What every corporate counsel should know about spotting a franchise

It is extremely easy to create an inadvertent franchise relationship when drafting or creating distribution, licensing, and other relationships

In this competitive and evolving business environment, companies constantly evaluate how to expand the distribution channels for their products and services. These distribution channels can include businesses operated by third parties under any one of a number of traditional legal structures:  dealerships or distributorships,  sales representatives or agents,  brokers, joint ventures, consulting arrangements, and other creative relationships. Under these arrangements, the third-party may be identified as an independent contractor or an agent. When the legal arrangement includes a "brand," in all likelihood there will be some sort of right to use the company's trademark or service mark. In these cases you need to first consider whether the arrangement may be a "franchise," which means that the arrangement is subject to specific requirements of state and federal laws.

When drafting agreements or creating these types of relationships, corporate counsel need to be cognizant of franchise laws to avoid accidentally creating a franchise relationship (typically referred to as an "inadvertent" or "hidden" franchise). It is extremely easy to create an inadvertent franchise relationship when drafting or creating distribution, licensing, and other relationships for the sale and delivery of branded products or services that will be identified by, or associated with, the seller's trademarks or service marks.

In addition to the FTC Rule on Franchising, an analysis of a relationship may include evaluating multiple state statutes. The jurisdictional scope of the various state statutes may be triggered by where the franchisor is incorporated, headquartered, or domiciled; where the offer is made; where the franchisee is domiciled; and/or where the franchisee will conduct the business that is the subject of the franchise relationship. Therefore, it is very likely that multiple franchise laws may need to be considered in connection with a single transaction. For example, if a company headquartered in New York makes an offer in Maryland to a person domiciled in California for the purchase of a franchise that will be located in Illinois, then that company will need to comply with the franchise laws in California, Illinois, Maryland and New York.

When evaluating a potential franchise relationship, the analysis of the element related to the significant control, significant assistance, marketing plan or community of interest is extremely imprecise because most trademark licensors will retain some quality controls related to the trademarks that can be the same as or similar to this element. In some of these situations, even experienced franchise counsel cannot opine with certainty on whether a court would find a franchise relationship. Further, when evaluating whether a relationship is a franchise, a court will consider the written agreements, oral promises, and how the relationship actually functions (including how it has evolved). This is very important to consider because aspects of an element may not initially be present, but the relationship may evolve to include additional aspects of an element.

Contributing Author

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Gerald Wells

Gerald Wells advises his clients on franchising, licensing, distribution, mergers and acquisitions, and general corporate law. He counsels start-up and established franchisors, licensors and manufacturers...

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