Franchising cannabis businesses

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McAfee & Taft

Since the adoption of state legal medical marijuana in Oklahoma in 2018, commercial licenses in the industry have proliferated. Many prospective licensees lack the relevant cannabis experience to fully develop their business models. This has presented a new type of business opportunity for those with mature, successful operations that are located either in or out of the state: franchising.

What is a franchise under federal law?

It doesn’t matter whether the parties characterize a transaction, agreement, or arrangement as a license, joint venture, consulting or supply agreement, or dealership. If an arrangement has all of the elements of a franchise, it’s a franchise. There are three principal elements of a franchise under federal law:

  • Substantial Association with Trademark or Commercial Symbol. The business must be substantially associated with the franchisor’s trademark or other commercial symbol for the business to be a franchise. This usually takes the form of a license to use the franchisor’s name, trademark, service mark, or logo.
  • Payment of a Fee. A payment by a franchisee does not have to be labeled a franchise fee to satisfy this requirement. Ongoing payments, such as royalty payments, license fees, or other types of payments, such as consulting fees, training fees, or site assistance fees, are sufficient, as long as they are paid for the right to operate the business.
  • Significant Control or Assistance. The licensor must be able to exert significant control over the licensee’s method of operating the business, or must offer significant assistance in the method of operation.

States regulate franchising and business opportunities

A number of states regulate franchises and business opportunities in various ways. In Oklahoma, a business opportunity includes an agreement between a seller and a purchaser for the purchase of any products, equipment, supplies, or services enabling the purchaser to start a business, where the seller represents directly or indirectly, orally or in writing, that the seller will provide a marketing plan. Oklahoma requires the registration of offers of business opportunities with the Oklahoma Department of Securities, but offers and sales of franchises made in accordance with federal law are exempt from registration.

Federal requirements for franchises

Franchisors must prepare a franchise disclosure document that adheres to a specified, detailed format and present it to the prospective franchisee at least 14 days before the sale of a franchise. Additionally, a number of states require the registration of a franchise or a notice filing in the state prior to the offer of a franchise to residents of that state.

Advantages to franchising

Franchising creates an opportunity for a business owner to monetize its operating expertise and expand its brand without the capital costs associated with adding company-owned outlets. For the licensee who is a novice business owner or a novice to the cannabis business, franchising offers an opportunity to learn from the experience of others in a highly regulated industry where mistakes can be catastrophic. Note that Oklahoma requirements for licensing and restrictions on residency for licensees would not apply to a franchisor by reason of the franchise relationship.

A well-constructed franchise opportunity will encompass many or all of the following:

  • A federally registered trademark. Cannabis remains illegal under federal law; consequently, some trade names, trademarks, and commercial symbols cannot be registered federally. The best marks are typically somewhat fanciful, rather than generic or descriptive.
  • Distinctive trade dress and design features, which will promote a uniform experience in franchised and company-owned outlets.
  • An operations manual, which provides operating procedures, training information, financial planning assistance, and general operating support. An operating manual would be of particular value to franchisees who are new to the cannabis business or who need assistance with the industry’s significant compliance requirements.
  • A protected geographic area for franchised and company-owned outlets.
  • Assistance with marketing and strategic planning, which can be enhanced by aggregating marketing efforts.
  • Required or suggested purchases of products and services. Although it would not be permitted to sell cannabis or cannabis products to a franchisee unless the franchisor is properly licensed in Oklahoma, a franchisor could require the purchase of other retail, promotional, personalized items, and swag, such as t-shirts, coffee mugs, gifts, collectibles, or other items or services related to the operation of the business.

Consequences of violations of franchise laws

Although it is generally much less capital-intensive than expansion through company-owned outlets, franchising nonetheless requires a substantial initial investment to commence operations and to maintain ongoing costs of compliance and operations. However, failure to comply can result in substantial penalties and expense.

The Federal Trade Commission may seek injunctive relief and restraining orders against violators of federal requirements. The FTC may also commence an action on behalf of franchisees and can seek civil and criminal penalties. As with state statutes, liability may extend to officers, directors, and control persons of the franchisor individually.

State law also provides for both civil and criminal remedies against both the franchisor and the individuals responsible for violating the law. With respect to civil actions, state laws recognize private remedies, including equitable relief and rescission.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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