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How To Deal With California AB 525
Requirements, Issues And What Franchisors Must Do Now To Avoid Costly Mistakes
Wednesday, December 9, 2015
Panel: Aaron Chaitovsky, CPA, Citrin Cooperman, New York, NY
Jan Gilbert, GPM, Washington, DC Carl Zwisler, GPM, Washington, DC
GPM Webcast
Why Is AB 525 Unprecedented?
• The franchisee defaults – the franchisor pays
• Franchisors must provide (written) standards for approving new and renewing franchisees when a transfer approval is requested
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Aaron Chaitovsky, CPA, CFE
Partner Citrin Cooperman
New York, NY
Aaron Chaitovsky, CPA, CFE, is the Partner-in-Charge of the Citrin Cooperman’s franchise accounting and consulting practice, focusing on audit and consulting services for franchisors and multi-unit franchisees. Citrin Cooperman is among the largest, nationally recognized full-service CPA firms in the United States– currently ranked in the top 25. With locations in New York, NY; White Plains, NY; Livingston, NJ; Norwalk, CT; Philadelphia, PA; Plainview, NY, and Bethesda, MD, Citrin Cooperman has steadily built its business serving a diverse and loyal clientele since 1979. Our daily mission is to help our clients “focus on what counts.” We enhance the business and personal lives of our clients through our customized approach which includes offering a wide range of attest, assurance, tax, and business advisory services, including valuation and forensic services, across the globe.
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Jan S. Gilbert Principal
Gray Plant Mooty Washington, DC
• Jan is a principal practicing in the Franchise & Distribution practice group • Worked with both start-up and developed franchisors and franchisees for
more than 25 years • Counsels on all aspects of domestic and international franchising • Experience includes structuring franchise programs, counseling on federal
and state regulatory issues, mergers and acquisitions, franchisee compliance issues, drafting franchisee- and distribution-related agreements, negotiating domestic and international agreements and disputes, obtaining exemptions and interpretative opinions from regulatory agencies, responding to state and federal administrative inquiries and investigations, and establishing franchise advisory councils and cooperatives
• Honors include Chambers USA: America’s Leading Lawyers for Business; The Best Lawyers in America; The International Who’s Who of Franchise Lawyers; The International Who’s Who of Business Lawyers; and Franchise Times “Legal Eagle” 4
Carl E. Zwisler Principal
Gray Plant Mooty Washington, DC
• More than three decades of experience advising franchisors and master franchisees on U.S. and international franchising issues
• Former IFA General Counsel, IFA Supplier Forum Chair, and Member of IFA Board of Directors
• Chair IFA’s SBA Franchise Registry Task Force • Member Maryland Attorney General’s Franchise Advisory Task Force • Chair GPM Webinar on Franchisor Joint Employer/Vicarious Liability • Principal Author - GPM analysis of California AB 525, NLRB v. Browning,
and GPM response to NASAA Commentary Financial Performance Representations
• Comments cited more than 160 times in Statement of Basis and Purpose to 2007 Amended FTC Franchise Rule
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20020. Except as provided in Section 20021, good cause shall be limited to the failure of the franchisee to substantially comply with the lawful requirements imposed upon the franchisee by the franchise agreement after being given notice at least 60 days in advance of the termination and a reasonable opportunity, which in no event shall be less than 60 days from the date of the notice of noncompliance, to cure the failure.
AB 525
The period to exercise the right to cure shall not exceed 75 days unless there is a separate agreement between the franchisor and franchisee to extend the time.
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What Must A Franchisor Know To Comply With
New Termination Standard?
• Definition of “substantially comply” • Exceptions to a 60-day cure period
(unless earlier termination is authorized by the CFRA)
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Consequences Of A Lawful Termination – Section 20022(a)
Lawful Franchisor Termination
No Franchisor ban on Franchisee’s control of
premises Franchisor collects
damages
Franchisor does not allow Franchisee to
control premises Franchisor buys
assets
Franchisor and Franchisee agree in
writing to termination / non-renewal
No asset purchase obligation outside of
agreement
Franchisor announces market area withdrawal
No asset purchase obligation; Franchisor must withdrawal from franchise
activities in the MSA
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Franchisee Terminates ?
Terms offered by Franchisor rejected by Franchisee
Non-renewal
No asset purchase obligation
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Franchisee does not request
renewal within time set in Agreement
Non-renewed ?
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Remedy For Unlawful Termination Or Non-renewal
Section 20035(a) • Franchisee is entitled to receive “fair
market value of franchised business and franchise assets and any other damages caused by the violation…”
• Franchisor may offset amounts “owed the franchisor or its subsidiaries….”
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Elements Of Purchase Requirement Section 20022(a)
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1. Franchisor shall purchase from the franchisee 2. At the value of price paid minus depreciation 3. All inventory, supplies, equipment, fixtures and
furnishings
7. At the time of the notice of termination or nonrenewal
4. Purchased or paid for: a) Under the terms of the franchise agreement b) Or any ancillary or collateral agreement by the
franchisee
5. To the franchisor or its approved suppliers and sources
6. That are in the possession of the franchisee or used by the franchisee in the franchised business
8. To which the franchisor receives clear title
How Will Accountants Interpret “The Value Of The Price Paid,
Minus Depreciation”?
• Which type of depreciation will be applied to which assets?
• What should be addressed in Franchise Agreements to determine depreciation?
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Depreciation Variables
• Depreciation is a systematic allocation of the cost of PP&E (less scrap or salvage value, if any) over the estimated useful life of the asset. It is a process of allocation, not of valuation.
• The objective of a depreciation method is to charge a portion of the cost of the PP&E to operations each year in order to match the revenue produced by the asset. Obviously, a critical factor in achieving that objective is the choice of the estimated useful life. It is important to note that useful life is an asset’s service life, which may not coincide with its physical life.
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Depreciation Methods Allowed By GAAP
• Straight-line: This method spreads the cost of the fixed asset evenly over its useful life
• Declining-balance: An accelerated method of depreciation, it results in higher depreciation expense in the earlier years of ownership
• Sum-of-the-years’ digits: Compute depreciation expense by adding all years of the fixed asset’s expected useful life and factoring in which year you are currently in, as compared to the total number of years
• Units-of-production: The total estimated number of units the fixed asset will produce over its expected useful life, as compared to the number of units produced in the current accounting period, is used to calculate depreciation expense 17
Financial Statement Footnotes
The following is a partial listing of items that must be explained in the footnotes that accompany the Franchisor’s financial statement with regard to the “purchase of the franchisees assets”: • The basis of valuation • The amount of major classes of assets, by
nature or by function • The amount of depreciation expense for each
period presented • The amount of accumulated depreciation,
either by major classes of asset or in total 18
A general description of the method(s) used in computing depreciation
Separate identification of the amounts of: • Idle property and equipment
A description of collateral and the amounts pledged
Commitments to purchase large amounts of property and equipment
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Select Key Information Needed To Evaluate Cost Of
Terminating A Franchise 1. Identity of each of its franchisees’ asset and
price paid 2. Purchase date of each asset 3. Depreciation method of useful life 4. Whether each asset is owned or leased 5. Whether each asset is subject to liens or
encumbrances – purchase money security interest, blanket
security interest, first refusal right, landlord’s lien, and tax lien
6. Date by which liens must be released 7. Calculation of franchisor’s set off 20
How Franchise Agreement Language May Prepare For A Post-Termination Purchase
1. Require periodic reports regarding all assets 2. Define every ambiguous term in AB 525 in
the Franchise Agreement and/or Asset Purchase Agreement: a) Define depreciation method and useful life of
franchisee’s assets b) Salvage value c) Fixtures d) Whether purchase price includes cost of removal
and transportation of assets e) Set-off calculation f) How closing date is to be set 21
Transfer Standards Section 20028(a)
1. Standards for approval of new or renewing franchisees
2. Made available to the franchisee 3. Consistently applied 4. To similarly situated franchisees 5. Operating within the franchise brand 6. Within 15 days of request for approval 7. Reasonable
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What Must A Franchisor Know To Comply
1. Standards for approval of: a) new franchisees b) renewing franchisees c) owner of a non-controlling interest
2. Whether standards can be merged and defined as a standard for transferees
3. How to document their consistent application to new and renewing franchisees
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4. Whether disclosure of standards to the
franchisee when proposed transferor is an owner of an equity interest constitutes requisite notice to the “franchisee”
5. How soft or subjective standards may be articulated and applied
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Will AB 525 Have Any Affect On Franchisor’s Financial Statements?
• Portion of franchisees in California • Franchisees in default when audit is
performed • Franchisees contemplated for nonrenewal
when audit is performed
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The Franchisor Financial Statement Impact
• Contingencies and their treatment – Something new to consider with AB 525
• A contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to a possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur. The term “loss” includes a charge to income that may otherwise be referred to as an expense.
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Following are probability classifications of loss contingencies: • Remote. The chance of the future event
occurring is slight.
• Reasonably possible. The chance of the future event occurring is more than remote but less than likely.
• Probable. The future event is likely to occur.
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• An estimated loss from a contingency should be accrued and charged to operations only if both of the following conditions are met: 1) Information available prior to the issuance
of the financial statements indicates that it is probable (virtual certainty is not required) that an asset has been impaired or a liability incurred as of the date of the financial statements; and
2) The amount of the loss can be reasonably estimated
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Conclusion
• AB 525 changes the cost and risk of franchising in California for franchisors. Although the legislation abounds with ambiguity, franchisors have the ability to lessen the impact of the law by carefully revising their franchise agreements to define terms and establish procedures for avoiding or addressing purchase obligations.
• They also have the opportunity now to create written transfer standards that may withstand challenges of unreasonableness and discrimination. 29
• Franchisors who fail to act to address these issues now will face unnecessary uncertainty, and the likelihood of making unnecessary payments and accepting unqualified transferees.
• We have prepared issues outlines that detail many of the issues that time did not allow us to address. Please contact us if you would like a copy.
• Thank you for joining us!
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Questions For Consideration
1. Should franchisors use asset or stock purchase options in California Franchise Agreements?
2. Should franchisors create new checklists? – Termination – Transfer – Renewals
3. Should franchisors include independent termination agreements in FDDs?
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4. Should franchisors who want to control real estate abandon franchising in California?
5. Should franchisors charge higher fees to California franchisees to compensate for added risk or expense?
6. When does it make sense to terminate in violation of AB 525 and elect those remedies?
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Thank You
Carl E. Zwisler Gray Plant Mooty
The Watergate - Suite 700 600 New Hampshire Avenue, N.W.
Washington, D.C. 20037 www.gpmlaw.com
Telephone: 202-295-2225 Facsimile: 202-295-2275 [email protected]
Jan S. Gilbert Gray Plant Mooty
The Watergate - Suite 700 600 New Hampshire Avenue, N.W.
Washington, D.C. 20037 www.gpmlaw.com
Telephone: 202-295-2230 Facsimile: 202-295-2280 [email protected]
Aaron Chaitovsky CitrinCooperman
529 Fifth Avenue New York, NY 10017
www.citrincooperman.com
Telephone: 212-697-1000 Facsimile: 212-697-1004
