A Massachusetts district court granted a product supplier’s motion to dismiss a distributor’s counterclaims that the supplier violated state franchise sales and consumer protection laws. The court found the distributor did not establish a franchise relationship existed.
Cognex Corporation granted Air Hydro LLC the right to sell Cognex’s products within a specified territory in a distribution agreement. After Cognex informed Air Hydro that it would not renew the agreement, the parties filed lawsuits against each other in Florida and Massachusetts district courts. Air Hydro, the defendant in the Massachusetts case, brought counterclaims alleging Cognex unlawfully sold Air Hydro a franchise in violation of Florida and Indiana’s franchise sales and consumer protection laws.
A franchise relationship exists where the franchisee obtains the right to operate a business offering or selling the franchisor’s goods or services under the franchisor’s trademarks, the franchisor exerts significant authority in and provides assistance with the business operations, and the franchisee agrees to make required payments to the franchisor for the right to operate the business.
Cognex argued there was no franchise relationship because Air Hydro did not make payments for the right to operate the business. Air Hydro argued it made required payments because it purchased Cognex’s demonstration equipment, paid software licensing fees, hired and trained employees to distribute Cognex products, and incurred costs in building demonstration facilities.
The district court found none of Air Hydro’s arguments persuasive because none of the purchases or payments were required. The court found Cognex merely recommended that Air Hydro purchase and maintain demonstration products and reserved the right to remove standard discounts if demonstration equipment was not purchased. The court found Cognex’s recommendation was a discount incentive, not a condition for obtaining a franchise. Similarly, fees for the licensing software were not expressly required in the agreement. Finally, the court was unconvinced that hiring and training employees, although Cognex conducted some of the training, and Air Hydro’s costs to build demonstration facilities were required by Cognex. Rather, the court found that these were ordinary business expenses to further Air Hydro’s business goals, not a fee for the right to operate.
Whether a payment is considered a required or indirect franchise fee can be a fact-intensive inquiry that goes beyond the plain words of the agreement. For example, a business that cannot feasibly be operated without paying for sales kits, instruction sets or other non-incidental expenses that reflect the dealer’s investment in the business could be deemed a franchise fee, even if the agreement said there was none. Parties looking to avoid the requirements of federal and/or state franchise laws are well-served having franchise counsel review and structure the arrangement to minimize risk of claims that the distribution, dealer or license agreement, however named, meets all elements of a franchise.
Cognex Corp. v. Air Hydro Power, LLC, No. 22-10051-NMG (D. Mass. Sept. 8, 2023)
