Franchise Your Business

While we always want to help our clients meet their own goals, this is usually one that is outside of our control. Under franchise law, a business is a “franchise” if it has the elements of a franchise. It doesn’t matter whether or not the business calls itself a “franchise” or a “license” or even what the business intended.

While there may be certain exemptions or unique factors that allow someone to license a business, it is very difficult to “license” a business and not run afoul of franchise laws.  A franchise is actually a “license,” just a special type of license that is regulated by state and federal law.

The types of arrangements that may work as “licenses” and not be considered “franchises” are generally licenses for assets and not for entire businesses. For example, a company could “license” the rights to print Mickey Mouse on a shirt, to sell superhero branded backpacks, or to use software. This type of license agreement restricts what the licensee can and cannot do with the licensed asset, it doesn’t govern the licensee’s business (which often falls into the “franchise” category). 

So, if you want to avoid being a “franchise” under franchise law, what should you be thinking about? There are three elements that, together, make a relationship a “franchise” under federal law (this applies in every state):
(1) licensing a trademark
(2) paying a fee (money)
(3) having significant control over or providing significant assistance in the operation of the business (we’ll call this control/assistance).

The first two are easy to meet (remember, if you meet all three elements, this means you are a franchise). If you are looking to grow your business, most likely there will be a trademark license involved.  For example, granting the licensee the right to use the business name is a trademark license. And you are not looking to grow the business for free (i.e. you expect a payment for your “license”).  We are already ⅔ towards a franchise and we just started.

The control/assistance element is a little more complicated. Clients often tell us that they don’t need to have control when they grant a license, or that they won’t be offering assistance. If you have created a business or a brand, the value of that brand depends on consistency among the locations. For example, if you are McDonald’s and you let your franchisees choose their standards, what would happen to the McDonald’s brand if some locations served Chinese food and other locations didn’t have French fries? McDonald’s needs to have control and provide assistance on its standards so that each McDonald’s has the same quality and offerings.

A franchise relationship is not determined by the contract language alone.  In addition to the contract, the actual relationship between the parties matters.  In other words, you could have a franchise if you provide your licensee with actual support, control, or assistance, even if your contract says “we won’t provide support.”  This means your lawyer could write up a beautiful license agreement saying that there won’t be control/assistance, but if you then go ahead and provide more control/assistance, you still may have a “franchise”. It also might mean that you could be restricted in your ability to support your licensee even if they really need the help.  You also can lose uniformity from location to location because you can’t exert control over how each location operates.  Examples of control to look out for in a license model include setting requirements for:

· site approval for new businesses
· site design or appearance
· hours of operation
· production techniques
· accounting practices
· personnel policies and practices
· promotional campaigns requiring participation or financial contribution
· restrictions on customers
· location or sales area restrictions

Examples of assistance to look out for in a license model include:

· providing formal sales or business training programs
· establishing accounting systems
· furnishing management, marketing, or personnel advice
· selecting site locations
· furnishing a detailed operating manual

Keep in mind that there are also state law franchise requirements, which are not always the same as federal laws. Even if you weren’t considered a “franchise” under federal law, you could still be considered a “franchise” (or even a “business opportunity”) under certain state laws. In general, state laws are usually different in the control/assistance element – state laws generally replace the control/assistance element with one of two different elements:  a “prescribed marketing plan” or a “community of interest.”

Here are some examples that may satisfy the “prescribed marketing plan” element under some states’ laws:

· assigning an exclusive territory
· limiting the sale of competitive products
· limiting the use of products
· requiring approval of advertising and signs
· providing training sessions
· use of an operation manual
· providing “trade secrets”

Here are some examples that may satisfy the “community of interest” element under some states’ laws:

· grant of an exclusive territory and sale of goods and services at bona fide wholesale prices
· covenant not to compete
· training programs
· required purchases from the licensor
· licensor-supplied advertising and leads
· prohibitions on selling competitive products

There is always a risk that any license agreement involving trademarks may be considered an “accidental” franchise under federal or state law.  Remember, even if you are an “accidental” franchise, you are still subject to franchise law. This usually comes up if you have an unhappy licensee, or if you decide at some time in the future to formally franchise your system. When two of the three franchise elements are present, a franchise attorney for an unhappy licensee or state regulator can generally make the argument that the 3rd element was present (e.g. the licensor provided marketing advice over the phone).

It’s also important to understand the risks here. If you sell a “franchise” (even if you thought it was just a “license”) and you haven’t complied with all relevant federal and state franchise laws, it’s possible that the “licensee” can sue you and ask for damages (in some cases, this could be their entire investment in the business, less profits).  Also, many states have regulators with the power to investigate and bring claims against you, which could include having to pay fines.

Note that if you offer a license, in addition to avoiding being deemed an “accidental franchise,” you must also be careful that your license doesn’t become an accidental “business opportunity.”  Business opportunity laws vary on a state-by-state basis (about half of all states have them) and do not necessarily involve a trademark association between the licensor and licensee.

Any time you have a relationship that meets the elements of a “franchise,” or you have some form of license agreement, you should always be evaluating whether you are actually a “franchise.”  This is true even if you have an agreement that says “THIS IS NOT A FRANCHISE” (again, the actual relationship between you and your licensee can dictate this as well as the contract).  Because of this, your risk tolerance will be a major factor in deciding the route to move forward.