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Lawletter No. 166 Incorporation won't always avoid franchise termination on dealer's death In Lawletter No. 163, we published a summary of the California service station franchise bequeathment law. The purpose of that article was to inform our readers of the most essential and basic steps necessary for protection of their families under the California bequeathment law, Business & Professions Code ¤21140.6. It contains checklists for insuring proper designation of a successor-in-interest and for making sure that the dealer's family has immediate access to solid proof of their legal rights in the event of his or her death. That article was also intended to provide a framework for future coverage. This and subsequent articles on the subject of bequeathment issues will amplify the points made in Lawletter No. 163 or cover additional or related issues. This month we address the question of the effect of incorporating a service station business on termination-on-death clauses in franchise agreements. The fact that we are covering additional issues in more depth does not mean that the checklist in last month's issue is incomplete with respect to the points it covers. Small businesspersons often entertain a variety of myths about the benefits of incorporation. Many incorporate without legal advice. Most do not consult an attorney to determine the legal effect of using the corporate form on important transactions. The use of the corporate form to transfer property upon death raises unusually complex problems. Such efforts should not be undertaken without sound legal advice. Nothing said here is meant to discourage a dealer from incorporating where he has sound reasons for doing so. But uninformed reliance on the corporate form to avoid the effect of burdensome contractual provisions can be a costly error. Checklist reference: The questions related to incorporating your business are covered in the Lawletter No. 163, under "Suggested checklist for incorporated dealer to determine whether to designate a successor" Summary of problems with reliance on corporate form: In theory, a corporation never "dies", and the death of even the majority shareholder does not affect its existence or its right to continue holding contract or property interests. While this is true as a very general rule, there are many exceptions. Unfortunately, one or more of these exceptions will usually prevent surviving family members from successfully using the corporate form to overcome a termination-on-death clause in the franchise agreement. Here are three of the more important exceptions: (a) The corporation is not the franchisee: Although the dealer may file tax returns as a corporation, often the franchise agreement does not name the corporation (as opposed to the individual dealer) as the franchisee. Therefore the existence of the corporation does not affect the oil companies right under the franchise agreement to terminate upon the "death of the franchisee." (b) The franchise agreement contains an overriding termination- on-death clause: Most major oil company franchise agreements now contain legally enforceable clauses permitting termination upon the individual dealer's death, notwithstanding that the agreement names the corporation as the "franchisee." (c) California incorporation insufficient to create survivorship rights: The dealer has a qualified "right" to incorporate his business under California Business & Professions Code section 21149. Section 21149 overrides any contrary provision of the dealer's lease or supply contract. However, it also contains two important limitations: (1) To rely on this law to authorize incorporation of the business, the dealer must offer to personally guarantee performance of the obligations of the franchise agreement; and (2) The dealer must retain "controlling interest" of the stock. Any transfer which results in the dealer's holding anything less than a majority of the corporation's voting stock therefore violates the franchise agreement. For example, transfer of property upon the dealer's death either by will or under the laws of inheritance would constitute an invalid assignment of the franchise. Similarly, if the franchise agreement is only in the dealer's name, and if a majority of the stock is held jointly by the dealer and his or her spouse, the transfer violates the franchise agreement. Recommended procedures: Lawletter No. 163 contains a specific checklist, which permits you to make a step-by-step determination of the effect of incorporation upon any termination-on-death clause in your franchise agreement. There might be a few cases in which the dealer may be able to overcome the effect of such a clause through incorporation, and the checklist will help you determine whether this is so in your case. If you followed the procedures suggested in that issue, there should be a copy of it in your Bequeathment Documentation File. You may also want to put this issue in the File for future reference. |
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