Registration and Disclosure


The Experienced Franchisee Exemption Under The California Franchise Investment Law

By Kevin A. Adams on July 14, 2017

In California, the offer and sale of a franchise is regulated by the California Franchise Investment Law (“CFIL”). The CFIL imposes a registration and disclosure obligation on franchisors requiring them to register their franchise offering with the California Department of Business Oversight prior to any offer or sale of a franchise, and to provide prospective franchisees with the franchisor’s then-current franchise disclosure document no less than 14 calendar days before signing a franchise agreement or accepting payment from the prospective franchisee.

There are a few exceptions to these registration and disclosure requirements. One of those is the “experienced franchisee” exemption set forth in Section 31106 of the CFIL.[1] Under the law, certain prospective franchisees may have a level of management, operational experience, and existing familiarity with the franchise that renders the registration and disclosure obligations of the CFIL unnecessary.

For the transaction to be exempted under Section 31106, the prospective franchisee must satisfy one of the following three criteria:

First, the transaction is exempt if the owner of the prospective franchisee (owning at least a 50 percent interest in the prospective franchisee) meets both of the following:

  • The owner has had, within the seven years before the date of the sale or other transaction, at least 24 months’ experience being responsible for the financial and operational aspects of a business offering products or services substantially similar to those offered by the franchised business, and
  • The owner is not controlled by the franchisor.[2]

Second, the transaction is exempt if the owner of the prospective franchisee (again owning at least a 50 percent interest in the prospective franchisee) meets both of the following:

  • The owner or owners are, or have been within 60 days prior to the sale or other transaction, an officer, director, managing agent, or an owner of at least a 25 percent interest in the franchisor for at least 24 months, and

     

  • The owner or owners are not controlled by the franchisor.[3]

Finally, if the transaction involves an additional franchise to an existing franchisee of the franchisor (or to an entity or individual with at least a 25 percent interest in the existing franchisee) the transaction is exempt under the CFIL so long as the existing franchisee has been engaged in a business offering products or services substantially similar to those to be offered by the additional franchise for the past 24 months.[4]

Along with satisfying one of the above three criteria, the franchisor must file a notice of experienced franchisee exemption with the DBO no later than 15 days after the transaction is complete.[5] This filing must be accompanied by a $450 filing fee for an initial notice of exemption and a $150 filing fee for each consecutive notice of exemption.[6]

If the prospective franchisee satisfies any of the above three criteria, and the franchisor timely files the notice and pays the required filing fee, the transaction “shall be exempted from provisions of Chapter 2 [of the CFIL] (commencing with Section 31110).”[7] This includes exemption from the registration (Sections 31110, 31114), disclosure (Section 31119), and renewal (Sections 31121, 31125) requirements set forth in Chapter 2 of the CFIL.

The burden of proving an exemption or exception under the CFIL is always “upon the person claiming it.”[8] Also, similar, although not identical, exemptions from the Federal Trade Commission’s Amended Franchise Rule can be found at 16 CFR § 436.8(a)(5)(ii) and (a)(6).

Franchisors should be aware that although the language of subsection 3 of Section 31106 expressly references an “additional franchise to an existing franchisee,” a district court in California found that the experienced franchisee exemption does not apply to “renewed agreements with franchisees.”[9] Instead, the exemption only applies if the existing franchisee is considering adding an additional franchised business.

This article was prepared by Kevin A. Adams (kadams@mulcahyllp.com), of the Irvine law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation firm that provides legal services to franchisors, manufacturers and other companies in the areas of antitrust, trademark, copyright, trade secret, unfair competition, franchise, and distribution laws.

Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.




[1] Cal. Corp. Code § 31106.
[2] Cal. Corp. Code § 31106(1).
[3] Cal. Corp. Code § 31106(2).
[4] Cal. Corp. Code § 31106(3).
[5] Cal. Corp. Code § 31106(b).
[6] See Cal. Corp. Code §§ 31106(f), 31500(f).
[7] Cal. Corp. Code § 31106.
[8] Cal. Corp. Code § 31153.
[9] Mahroom v. Best Western Intern., Inc. (N.D. Cal. 2007)) 2007 WL 2123565, at *5.

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