International Franchise Association
44th Annual Legal Symposium
Washington, D.C.
May 15-17, 2011
BASICS TRACK
What Is A Franchise?
Emily Decker
Vice President, General Counsel
Buffalo Wild Wings
Maral Kilejian
Attorney
Mullin Law, PC
Danell Olson Caron
Associate
Faegre & Benson LLP
Table of Contents
I.Introduction ……………………………………………………………………………………………..1
II.A Franchise is a Legal Definition……………………………………………………………….1
A.The Definition of a Franchise under Federal and State Law.……………………….. 2
1.Federal Definition………………………………………………………………………. 2
2.State Definition………………………………………………………………………….. 7
3.What Types of Relationships are not Covered.………………………………. 9
4.Exemptions. ……………………………………………………………………………… 9
5.Exclusions………………………………………………………………………………. 13
B.Legal Implications of Meeting the Franchise Definition……………………………… 14
1.Disclosure Requirements………………………………………………………….. 14
2.Registration Requirements………………………………………………………… 14
C.What is a Business Opportunity…………………………………………………………….. 15
1.Federal Regulation…………………………………………………………………… 15
2.State Regulation ……………………………………………………………………… 17
III.A Franchise is a Contract……………………………………………………………………….. 18
A.The Single-Unit Franchise Agreement……………………………………………………. 18
1.The Grant Clause…………………………………………………………………….. 18
2.Territorial Rights………………………………………………………………………. 20
3.Initial Term ……………………………………………………………………………… 22
4.Renewal…………………………………………………………………………………. 23
5.Royalty Fees …………………………………………………………………………… 24
6.Advertising ……………………………………………………………………………… 25
7.Franchisor’s Trademarks…………………………………………………………… 28
8.System Standards……………………………………………………………………. 30
9.Default and Termination……………………………………………………………. 31
10.Obligations upon Default and Termination…………………………………… 33
B.Contracts Relating to the Franchise Relationship …………………………………….. 34
1.Area Development Agreement…………………………………………………… 34
2.Master Franchise Agreement or Subfranchise Agreement …………….. 34
3.Development Agent Agreement …………………………………………………. 35
IV.A Franchise is a Relationship …………………………………………………………………. 36
A.Franchise Advisory Councils…………………………………………………………………. 37
B.Franchisee Associations………………………………………………………………………. 37
C.Communication…………………………………………………………………………………… 38
D.Frequent Franchisee Contact ……………………………………………………………….. 38
I. Introduction
What is a franchise? A franchise business model has many components and this
paper analyzes a franchise from three different angles. First, Section II of this paper
analyzes the legal definition of a franchise. Regardless of what a business arrangement
is called, if the three definitional elements of a franchise are met, then the business
arrangement is a franchise. Given the state and federal enforcement rights for non-
compliance, it is imperative for businesses to understand the legal components of a
franchise and to comply with the unique franchise registration and disclosure obligations
if their business meets the franchise definition. Section II concludes with a brief
discussion of the exemptions to the federal definition of a franchise and an analysis of
the business opportunity rule.
Section III of this paper analyzes a franchise from a contractual perspective.
Section III focuses primarily on the single-unit franchise agreement and the common
contractual provisions governing a single-unit franchise. This section highlights the
pressure points and issues a franchisor may want to consider when drafting a single-
unit franchise agreement. This section concludes with a summary of the most common
forms of franchise agreements including, a single-unit agreement, area development
agreement, master franchise agreement and development agent agreement.
Section IV of this paper analyzes a franchise from a relationship standpoint. A
franchise is more than a legal definition or a contract. A franchise is a relationship
between a franchisor and franchisee. Section IV includes a discussion of the common
methods and techniques used by franchisors to strengthen and preserve the franchise
relationship.
II. A Franchise is a Legal Definition
Regardless of one’s intent, from a legal perspective a franchise is formed if the
business arrangement meets the legal definition of a franchise. The existence of a
franchise is not about labels or feelings. It does not matter whether the parties call their
relationship a “franchise,” a “license,” or a “distributorship,” or whether they feel like they
are in a franchise relationship. From a legal perspective, the existence of a franchise is
a matter of definition.
Franchising is a highly regulated business format, regulated at both the federal
and state level. Accordingly, it is important for businesses to understand whether their
business arrangement meets the legal definition of a franchise and, if it does, to comply
with all applicable federal and state regulations. At the federal level, franchising is
regulated by the Federal Trade Commission (the “FTC”) under the FTC Rule – 16
C.F.R. §436.1, et seq., which identifies a number of disclosures that a franchisor must
provide to a prospective franchisee in a written document called a franchise disclosure
document (“FDD”). The FTC Rule applies to franchise opportunities in each of the 50
states, Washington D.C., and all U.S. territories. Thus, a company offering a business
arrangement that meets the legal definition of a franchise under the FTC Rule must
present a prospective franchisee with an FDD which contains specific and detailed
information about the franchisor and the franchise opportunity. Although a franchisee
wronged by the failure to disclose may not have a private right of action, the FTC can
bring enforcement proceedings against the franchisor.
In addition to the FTC Rule, certain states also regulate particular aspects of a
franchise business arrangement including, requiring disclosure and registration of the
franchise opportunity and, in certain states, regulating the parties’ relationship.
Accordingly, it is important to understand the definitional elements of a franchise at the
state level. In states with their own disclosure laws, a failure to comply with that state’s
disclosure law allows a franchisee to seek equitable relief and damages and, in some
states, exemplary damages, criminal penalties and fines.
As you can see, understanding whether your business arrangement meets the
legal definition of a franchise is important. So, what constitutes a franchise from a legal
perspective?
A. The Definition of a Franchise under Federal and State Law.
What qualifies as a franchise under federal law may not meet a state law
definition, or vice-versa. Accordingly, it is imperative to understand both the federal and
state definitional elements of a franchise and the interplay of federal and state law.
1. Federal Definition
The term “franchise” is defined under the FTC Rule to mean any continuing
commercial relationship or arrangement, in which the terms of the offer or contract
specify, or the franchise seller promises or represents, orally or in writing, that:
(1) the franchisee will obtain the right to operate a business that is
identified or associated with the franchisor’s trademark, or to
offer, sell, or distribute goods, services, or commodities that are
identified or associated with the franchisor’s trademark;
(2) the franchisor will exert or has authority to exert a significant
degree of control over the franchisee’s method of operation, or
provide significant assistance in the franchisee’s method of
operation; and
(3) as a condition of obtaining or commencing operation of the
franchise, the franchisee makes a required payment or commits
to make a required payment to the franchisor or its affiliate.1
1 16 C.F.R. §436.1(h).
2
In short, a business arrangement meets the FTC Rule definition of a
franchise if the business arrangement involves: (i) the grant of a trademark, (ii)
the franchisor exerts or has the authority to exert significant control or assistance
over the operation of the business, and (iii) the franchisee pays the franchisor or
its affiliate a fee. The meaning and application of each of these definitional
elements of a franchise are described further below.
a. Grant of a Trademark.
The first definitional element of a franchise requires the grant of a trademark.
The trademark element is satisfied if the franchisee is granted the right to operate a
business under the franchisor’s trademark, or the franchisee has the right to offer, sell,
or distribute goods, services, or commodities that are identified or associated with the
franchisor’s trademark.2 The FTC Rule defines the term “trademark” broadly to include
not only registered trademarks, but any service mark, trade name or other advertising or
commercial symbol.3 Further, it is not necessary that the franchisor own the mark itself
for the trademark element to be satisfied. So long as the franchisor has the right to
license the use of the mark to others, the trademark element will be met.4
The trademark element is the easiest element to identify and, for those business
arrangements that wish to avoid the application of the FTC Rule, the easiest element to
remove. Specifically, a business can avoid being classified as a franchise if it expressly
prohibits the use of its trademark and the business does not use the trademarks. As the
court held in Wright-Moore Corp. v. Ricoh Corp., simply prohibiting the use of a
trademark is insufficient if, in practice, the third party uses the trademark. The court in
Ricoh found the trademark element satisfied even though the dealer was expressly
prohibited from using Ricoh’s trademark.5 Specifically, the court reasoned that a grant
of a trademark license existed because the dealer had the right to promote its status as
an authorized Ricoh distributor and use Ricoh-supplied advertising.6 Further, courts
have found the trademark element satisfied when the licensee has an obligation to: (i)
use best efforts to promote the sale of branded products, (ii) wear uniforms or operate
vehicles containing the licensor’s trademarks or logos, (iii) complete special training, (iv)
sell unique products which consumers readily associate with a particular manufacturer,
or (v) advertise its authorized dealer status locally. 7
2 16 C.F.R. §436.1(h)(1).
3 16 C.F.R. §436.1(v).
4 Franchise Rule Compliance Guide at p.2 (May 2008).
5 Wright-Moore Corp. v. Ricoh Corp., 908 F.2d 128 (7th Cir. 1990).
6 Wright-Moore, 908 F.2d at 135. Despite the distribution agreement prohibiting Wright-Moore
from using Ricoh’s name or trademark, the distribution agreement expressly permitted Wright-Moore to
state in writing that it was an authorized distributor of Ricoh products. Further, Wright-Moore was
provided with advertising materials with Ricoh’s trademark.
7 See, Cassidy Podell Lynch, Inc. v. Snyder General Corp., 944 F.2d 1131, 1139 (3d Cir. 1991)
(finding that a trademark license was granted because Cassidy displayed signage bearing Snyder’s
trade name at its repair center, was required to maintain yellow pages advertisements designating itself
as an authorized Synder seller, and its servicemen wore uniforms bearing Synder’s trade name);
Cooper Distrib. Co., Inc. v. Amana Refrigeration, Inc., 63 F.3d 262, 272-73 (3d Cir. 1995) (holding that a
trademark license was granted because Cooper’s showroom display the Amana sign, Cooper’s
3
Accordingly, so long as a purported franchisor is not permitting a third party to
use its trademark, service mark, trade name or other commercial symbol, and the third
party is in fact not using the trademark, the business arrangement will not satisfy the
FTC’s first definitional element of a franchise.
b. Significant Control or Assistance.
The second definitional element requires the franchisor to exert, or have the
authority to exert, a significant degree of control over the franchisee’s method of
operation, or provide significant assistance in the franchisee’s method of operation.8
The significant control or assistance element exists to acknowledge a franchisee’s
reliance on the franchisor’s business experience, and the franchisee’s use of such
expertise to reduce business risks and increase its probability of success. The more a
franchisee relies upon the franchisor’s control or assistance, the more likely the control
or assistance will be considered significant. Generally reliance is found when a
franchisee is inexperienced in the business or industry, the franchisee undertakes a
large financial risk, or when the controls or assistance provided by the franchisor are
unique to a particular industry as opposed to businesses in general.9 To be deemed
“significant,” the control or assistance must relate to the franchisee’s overall method of
operation – not merely a small or marginal aspect of the franchisee’s business.10
So, what constitutes “significant control or assistance”? In the Franchise Rule
Compliance Guide (the “Compliance Guide”), the FTC provided some guidance in this
area. According to the FTC, the significant control element may be established by the
franchisor having some control over any of the following: (i) site approval or site
selection, (ii) site design or appearance requirements, (iii) hours of operation, (iv)
production techniques, (v) accounting practices, (vi) personnel policies, (vii) required
franchisee promotional campaigns or financial contribution, (viii) restrictions on
customers, or (ix) locale or area of operation.11 Similarly, the FTC noted that the
significant assistance element may be established by the franchisor doing any of the
following: (i) providing formal sales, repair, or business training programs, (ii)
establishing accounting systems, (iii) furnishing management, marketing, or personnel
advice, (iv) selecting site locations, (v) furnishing systemwide networks and websites, or
(vi) furnishing a detailed operating manual.12 To a lesser extent, the FTC noted that the
following factors will be considered when determining whether significant control or
assistance is present in a relationship: (i) a requirement that a franchisee service or
servicemen wore Amana uniforms, Cooper was required to use its best efforts to promote the sale of
Amana products, and Cooper advertised itself as an Amana servicer), and Lobdell v. Sugar ‘N Spice,
Bus. Franchise Guide (CCH) ¶ 7947 (Wash. Ct. App. 1983) (reasoning that a trademark license was
granted when the franchisee was granted the right to sell the company’s self-described instantly
recognized products in a particular territory).
8 16 C.F.R. §436.1(h)(2).
9 Franchise Rule Compliance Guide at p.2.
10 Id.
11 Id. at p.3.
12 Id.
4
repair a product, (ii) inventory control, (iii) required displays of goods, and (iv) on-the-job
assistance with sales or repairs.13
Not all actions by a franchisor will qualify as significant control or assistance. In
fact, the FTC has expressly stated that promotional activities alone will not be deemed
significant control or assistance.14 For example, simply furnishing a distributor with
point-of-sale advertising displays, sales kits, product samples, or other promotional
materials is insufficient to constitute significant control or assistance. Further, the FTC
has stated that the following items do not constitute significant control or assistance: (i)
trademark controls designed solely to protect the trademark owner’s legal ownership
rights in the mark under state or federal trademark laws (such as display of the mark or
right of inspection), (ii) health or safety restrictions required by federal or state laws or
regulations, (iii) agreements between a bank credit interchange organization and
retailers or member banks for the provision of credit cards or credit services, and (iv)
assisting distributors in obtaining financing to be able to transact business.15 The
actions noted above, without more, are insufficient to establish the significant control or
assistance requirement.
c. Payment of a Fee.
The final FTC Rule definitional element of a franchise is the requirement that the
franchisee make a required payment or commit to make a required payment to the
franchisor or the franchisor’s affiliate.16 The term “required payment” is defined broadly
to mean:
