When is a license not just a license, but also a regulated franchise?  If you are expanding your business through the authorized use of your trademarked products or services, you may think: “I don’t want a franchise, just make it a license agreement;” or “A trademark license isn’t a franchise is it?” or “I want to set up dealers, those aren’t franchises, are they?” This article tries to answer these questions.

Franchise laws have been applied to contractual relationships that to some appear far removed from the traditional franchise industries, including software licenses, merchandising licenses, and Internet technology licenses.

Franchising as an identifiable form of business began in the 1950’s with such chains as McDonald’s, Holiday Inn, H&R Block, Century 21, and KFC. Growth accelerated in the late 1970’s, and shows no sign of slowing. With the growth of franchising has come government regulation, to curb perceived industry abuses. In the U.S. about 40 states and the Federal Trade Commission (“FTC”) now regulate franchise offers.

Internationally, about 25 countries also have passed franchise registration, disclosure or relationship laws, including, for example, some major U.S. trading partners: Canada (Ontario and Alberta provincial laws), Mexico, Brazil, China, Korea, Japan, France, Spain, Russia and Australia. Many countries also have distribution and licensing laws that apply to franchise agreements. Examples of such laws include: trade regulation laws that limit certain restrictive covenants in franchise and distribution agreements, technology transfer agreement registration laws in many developing countries, and laws restricting termination of agents and distributors that may apply to franchises.

If a relationship is a franchise, franchise laws may regulate pre-offering disclosure, may require registration with and approval by a government agency, and may regulate the contract and the relationship, including territory, transfer, termination, and renewal. Violations of these laws can result in criminal charges, fines, civil liability with private causes of action, personal liability of responsible employees and owners, damages, rescission (return of investment), voiding of the agreement, attorneys fees, court costs, and punitive or treble damages.

What Is A Franchise?

The definition of what constitutes a franchise under law varies considerably from country to country, and from state to state. The definition that applies throughout the United States by virtue of the Federal Trade Commission Rule (“FTC Rule”), is that a franchise is an oral or written agreement (or series of agreements) that contains each of the following three elements:

1)    The franchisor offers the right to distribute goods or services associated with or identified by the franchisor’s trademark or other commercial symbol;

2)    The franchisee is required to make any direct or indirect payment to the franchisor or its affiliates (except only a bona fide wholesale price for goods for resale); and

3)    The franchisor exercises significant control over, or offers significant assistance to, the franchisee (in some states this is defined as a marketing plan or as an ongoing commercial relationship between the parties).

4)    The parties’ written characterizations of the nature of the relationship are not binding. “A rose is still a rose, by any other name.”

Thus broadly defined, franchising is not limited to particular industries. However, some industries are subject to state and federal legislation dealing solely with the specific industry, and may be therefore exempt from general franchise or business opportunity statutes. Industries with specific franchise or dealer relation laws in the U.S. include:

• Motor Vehicle, Motorcycle, Recreational Vehicle, and Farm Implement, and Boat Dealers
• Beer & Wine & Liquor Distribution
• Gasoline and Petroleum Dealers and Distributors
• Cigarette, Wine, Beer and Liquor Distribution
• Soft Drink Bottlers

The U.S. state and federal business opportunity laws also vary in their scope, but generally require pre-offering disclosure and registration of offers of assistance or marketing plans to enable others seeking to establish a business, with or without a trademark license. State sales agents laws also provide protection to commissioned agents, regarding payment of commission and termination rights. When considering franchise laws, include in your research these related industry, dealerships, sales agent, and business opportunity laws.

Licensees May Be Franchisees

An important decision involving a software license and distributorship agreement illustrates the broad reach of certain state franchise laws. In the case of Modern Computers Systems, Inc. v. Modern Banking Systems, Inc., the Eighth Circuit court assumed for purposes of its decision that a computer software distributorship agreement was a franchise within the meaning of the Minnesota Franchise Act. The Act defines a franchise to be a relationship where a franchisee: (1) has a right to use the franchisor’s trade name or commercial symbol, (2) shares a “community of interest” with the franchisor, and (3) is required to pay a fee to the franchisor. As to the definitional element of use of a trade name, it was clear from the court’s discussion in Modern Computers that the plaintiff did not operate its business under the alleged franchisor’s trademark, but did use the trademark on its software products. Nevertheless, the court found that the plaintiff distributor had a likelihood of success on the merits and was entitled to an injunction protecting it from termination as a distributor, and remanded the case to the district court to make specific findings regarding whether all three criteria for finding a franchise were met.

However, certain trademark licenses with no significant control or assistance to the licensee (under the FTC Rule), and no “community of interest” under certain state laws, may not be franchises. Care must be taken in structuring all trademark licenses to avoid the franchise laws.

TIP: For a trademark license to not be a franchise: Eliminate all of the following from the relationship: control (except minimum control necessary to maintain the trademark), assistance, marketing plan, and continued financial interest (as defined by case law).

Dealers and Distributors May Be Franchisees

The analysis of whether a distributor or a dealer is a franchisee under law frequently focuses on whether there is a “franchise fee” being charged. The FTC Rule defines a franchise fee very broadly. The intention is to cover all required payments. The only exception is a payment made at a bona fide wholesale price for reasonable amounts of merchandise  for resale. If a licensor or supplier provides substantial training, support, and assistance, it may be difficult to argue that there are no “hidden” fees for these services, imbedded in the product prices.

Laws vary in the definition of a “franchise fee.” However, even without a “franchise fee” as defined above, certain business opportunity laws and special dealer laws will cover dealer agreements. Care must be taken in structuring all distribution agreements to avoid or comply with such laws.

TIP: For a dealership to not be a franchise, normally the only payment that can be paid to the supplier is a bona fide wholesale price for goods for resale. Business Opportunity and Dealer laws may apply.

Summary

Whether license or distributorship agreements can be made “franchise­proof” often depends upon the jurisdictions involved, and willingness to modify the agreement to exclude definitional elements under these laws.

Businesses must be especially careful to consider the applicability of franchise and similar laws in the following agreements and relationships:

(1)  Trademark license agreements, especially those with marketing assistance;

(2)  Dealer and distributorship agreements, especially those that involve use of a unified trademark on products or services, and that require payments to the supplier for anything other than products for resale;

(3)  Joint ventures and “strategic alliances”, especially those that involve use of a unified trademark;

(4)  While rather rare, retail subleases with co-branding using a unified trademark, and percentage rent, plus marketing assistance;

(5)  Business start up consulting offers, with or without permission to use the sellers’ trademark.