This seems like a simple question. Am I running a McDonalds or a Best Buy? Easy, right? As a franchisee (an operator of a franchise) it’s fairly simple to answer. But if you own your own business and are keen to expand using a strategy that includes licensing of your brand, evenif you don’t consider it a franchise opportunity, you may be operating a franchise under the law.
Here’s a better question, why do you care? The Federal Trade Commission (FTC), and a number of states, have instituted stringent rules governing the owning, selling and operation of franchises. Failure to comply with these rules can subject your business to stringent penalties. As always, failure to know or apply the law to your business is no excuse for not complying.
So let’s talk franchise. Franchising is a model that companies use to expand their brand. In general, a business owner (“franchisor”) grants rights to a third party (“franchisee”) to use the trademarks, trade names, products, services and business methods of the company in order to allow the franchisee to open a similar business. The franchisor grants these rights in exchange for payment that commonly includes both an up front franchise fee and ongoing royalties. The franchisor typically imposes quality control requirements and provides training to the franchisee to ensure the good will of the brand does not suffer in the franchisee’s hands.
For the world traveler, the franchise model is responsible for your Big Mac containing the very same “special sauce” in Paris as it does in Prague and Portland. But even if your business doesn’t yet have global outposts, any growth involving licensing of your brand needs a closer look. In addition to significant fines and freezing of assets, penalties for failure to comply with the FTCs franchise regulations can result, under the worst circumstances, in prison time.
A name is not just a name according to the FTC. If it quacks like a franchise, it’s a franchise, despite being called a “license” or a “business opportunity”. The current Franchise Law, 16 CFR 436.1, establishes three key elements of any arrangement that cause it to be considered a franchise under the law:
- the license of a trademark from the franchisor to the franchisee,
- the ability of the franchisor to exert a significant degree of control over, OR to provide significant assistance with, the franchisee’s method of operation; and
- a required payment from the franchisee to the franchisor as a condition of obtaining or commencing the business of the franchise.
If your business even arguably meets all three criteria (meaning it does not clearly fail at least one of the 3 prongs) caution would warrant a more thorough review of the franchise laws, both federal and state. And, if your business falls within these laws, next steps would include preparing (and possibly filing) certain legal documents including a Franchise Disclosure Document (“FDD”) and providing the FDD to all potential franchisees. The FDD is a very comprehensive document with 23 specifically required disclosures that require certain additional documents to be attached.
Sound daunting? There’s no need to panic. While complying with franchise law is a detailed and somewhat complicated process, it is not something that an experienced franchise lawyer can’t navigate for you. Knowledge is power and this first step analysis is key to getting your business growth on track while minimizing risk. There is a reason some of the world’s most successful businesses are franchise operations.
Need an analysis of whether your business constitutes a franchise under the franchise laws or just want to talk about franchise law? Contact any of Culhane Meadows’ franchise partners who are all knowledgeable and capable of creating a strategy tailored to your specific business needs. We look forward to hearing from you.
Author Dana W. Lynch joined Culhane Meadows from FisherBroyles LLP, where she split her time between managing that firm’s Chicago office and practicing corporate and franchise law. Ms. Lynch has extensive experience structuring and negotiating commercial agreements, such as manufacturing, franchising, licensing, distribution, consulting and sales agreements, for a variety of clients. She can be reached at dlynch@CulhaneMeadows.com