Your business is doing great. Someone even wants to use your trademark to open their own business. As a result, you begin to consider a license agreement. If you proceed, will you be an accidental franchise?
Regardless of what you call your business relationship, if the relationship meets the definitional elements of a franchise, it is considered a franchise and is subject to federal and state regulation.
What are the Elements of a Franchise?
Under the Federal Trade Commission (the “FTC Rule”), a franchise exists where there are three elements present:
- Use of a trademark
- Required payment or fee
- Significant assistance or control in the method of operation
Franchise regulation states look to similar elements, but have their own franchise definitions. The majority of franchise regulation states define a franchise as an agreement between two or more parties where there is:
- A prescribed marketing plan or system (“Prescribed Marketing Plan”)
- Substantial association with the franchisor’s trademark, advertising, or other commercial symbol
- A required payment or fee
A minority of franchise regulation states will find a franchise relationship exists where there is a “Community of Interest” between the parties instead of a Prescribed Marking Plan.
New York materially differs from other states and will find a franchise relationship exists where there is a required fee and only one other definitional element.
Does it matter if you become an accidental franchise?
Yes, if an accidental franchisee becomes displeased it may decide to bring action against you for violation of franchise laws. Alternatively, a regulator may independently discover the violation, or a competitor may report the accidental franchise.
State franchise laws provide accidental franchisees with private rights of action for the accidental franchisor’s failure to comply with disclosure laws. Regulators who becomes aware of the situation could also impose their own sanctions on the accidental franchisor and its principals.
Potential penalties may include monetary fines; damages; injunctions; rescission; and, termination of the accidental franchisor’s right to conduct business within the state. Some state laws provide for criminal penalties and other significant consequences.
How do you avoid being an Accidental Franchise?
You can significantly minimize your chances of being considered an accidental franchise by carefully crafting your license agreement to eliminate one of the definitional elements.
Further, a business relationship that meets all of the definitional elements of a franchise may not be regulated as a franchise if the relationship falls within a specifically promulgated exemption or exclusion.
Before entering a license agreement, consult with an experienced franchise attorney. An experienced franchise attorney can help you franchise your business and ensure compliance with applicable laws, or carefully craft your business relationship to fall outside such laws.
Garcia and Milas Law Firm has several experienced franchise attorneys that are ready to help you navigate this process and ensure that your business is compliant, and not considered an accidental franchise.
By Jaime Paoletti, Garcia & Milas, P.C.
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Jaime Paoletti is an attorney at Garcia & Milas, P.C. who represents franchisors and franchisees nationwide, as well as start-up companies and wholesale distributors. Attorney Paoletti’s experience with the franchise model from both the franchisor and franchisee perspective provides her with valuable knowledge and insight that she applies to the benefit of her clients.
This publication is for general information purposes only and is not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.