open a franchised business with a national restaurant brand. With a lot of hard work and care, your business is thriving.
Then, you start hearing about a nearby franchisee trying to squeeze extra dollars out of the business by underportioning orders to reduce food costs. As a result, customers are getting less than they pay for. Or, this franchisee may be understaffing the restaurant to save on labor costs, resulting in a dirty restaurant with slow or unfriendly service.
This franchisee is damaging consumers’ perceptions of the brand in which you’ve invested your time and savings. The only place you can look for protection is your franchisor. After all, it’s the franchisor’s job to protect the brand’s image.
In most states, the franchisor would send a letter demanding that the offending franchisee immediately comply with the terms of the franchise agreement. But, under California’s so-called “Franchise Bill of Rights,” to terminate a franchise agreement without the 60-day cure period, the franchisor would first have to show that the offending franchisee’s conduct “reflects materially and unfavorably” on the brand’s “operation and reputation.”
Of course, the offending franchisee would argue that underportioning or understaffing are immaterial infractions, to the extent any even occurred. This would leave the franchisor with a choice between being sued, if it acted immediately to protect the brand, or giving the 60-day notice to cure. To avoid the costs and risks of litigation, most franchisors would choose the cure period, allowing the offending franchisee to continue its brand-damaging conduct for at least another 60 days.
The offending franchisee would then have the opportunity to sue the franchisor during the 60-day cure period, arguing that there was no “good cause” for termination as the franchisee was always in “substantial” compliance with the franchise agreement because any underportioning or understaffing were minor infractions. As the case meanders through the judicial maze, the brand’s reputation for food quality, good service and cleanliness would continue to decline, damaging the entire franchise system.
To avoid such protracted and brand-damaging litigation, a number of our franchisees have either sent letters, made calls or traveled to Sacramento to tell legislators about their opposition to a “Franchise Bill of Rights.” Our franchisees’ association even signed a coalition letter to express its concerns. Franchisees from other brands have undertaken similar efforts. It’s these franchisees who are performing responsibly that this legislation would hurt.
The irony is that franchisors aren’t looking to terminate good franchisees; we’re competing to find and retain them. Burger King has recently increased its percentage of franchised restaurants to nearly 100 percent. McDonald’s and Wendy’s have announced plans to increase their franchise percentages to 90 percent. At Carl’s Jr., over the past year we’ve increased our franchised percentage from 74 percent to close to 90 percent, and we may go higher.
In my 15 years as CEO, I can't recall when, if ever, we permanently terminated a Carl’s Jr. franchisee for failing to comply with the franchise agreement. Industrywide, franchise agreements are renewed more than 90 percent of the time, according to independent consulting firm FRANdata.
The impact of this legislation on franchisees renewing their agreements will come over time. However, we’ll never know how many young entrepreneurs looking to open new franchise businesses in California decide not to do so because our state limits the ability of franchisors to protect franchisees’ investments.
With all due respect to our elected leaders, there is no problem to fix. AB525 itself is a problem, and one California can easily live without.
Andrew Puzder is CEO of CKE Restaurants, parent of Carl’s Jr. and Hardees.
This article can be found on the OC Register.
Date: 2015-06-19
