Franchising Fridays - Is Your Licensing Agreement Really a Franchise? And What Are the Consequences if It Is?

This post originally appeared on the blog of the Denver Bar Association Young Lawyers Division, of which author Laura Liss is a member and guest author. Check out the DBA-YLD blog for posts on all kinds of legal issues, not just business and franchising matters. Now, on with the show!

A franchise is, at its core, a licensing agreement.

So what morphs a commonplace licensing agreement into a franchise?

A license becomes into a franchise when:

(i)            One grants another the right engage in a business;

(ii)          Using the grantor’s brand identification (e.g. logo, registered or unregistered trade/service mark, or advertising);

(iii)         Subject to the grantor’s significant control or assistance (such as a training program or coaching); and

(iv)         The grantee pays more than $500 to enter into or continue the relationship.

While all the above elements are necessary, the grantor’s significant control or assistance and the use of common branding are what usually push a licensing agreement into being a franchise. When evaluating a licensing program, consider whether the above elements actually create a franchise out of the licensing agreement you are reviewing.

If It Is is a Franchise, Federal and State Franchise Laws Apply.

The Federal Trade Commission’s (“FTC”) Franchise Rule applies in all 50 states and many states have state-specific franchising rules.  The most fundamental rule requires the preparation and delivery of a Franchise Disclosure Document containing hundreds of pages of required disclosures that must be given to the potential buyer within a specified time.  State and FTC enforcement of these rules can be harsh.  Fines, refunds, buybacks, and awards of attorney’s fees are routine if a Franchise Disclosure Document is not prepared or delivered as required.

When Do State Franchising Laws Apply?

These state laws may be triggered if any the following occurs in a state:

(1) The offer originates, is received, or is accepted in the state;

(2) Meetings between the franchisor and prospect occur in the state;

(3) The franchise business location will be operated in the state or any part of the territory will be in the state; or

(4) The prospect is a state resident.

Consider this example: North Dakota resident meets Colorado franchisor (your client) at a trade show in California. The North Dakota resident later accepts the offer to buy a your client’s franchise, the territory of which will be located in Washington.

This example could require your client’s compliance with four sets of franchising laws: North Dakota, California, and Washington state-franchise law, in addition to federal franchise law that applies everywhere. Note that Colorado does not have its own state-specific franchise laws.

Take Away Points: Discuss licensing agreements carefully with your client (or your lawyer if you're the client) to discover if the business model may implicate a franchise based on the above elements. Frequently, there are strong business reasons to expand the business through franchising, namely the influx of someone else’s capital into the business. If you are unfamiliar with the franchising laws, consult with a franchise attorney when evaluating or structuring a potential licensing or franchising program to make sure the program and documents are done correctly.