Franchise 101: California’s Dynamex/ABC Test is Retroactive; and No Excuse for Late Notice

January 28, 2021

Franchisor 101: California’s Dynamex/ABC Test is Retroactive

In 2019, the U.S. Court of Appeals for the Ninth Circuit held that the ABC Test announced in a California Supreme Court decision, Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018) could apply to franchise relationships in California. The Ninth Circuit then withdrew its opinion, and certified a question to the California Supreme Court: whether Dynamex applied retroactively, before franchisors and franchisees knew the ABC Test could apply to them.

The California Supreme Court answered, Yes. The Court applied the general rule that judicial decisions are given retroactive effect. The Court found no exception applied. The ABC Test applies as the rule of decision in all cases pending when Dynamex became final.

The Supreme Court was silent about applying the ABC Test to franchises, stating in a footnote, that although the case arose in the context of a franchise, the question of law asked by the Ninth Circuit “does not involve any inquiry into the general relationship or applicability of the Dynamex decision to franchise agreements or arrangements, and we do not address that subject.”

There is a growing split among courts about applying the ABC Test to franchises. The Ninth Circuit suggested the ABC Test applies. On the other hand, a federal court in Massachusetts held that state’s ABC Test did not apply to 7-Eleven franchisees, finding that franchisors are expected and by regulation are allowed to exert significant control over franchisees’ method of operation without becoming employers. A lawsuit in a California federal court brought by the International Franchise Association and independent franchise associations seeks a declaratory judgment that franchisors and franchisees alike are exempt from AB 5’s sweeping ABC Test.

While case law remains in flux about applying the ABC Test to franchises, it is now clear that in California, Dynamex and its ABC Test apply retroactively. Misclassification claims that predate the 2018 Dynamex decision may fall under the ABC Test depending on timing and pendency of suit, and whether the trial court finds the ABC Test appropriate. Franchisors with franchisees in California should consult California franchise attorneys with questions on this developing area of law.

Franchisee 101: No Excuse for Late Notice

The U.S. Court of Appeals for the Fifth Circuit reversed a trial court judgment against a Texas franchisor, finding the lower court erred in excusing an untimely renewal notice of area development agreements. The Court held a franchise developer may not invalidate plain terms of an option agreement when the developer failed to timely exercise the option.

The developer Clairday, entered into two area development agreements. Under the agreements Clairday would recruit and develop franchises in an assigned territory of several states. To renew, Clairday was required to provide notice of renewal at least six months prior to expiration.

Clairday timely exercised his first five-year renewal option when the initial 20-year term of the agreements neared expiration. But his notice of intent to renew under the second option was two months late. The franchisor did not renew, and ultimately sought a declaratory judgement that nonrenewal was proper.

Clairday counterclaimed for breach of contract for failure to renew the agreements. Clairday relied on the equitable-intervention doctrine. That doctrine provides an exception to strict compliance with contract terms, where failure to strictly comply may be excused to prevent unconscionable hardship if the failure was due to a justified honest mistake and not due to willful or gross negligence. The trial court upheld the jury verdict for the franchisee, concluding the equitable-intervention doctrine excused strict compliance with the option agreement terms.

The Fifth Circuit assumed the franchisee’s delay was slight and financial loss to the franchisor small. Still, rejecting the renewal would not create any unconscionable hardship. The appellate court was not convinced that Clairday lost part of the initial investment of $1.25 million, because he “indisputably received” the benefit of his bargain for rights as an area developer. As an option holder, he stood to lose no more than his power to exercise the option. Clairday’s claim of lost profits was not unconscionable, because Texas law says losing the opportunity to turn a profit does not “shock the conscience.” Nor did the Fifth Circuit connect the franchisor’s decision not to renew the agreements with Clairday’s closure of a franchised store. This was because the store was in a different entity, not associated with the development agreements.

Franchise and area development agreements generally expire after a defined term. The franchisee or area developer may have an option to renew. Franchisees should be vigilant to comply with renewal terms to avoid loss of the benefits of renewal. This is especially so in states lacking franchise relationship laws. Franchisees should contact franchise counsel well in advance of the period when a renewal may be exercised, to consult on compliance with all renewal procedures and possibly evaluate if any terms should be or may be revised prior to renewal.