Licensing vs. Franchising: Are You Accidentally Creating a Franchise?



A trademark license may seem straightforward. It is an arrangement that gives a licensee the right to use the licensor’s mark in some manner for some amount of time, with the licensor exercising quality control over the goods offered and services rendered under the mark. Since a license is like any other contract, the licensor can add any number of conditions to the agreement, right? Not necessarily. This could inadvertently create a franchise and subject you to civil and criminal penalties.

What is a franchise?

From a 5,000-foot view, a franchise involves one party allowing another to use its brand, which may include products and services, intellectual property, and sometimes more, in exchange for a fee. Under 16 CFR § 436.1(h) (the FTC Rule), “a franchise” means “any continuing commercial relationship or arrangement” where (1) the franchisee will obtain the right to operate a business that is associated with the franchisor’s trademark, (2) the franchisor may provide assistance with or has authority to exert control over the operation of the business, and (3) the franchisee is required to pay a fee to the franchisor. Some recognizable franchises are McDonald’s, KFC and Taco Bell. Note that some courts have found that provisions specifically disclaiming franchise status are not dispositive of the status of the parties’ relationship. Unlimited Prepaid, Inc. v. Air Voice Wireless LLC, 2018 WL 6303852 (C.D. Cal. Sept. 28, 2019). In other words, it matters what it is, not what you call it. Also note that each state may have its own franchise laws.

How does a license differ from a franchise?

The big differences include (1) what the grantor is bringing to the table, (2) control over the business, (3) the type of business and (4) legal regulations. For a franchise, the franchisor is typically providing more than just a trademark, such as a business model and support. However, as you might imagine, the business model typically runs hand in hand with the franchisor’s ability to control the business. In other words, the franchisee is required to operate the business in a certain manner in order to keep up their end of the bargain. As you might imagine, franchises usually involve the sale of a product rather than a service, but that’s not always the case. Finally, a franchise is subject to many more regulations than a license because it involves much more than a trademark.

What could happen if someone creates an accidental franchise?

Since the Federal Trade Commission is entrusted with enforcing the FTC Rule, it has the ability to seek injunctive relief and civil penalties of $11,000 per violation. 15 U.S.C. § 45(m)(1)(A). Under some state statutes, an accidental franchise could constitute a misdemeanor or even a felony. See, e.g., Alaska Stat. § 45.66.210(a) (2009); Fla. Stat., Ch. 559, § 559.815 (2006); and Ind. Code tit. 24, Art. 5, Ch. 8, § 19 (2006).

In terms of a civil action, among other causes of action, a licensor may be subject to claims for fraud or deceptive trade practices. Rodopoulos v. Sam Piki Enterprises, Inc., 570 So.2d 661 (Ala. 1990); KC Leisure, Inc. v. Haber, 972 So.2d 1069, 1074 (Fla. 5thDist. Ct. App. 2008).

How does someone find themself in an accidental franchise?

Typically, this issue comes to light during litigation between the parties to the agreement or during due diligence surrounding the purchase of a company. Litigation might arise because the arrangement falls short of the licensee’s expectations or the licensor terminates the license without cause as permitted by the agreement.

How can someone avoid an accidental franchise?

Generally, it is best to avoid requirements that allow a licensor to have influence or control over the licensee’s business. But it is best to take a look at the FTC Rule and any applicable state rules to see whether a proposed arrangement would violate any of them.

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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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