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Chapter 40Franchises and Special Forms of

Business

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Franchising is an important Franchising is an important method of distributing goods method of distributing goods and services to the public.and services to the public.

In the United States, In the United States, franchising accounts for over franchising accounts for over 25 percent of retail sales and 25 percent of retail sales and 15 percent of gross domestic 15 percent of gross domestic product (GDP).product (GDP).

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Franchise

• Established when franchisor licenses franchisee to use the franchisor’s trade name, trademarks, commercial symbols, patents, copyrights, and other property in the distribution and selling of goods and services.

• Franchisor and the franchisee are usually established as separate corporations.

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Advantages to Franchising

1. The franchisor can reach lucrative new markets.

2. The franchisee has access to the franchisor’s knowledge and resources.

3. Franchisee runs an independent business.

4. Consumers are assured of uniform product quality.

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Parties to a Typical Franchise Agreement

Grant of franchise and Grant of franchise and license to use trademarks, license to use trademarks, service marks, and trade service marks, and trade secretssecrets

Franchisor Franchisor (Licensor)(Licensor)

Franchisee Franchisee (Licensee)(Licensee)

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Distributorship Franchise

• Franchisor manufactures a product and licenses a retail franchisee to distribute the product to the public.– Manufacture of automobiles

and franchises independently owned dealers to sell them to the public.

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Processing Plant Franchise• Franchisor provides a secret

formula or process to the franchisee.

• Franchisee manufactures the product and distributes it to retail dealers.– Regional bottling companies

to manufacture and distribute soft drinks under the “_ _ _ Cola” brand name.

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Chain-style Franchise• Franchisor licenses the

franchisee to make and sell its products or distribute services to the public from a retail outlet serving an exclusive territory.– Franchises independently

owned restaurant franchises to make and sell pizzas to the public under the “Pizza _ _ _ _” name.

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Area Franchises

• Franchisee may be granted the authority to negotiate and sell franchises in the designated area on behalf of the franchisor.– Franchisee is also called

the subfranchisor.

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Example of an Area Franchise

Area Area FranchiseFranchise

FranchisorFranchisor

FranchiseFranchise

FranchiseFranchise

FranchiseFranchise

SubfranchisorSubfranchisor

FranchiseeFranchisee FranchiseeFranchisee FranchiseeFranchisee

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State Disclosure Laws• Many states have enacted

statutes that require franchisors to make specific presale disclosures to prospective franchisee.

• Most states use a uniform disclosure statement called the Uniform Franchise Offering Circular (UFOC).

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FTC Franchise Rule• The FTC requires franchisors to

make presale disclosures to prospective franchisees.

• The franchisor must disclose assumptions underlying any estimates and hypothetical data.

• If projections are based on actual data, franchisor must disclose specifics.

• The franchisor must provide a mandated precautionary statement.

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Trademarks• A franchisor licenses the use of

its trademarks and service marks in the franchise agreement.

• Anyone who uses a mark without authorization from the franchisor may be sued for trademark infringement.

• The franchisor can recover damages and obtain an injunction prohibiting further unauthorized use of the mark.

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Misappropriation of Trade Secrets

• Anyone who steals and uses a franchisor’s trade secret is liable for misappropriation of a trade secret.

• The franchisor can recover damages and obtain an injunction prohibiting further unauthorized use of the trade secret.

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The Franchise Agreement• An agreement that the franchisor

and the franchisee enter into that sets forth the terms and conditions of the franchise.– Quality control standards– Training requirements– Covenant not to compete– Arbitration clause– Use of franchisor’s trade

name, logo, and trademark– Conditions for the termination

of the franchise

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Franchise Fees• Franchise fees payable by the

franchise are usually stipulated in the franchise agreement.

– Initial license fee

– Royalty fee

– Assessment fee

– Lease fee

– Cost of supplies

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Termination “For Cause”

• A franchisor can terminate a franchise agreement for “just cause.”– Nonpayment of franchise fees

by the franchisee– Continued failure to meet

quality control standards

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Wrongful Termination• If a franchisor terminates a

franchise agreement without just cause, the franchisee can sue the franchisor for wrongful termination.

• The franchisee can recover damages caused by the wrongful termination and recover the franchise.

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Breach of the Franchise Agreement

• Lawful franchise agreement is an enforceable contract.

• Each party owes a duty to adhere to and perform under the terms of the franchise agreement.

• Aggrieved party can sue the breaching party for rescission of the agreement, restitution, and damages.

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Independent Contractor Status

• If properly organized and operated, the franchisor and franchisee are separate legal entities.

• The franchisor deals with the franchisee as an independent contractor.– A franchisee is not the agent

of the franchisor.– The franchisor is not liable for

the franchisee’s contracts and torts.

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Contract and Tort Liability

• Franchisors and franchisees are liable for their own contracts.

• Franchisors and franchisees are liable for their own tort liability.– If a person is injured by a

franchisee’s negligence, the franchisee is liable.

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Licensing• A business arrangement that

occurs when the owner of intellectual property (the licensor) contracts to permit another party (the licensee) to use the intellectual property.– Trademarks, service marks, trade

names, copyrights

• Licenses are issued for distribution of goods, services, software, and digital information.

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Joint Venture• A joint venture is an

arrangement where two or more business entities combine their resources to pursue a single project or transaction.– Joint venturers have equal

rights to manage the joint venture

– Joint ventures owe each other the fiduciary duties of loyalty and care.

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Joint Venture Partnership

• Joint venture operated as a partnership.– Each joint venturer is considered a

partner of the joint venture.

• Each joint venturer is liable for the debts and obligations of the joint venture partnership.

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Joint Venture (continued)

Joint Venturer

Joint Venturer

Joint Venture

Partnership

Investment of capital

Investment of capital

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Joint Venture Corporation

• Two or more joint venturers corporations create a third corporation to operate a joint venture.

• The joint venturers are shareholders of the joint venture corporation.

• The joint venture corporation is liable for its own debts and obligations.

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Strategic Alliance

• An arrangement between two or more companies in the same industry.

• Companies agree to ally themselves to accomplish a designated objective. – Strategic alliances do not

have the same protection as mergers, joint ventures, or franchising.