According to the old saying, “If it walks like a duck and quacks like a duck, it’s a duck.” Many a businessperson has decided that if franchising would be too burdensome, it’s time to consider licensing instead. Yet “licenses” that are born of franchise avoidance are rarely anything but thinly disguised franchises. You see what I’m saying, “If it walks like a duck . . . .”
But suppose your license agreement really is a franchise; why does that matter? Well, for starters, in a state, like Washington, which has an expansive franchise statute creating a private right of action, the buyer of a disguised franchise may be able to sue for rescission and damages—and those damages can be increased up to three times the actual number–as well as costs and attorneys fees. Worse still for the “licensor”, its officers, directors, owners, agents and others may all be personally liable to the “licensee” under state franchise law, even if it did business as a corporation or LLC.
Many states, including Washington, require the registration of franchise offerings. It goes without saying that the unintended franchise will not have been registered. The state too may want its pound of flesh, including penalties and, potentially, criminal sanctions. And because a pre-sale, mandatory franchise disclosure document is required in all 50 states, the Federal Trade Commission Rule has also been violated in the unintentional franchise setting.
So what makes your license a franchise? With some minor variations from state to state, under the laws of Washington and at least twelve other jurisdictions, including California and Oregon, a franchise is defined as the grant of the right to conduct a business having the following three elements: (1) a franchise fee; (2) substantial association with the grantor’s name and marks; and (3) the grantor’s marketing plan or system. It is far easier for a business arrangement to fall under this definition than you might imagine. Let’s look at each in turn:
- Franchise fees
Examples of franchise fees can include an initial lump sum fee, a fee calculated as a percentage of revenues, a fee for training or other services, or a mark-up contained in the prices of items sold to the licensee. The notion that a license agreement is not a franchise as long as the licensor does not charge an upfront fee is a myth.
- Substantial association with the grantor’s name and marks
For any businessperson who wants to avoid creating a franchise, prohibiting name association would probably the safest way to go about it. But this is the last thing that probably 99% of these “licensors” would ever want to do. They want the name association. The licensor may explicitly require the use of its name or it may simply be understood that the licensee will use the name and marks in the business. Often, as part
of the license, the licensor provides marketing materials emblazoned with the name and marks.
- Marketing plan or system
A marketing plan or system does not require very much. In the State of Washington, which defines the term by statute, a “marketing plan” could be present based on as little as the availability of training or advice on an aspect of the business offered by the grantor. There are very few license agreements that don’t involve at least that much assistance by the licensor.
What should you do? Whether you are a “licensor” or a “licensee”, if you suspect your license agreement is a franchise, you should seek immediate legal assistance. You need an experienced franchise lawyer in order to evaluate your position, your risks and your opportunities. If you have unintentionally sold a franchise, you may be able to mitigate the adverse consequences by acting promptly. If you bought an unintended franchise, you may have options and opportunities you did not realize were present. An experienced franchise lawyer can help you formulate your strategy and plans.