You’re thinking about expanding your brand. Perhaps you want to open new restaurant locations or create a product line. Regardless of your method of expansion, you will, by necessity, be licensing your intellectual property. One of the most common pitfalls in IP licensing is the unintended birth of a franchise, more commonly referred to as the accidental franchise.
Franchises are highly regulated in the U.S., on both the state and federal level. A franchise, as defined by the Federal Trade Commission, involves three (3) elements:
- The franchisee has the right to use a trademark;
- The franchisee must be required to pay royalties or fees to the franchisor/trademark owner; and
- The franchisor must impose substantial control/involvement/assistance in the franchisee’s business that uses the trademark.
The two most troublesome areas relate to payment and control. In the “control” realm, certain items are almost certainly guaranteed to drive your license into the land of franchise, such as requiring the licensee to: adopt particular business hours, follow certain HR policies, bookkeeping and accounting practices, undergo extensive advertising and marketing campaigns, follow site design or appearance requirements, production techniques, or use pre-prepared, detailed operating manuals. Additionally, helping select site locations or materials sources can denote a franchise. Limiting your control over the licensee’s business operation as much as possible will help you to avoid being deemed a franchise. If a control provision is strictly necessary to protect your rights as the trademark owner, it stands a better of chance of not causing your arrangement to be considered a franchise. If, however, the provision seems more of a day-to-day control over the licensee’s business, it will work against you.
In terms of payment, if you as the licensor require the licensee to purchase goods from you for resale at a higher price than the wholesale price, the franchise fee requirement will have been met and your license agreement will be deemed a franchise agreement. How can you avoid the fee requirement? For starters, by limiting the price of goods and materials to the bona fide wholesale price. Another way is to limit the fees that a licensee is required to pay. Be warned: a nominally optional payment will be classified as a required payment if it is practically necessary for a successful business operation. A commission-based relationship, in which the licensee does not make payments to the licensor, but rather, receives a commission as compensation successfully avoids the franchise label. Also, while there are additional exemptions from federal law, they may not be available or applicable in a particular state.
Being aware of what constitutes a franchise and having a carefully prepared agreement can help keep your arrangement as a license, but where there is any question of whether the elements of a franchise are present, a prudent licensor should be sure to seek the advice of an attorney well-versed in federal and state franchise law.