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Presenting a live 90-minute webinar with interactive Q&A
Avoiding the Accidental Franchise When
Structuring Licenses or Distribution Agreements
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
THURSDAY, MARCH 2, 2017
Craig R. Tractenberg, Partner, Fox Rothschild, New York
Rochelle (Shelley) Spandorf, Partner, Davis Wright Tremaine, Los Angeles
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Avoiding the Accidental Franchise When
Structuring Licenses and Distribution Agreements
THURSDAY, MARCH 2, 2017
Rochelle Spandorf, Davis Wright Tremaine LLP
Craig Tractenberg, Fox Rothschild LLP
Discussion Points:
Why does Franchise status matter?
So, what exactly is a Franchise?
How and why do accidental Franchises happen?
Examples of accidental Franchises
Strategies for drafting licenses and distribution agreements
to avoid inadvertent Franchises
Common issues and stress points in Franchise relationships
Q&A
6
Why does Franchise status matter?
7
License vs. Franchise
By legal definition, every franchise is a trademark license.
However, not every trademark license is a franchise!
TM ≠
F
F =
TM
A trademark license may be express or implied.
A distribution agreement that gives distributor or dealer a right to sell
branded goods is an implied trademark license (if not an express one)!
8
Franchises = creatures of statute
or
or
+ +
SIGNIFICANT
ASSISTANCE/
CONTROL
MARKETING
PLAN
COMMUNITY
OF INTEREST
REQUIRED
FEE TRADEMARK
9
So why does Franchise status matter?
Franchises are subject to extensive regulation that licensors of
non-franchise trademark licenses are able to bypass
Federal and state franchise sales laws – “front end”
Regulates the sales process
Public disclosure of financial statements
Personal liability for top management
State relationship laws - “back end”
Must have “good cause” to end a franchise relationship
Some relationship laws impose other substantive contract
terms, e.g., transfer, unilateral changes imposed by the
franchisor/supplier, and more
10
So why does Franchise status matter?
Non-franchise trademark licenses are private, consensual
Non-franchise trademark franchisors do not have to make any public
disclosure about their financial condition or other sensitive
information
No “front end” or “back end” laws regulate how non-franchises
trademark licenses are formed or may end
“At will” arrangements that allow a non-franchise a trademark
licensor to terminate on X days notice = enforceable
No personal liability if a non-franchise trademark licensor breaches
the contract
11
Complications of Being a Franchise - Overview
Franchise Sales Laws (‘front end” laws)
Federal: Amended FTC Rule: presale disclosure duty, but no
federal filing
State: Presale disclosure + registration/filing duty
Business Opportunity Laws (“front end” laws)
Even if not a franchise, arrangement may be a “bus/op”
Federal: Exempts franchises that comply with Amended FTC
Rule
State Laws: Presale disclosure + registration/review
More states with Bus/Op laws than franchise sales laws
Most Bus/Op laws regulate only when buyer starts a business, not
when expanding into new line
Franchise Relationship Laws (“back end” laws)
Federal: none
State laws: widely vary; override contract terms
12
State Laws Regulating Franchise Sales – “Front End”
Registration Filing - Full Agency Review
Notice Filing for Bus/Op Exemption
Notice Filing for State Franchise Sales Law
Amended FTC Rule – Disclosure, but no filing req'd 13
More complications: which law applies?
Amended FTC Rule applies to all franchise sales in US even when
franchisor, franchisee + franchise location/territory are in same state
No private right of action
However, in many states, plaintiffs may bring a state “baby FTC
Act” claim and rely on Amended FTC Rule violation as predicate
unfair or illegal act or practice
State law jurisdiction varies according to:
Assigned territory; distributor or licensee’s residence/domicile;
where offer/acceptance take place
New York approach to jurisdiction
Some state laws require that distributor/licensee maintain “place of
business” in state; a warehouse may suffice
No uniformity across states re: jurisdiction, exemptions, exclusions
No federal preemption. A transaction may be exempt from Amended
FTC, but, if no counterpart state law exemption, must comply with
state franchise sales law; and vice-versa.
14
Key Points About Franchise Sales Laws
Amended FTC Rule
Pre-sale disclosure via uniform form of franchise disclosure
document (“FDD”)
14 day “waiting period” before signing any contract or paying
any money even refundable deposit
No federal filing requirement or FTC review
FDD must include audited financial statements for last 3 years
FDD must be updated annually w/in 120 days after each FYE
Material change amendments = quarterly
Record keeping duties (varies by state law)
No financial performance representations (FPR) without
complying with FDD Item 19 disclosure rules
State franchise sales laws
Same pre-sale disclosure duty + 14 day delivery requirement
Must register with state franchise agency before offering or
selling franchises to state resident or for location/territory in the
state
15
States Regulating Franchise Sales
California
Hawaii
Illinois
Indiana
Maryland
Michigan
Minnesota
New York
North Dakota
Rhode Island
South Dakota
Virginia
Washington
Wisconsin
States with bus/op laws that
exempt franchise sales if filing
made:
Florida
Kentucky (one time)
Nebraska (one time)
Texas (one time)
Utah
16
Business Opportunity (Bus/Op) Laws
“Front End” only; no relationship regulation
Goods/
Services
$$$ to promoter
(minimum
amount varies)
Start a business
(some, maintain
or operate a
Business)
Triggering
Representations +
+
+ +
17
States Regulating “Business Opportunity” Sales
Alabama Kentucky North Carolina
Alaska Louisiana Ohio
California Maine Oklahoma
Connecticut Maryland South Carolina
Florida Michigan Texas
Georgia Minnesota Utah
Illinois Nebraska Virginia
Indiana New Hampshire Washington
Iowa
18
State “Relationship Laws” – “Back End” Laws
GC for termination + payment of a required fee besides cost of product (“3 prong states”)
GC for termination, but no required fee (“2 prong states”)
PR & VI
19
No federal franchise relationship law
State franchise relationship laws
Dealer termination laws
Special industry laws
“3-prong” -
“2-prong” -
Key Points About Franchise Relationship Laws
“2-prong” -
20
Alaska Maryland South Dakota
Arkansas Michigan Virginia
California Minnesota Washington
Connecticut Mississippi Wisconsin
Delaware Missouri Puerto Rico
Hawaii Nebraska U.S. Virgin Islands
Illinois New Jersey
Indiana North Dakota
Iowa Rhode Island
States with a “Relationship” Law (not industry-specific)
21
Legal Consequences: Statutory Remedies –
Franchise Sales Laws (“Front End Laws”)
Franchise
Damages
Injunctive Relief
Rescission
Potential personal liability
Criminal prosecution - felony
Administrative agency remedies including restitution, asset freeze, C&D
Attorneys fees
22
Franchise
Legal Consequences: Statutory Remedies –
Franchise Termination Laws – “Back End Laws”
Damages for wrongful termination or other statutory violation (some states treble damages or award a multiple of lost profits, some 5-10X)
California offers remedies to a lawfully terminated franchisee if the franchisor assumes operation of former franchise location
Potential personal liability
Inventory repurchase
Injunctive relief
Attorneys fees
23
So, what exactly is a Franchise?
24
A Franchise = 3 legged stool (if any leg is missing ≠ F)
or
or
+ +
SIGNIFICANT
ASSISTANCE/
CONTROL
MARKETING
PLAN
COMMUNITY
OF INTEREST
REQUIRED
FEE TRADEMARK
25
Definitional variations
“substantial association” with a licensor’s TM
TM license
Defacto or implied licenses
“Smith’s Appliances, an authorized Brand X Service Center”
ABC, a member of the Oracle Partner Network
(displayed with logo)
Branded products or services account for a significant % of the
licensee/operator’s overall sales/revenue (generally > 20%)
Trademark leg is essential to franchise status, but not bus/op
status
Licensor’s quandary
Trademark
26
SIGNIFICANT
ASSISTANCE/
CONTROL
MARKETING
PLAN
COMMUNITY
OF INTEREST
Definitional variations depend on jurisdiction
Substantial assistance/significant control
“Marketing plan prescribed in substantial part”
Community of interest
No minimum number of facts must co-exist
Most subjective definitional element
Licensor’s dilemma
27
SIGNIFICANT
ASSISTANCE/
CONTROL
MARKETING
PLAN
COMMUNITY
OF INTEREST
Similar tests for “substantial assistance/significant control” and
“marketing plan prescribed in substantial part”
Focus on training; marketing support; purchasing
requirements; licensor prior approval of 3P suppliers,
restrictions on licensee competitive activities; limits on
collateral services to customers, lead generation support,
assignment of exclusive territory; uniformity of design and
appearance; operating protocols; network-wide activities
“Normal” routines ≠ marketing plan
Distinguish technical training vs. training and support that
covers core aspects of operations and marketing
Focus on whether network members operate in a manner
that suggests centralized rules/management
28
SIGNIFICANT
ASSISTANCE/
CONTROL
MARKETING
PLAN
COMMUNITY
OF INTEREST
“Community of interest” in marketing goods/services = broader
Licensor/licensee: common source of revenue
Licensor has a “continuing financial interest” in franchisee
Interdependence of parties: if arrangement ends, licensee is
“over a barrel”
29
Captures all sources of revenue to licensor or licensor’s affiliate for
the award of distribution or licensing rights
Nominal minimum threshold (> $500)
Lump sum, installment or recurring; fixed, fluctuating or
percentage fee
Springing franchises (no payment at inception; payments
start/stop)
Bona fide wholesale price exception for goods bought for resale
(inventory); but excessive purchasing obligations = fee
Optional vs. required payments (truly optional vs. nominally optional)
Ordinary business expenses paid to 3P
Direct and indirect fees
Money flow (licensee to licensor, not vice-versa)
Required Fee
30
Example
In To-Am Equip. Co., Inc. v. Mitsubishi Caterpillar Forklift America,
Inc., a jury awarded $1.5M in damages for wrongful termination of
a distributorship agreement found to violate Illinois Franchise
Disclosure Act.
Mitsubishi ended relationship per contract’s “at will” termination
provision in order to take distribution in house; no good cause for
termination.
Relationship not a franchise at inception; morphed into one years
later when cumulative payments for sales manuals > $500
7th Circuit Ct. of Appeals affirmed stating:
“Like many manufacturers, MCFA simply did not appreciate how
vigorously Illinois law protects "franchisees." … While we
understand MCFA's concern that dealerships in Illinois are too
easily categorized as statutory franchises, that is a concern
appropriately raised to either the Illinois legislature or Illinois
Attorney General, not to this court.”
31
What Parties Call the Arrangement is … Irrelevant
License
Dealership
Distributorship
Strategic alliance
Marketing affiliation
Joint Venture
Affiliate Program
Co-Branding Program
Membership Agreement
Partner (any title using “partner”
is not a good idea for other reasons)
32
No Defense to Statutory Violations if …
Violation is inadvertent
Violation is unintentional
Seller lacks knowledge of the law
Competitors don’t comply
Buyer agreed to waive compliance
33
Top 10 Excuses Why a License or Distribution
Agreement Can’t be a Franchise
10. “Everyone else in our industry does it this way”
9. “We grant licenses, not franchises”
8. “We’ll just call it something else”
7. “We’re partners, really …”
6. “We don’t tell them how to operate their
business”
2009 Rochelle Spandorf, Davis Wright Tremaine LLP
34
Top 10 Excuses Why a License or Distribution
Agreement Can’t be a Franchise
5. “They use their own trade name, not ours”
4. “They buy products from our affiliate, not us”
3. “They sell other products/services besides ours”
2. “We never intended it to be a franchise”
1. “We didn’t know about the law when we signed
the contract”
2009 Rochelle Spandorf, Davis Wright Tremaine LLP
35
How and Why Do
Accidental Franchises Happen?
36
How Do Accidental Franchises Happen?
Ubiquitous branding – businesses want to
affiliate with another person’s brand for
“halo effect”
TM owner unaware why TM license is not
a F tacks on fees for training, sales tools,
or more -“nickels and dimes” - causes TM
license to be a F when wrongful
termination claim is raised
Dealers/distributors make “sunken
investments” – follow the “money flow”
to licensor or its affiliate
Fees paid to brand owner are nominally
optional, not truly optional
Joint venture with brand owner may be a
hidden franchises
37
Why Do “Accidental” Franchises Get Discovered?
Licensee, distributor or dealer fails to achieve business goals
Buyer’s remorse
Loss of investment
Termination, non-renewal or cancellation of rights
Parties may dispute if grounds exist
Licensor/supplier exercises contract right giving both parties the
same right to terminate on X days notice for any reason
Licensor/supplier’s conduct that complies with terms of
contract is no defense to statutory claim
Bilateral/equal right to terminate on X days’ notice without GC
is no defense to statutory claim
38
Distributorship or License vs. Franchise
Examine contract terms (oral and written)
Examine parties’ course of dealing
Are so-called “optional” requirements truly optional?
Examine representations by seller (help with finding outlets,
accounts or buy-back inventory; income from distribution rights >
initial investment?)
Are mandatory purchases of inventory excessive?
Does 20% rule apply?
Ignore contract disclaimers and waivers
What state law applies based on the location of the dealer?
What law applies under the written contract?
39
Examples of Accidental Franchises
40
Accidental Franchises?
Product distributorships and dealerships
Certification programs, especially in the fitness industry
Apparel/retail stores independently owned
Joint ventures between “brand owner” and “operating partner”
for a service business
Management arrangements – medical, dental and hotel
Driver networks and “last mile” delivery services fulfilled by
independent contractors
Arrangements among non-profit organizations
Independent consultants providing training in branded software
applications or other subjects
Patent and “know-how” licenses
41
Product Distributorships
Typical structuring
No express trademark license
Payments for reasonable quantities of inventory sold at a bona
fide wholesale price
Marketing support, assigned territory, restrictions on sales of
competing goods, sales quotas, merchandising requirements
Traps to fall into a “franchise”
Extensive use of marks and branding
Add-on fees (truly optional vs. nominally optional)
Minimum purchasing requirements – excessive?
Multi-line distributors – fractional franchise? Substantial
association with trademark?
2-prong state relationship laws may still apply
42
Certification Programs
Exercise programs: e.g., CrossFit, Zumba
Certification on how to teach particular type of fitness classes
Traps to fall into a “franchise”
TM license vs true “certification” trademark
Common branding elements, marketing plan
Location approval; curriculum control; restrictions on scope of
services
Fees for trademark use
Minimize controls? Minimize assistance?
43
Apparel / Retail Stores
Typical structuring to avoid a “franchise”
No upfront or continuing fee
Inventory sold at a bona fide wholesale price
May have minimal control
Highly fact-specific
Traps to fall into a “franchise”
Add-on fees
Significant control or assistance
Branding
International issues
44
Joint Ventures
Joint venture
Brand owner is co-owner of JV and awards JV a license to use
brand in operation of JV business; two hats
Varying structures: LLCs, limited partnerships, general
partnerships
Analyze
Ownership: does it matter if brand owner is minority or majority
owner?
Outsider earns “sweat equity”
Brand is licensed, not transferred to JV
Financial distributions to JV owners = hidden franchise fee
45
Management Agreements (Dental, medical, hotel)
Licensee may assign significant day-to-day control to professional
management company or to brand owner
Traps
Through management agreement, brand owner provides
significant assistance or imposes business plan
Extensive use of marks and branding
Fees paid by licensee to brand owner for affiliation rights
Health care licenses - additional health care regulatory overlay
does not preclude franchise status, but complicates franchise
arrangement
46
Driver Networks and Delivery Services
Contractors may wear uniforms for company they drive for (e.g.,
Sears), but not always (e.g., Lyft, restaurant delivery services)
Contractors deliver packages w/brand owner’s name (e.g., Sears;
restaurant delivery services)
Drivers are assigned delivery territory
Mandatory reporting requirements, but not always
Minimal requirements for appearance/condition of vehicle
Nominal training for drivers on how to interact with customers and
complete any reporting requirements
Varied facts = often key to franchise status
Driver collects money upon pickup and remits % to brand owner
All money is paid to brand owner or delivery service and driver
receives a % commission of revenue per pickup
47
Non-Profits
Both TM licensor and licensee are non-profit entities
Federal franchise law vs. state franchise law
Federal = F is a continuing commercial relationship
State law
Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the United
States of America: trademar license between 2 non-profits
7th Circuit Court of Appeals ruled that the Wisconsin Fair
Dealership Law (WFDL) prohibited the national council from
realigning local council’s territory
Local girl scout council was held to be a “dealer”
Under WFDL, a TM licensor may not “substantially change the
competitive circumstances of a dealership agreement w/o good
cause”
The national council’s own economic reasons for realigning
territory ≠ good cause
48
Independent Consulting / Training Programs
Typical structuring to avoid a “franchise”
No trademark license
No control over the method of operating the business
Traps to fall into a “franchise”
Likely brand affiliation; right to use marks and branding
Software owner promotes fleet of qualified trainers
Software owner’s website identifies local trainers by geography
Control or assistance “creep”
Trainers pay various fees for training and maybe on sales
49
Patent and “Know-How” Licenses
Technical “know-how” license often does not involve significant
assistance or control over the entire method of operation
Marginal vs. significant effect
Patent owner relies on licensee’s skills and know-how to bring
patented product into marketplace
50
Strategies for drafting licenses and
distribution agreements
to avoid inadvertent Franchises
51
Structuring to Avoid “Accidental” Franchises
Eliminate one leg of the stool (if any one leg is missing it does not
matter how prominent the other two legs are)
Trademark
Fee
Control, Assistance, Marketing Plan
Not all jurisdictions define protected arrangement as a 3-legged stool
NY franchise sales law
2-prong state relationship laws
Structuring solutions vs. sacrificing business goals
52
Naked Trademark Licenses
Lanham ACT, 15 U.S.C. §1127: “A mark shall be deemed ‘abandoned’
. . . [w]hen any course of conduct of the owner, including acts of
omission as well as commission, causes the mark to become the
generic name for the goods or services or in connection with which it
is used or otherwise to lose its significance as a mark.”
Uncontrolled or “naked” licensing:
Trademark ceases to function as a symbol of quality and
controlled source
Inherently deceptive and constitutes abandonment
No need to show that owner had subjective intent to abandon
the mark
Can result in forfeiture of owner’s rights in the mark and
cancellation of registration
53
Franchise Risk Assessment Depends on Which Law Applies
Federal law – evaluate viability of a state “baby FTC” Act
State Franchise law jurisdiction varies – look at:
Assigned territory
Location
Distributor/licensee’s residence/domicile
Where offer/acceptance take place
New York connection?
“Place of business” requirement?
Other jurisdictional prerequisites
Franchise agency administrative claim?
Statute of limitations period
54
Reducing Franchise Risks by Taking Advantage
of Exclusions from Federal Amended FTC Rule
Employment Relationships
General Partnerships
Cooperatives
Bona fide certification and testing services (AAA, Good
Housekeeping)
Bona fide single trademark licenses
HOWEVER, unless you can find a state law exemption or exclusion
(which need not be the same as the Amended FTC Rule exclusion),
state franchise laws still apply!
55
Reducing Franchise Risks by Taking Advantage
of Exemptions from Federal Amended FTC Rule
Frequently used Amended FTC Rule exemptions:
Large franchisee (>$5M net worth)
Large transaction (invest >$1M to launch)
Fractional franchise (<20% total revenue/brand)
HOWEVER, unless you can find a state law exemption or exclusion
(which need not be the same as the Amended FTC Rule
exemption), state franchise sales and relationship laws still apply!
56
Reducing Franchise Risks by Taking Advantage
of State Law Exemptions
OK to piece together different types of exemptions/exclusions by
jurisdiction according to facts
Large franchisor
Fractional franchise (2 yr experience + 20% of total revenue; but
some states apply test annually)
Sophisticated or large franchisee
Franchise sales to “insiders”
Sales by franchisee for own account (if franchisor involvement is
limited to approving buyer)
Check franchise sales law to determine if exemption excuses both
registration and disclosure
No uniform set of exemptions/exclusions across states!
57
Exemption-Based Franchising
Starbucks example
Airport and universities – concession contracts
Discretionary exemptions
Some states require filing to qualify for exemption
Creating a national distribution program by piecing together a mix
of structuring solutions and different federal and state exemptions
and exclusions
58
Common issues and stress points in
Franchise relationships
59
Common issues and stress points
TM uniformity to enhance consumer awareness & brand identification
Implementing system-wide changes
Long term contracts vs. keeping system competitive
Enforcing post-termination covenants not to compete
Policing against “break-aways”
Enforcing system standards
Dangers of being joined at the hip: the franchise network is only as
strong/competitive as the weakest link
Vicarious liability
Is the franchisor liable to 3P for the franchisee’s acts/omissions?
Is the franchisor liable to 3P for the franchisee’s employee’s
acts/omissions?
Is the franchisor a joint employer with the franchisee of the
franchisee’s employees?
60
Q&A
Rochelle Spandorf
Davis Wright Tremaine LLP
213/633-6898
Craig Tractenberg
Fox Rothschild LLP
646-601-7639 / 215-444-7161
61
