When Is a "License" Really a "Franchise"?
by Mario L. Herman, Esq.
The Federal Trade Commission Franchise Rule, 16 C.F.R. 436.1 et seq.,
governs, at a federal level, disclosures which a "franchisor" must provide
to each prospective franchise. There are also numerous state laws
which may apply in any given situation. The discussion in this article
will be limited to the requirements under the Franchise Rule.
Several types of continuing commercial relationships are governed under
the Franchise Rule. Two specific types of relationships are: 1)
package franchises: in which the franchisee adopts the business format
established by the franchisor and is identified by the franchisor's
trademark; and 2) product franchises: in which the franchisee distributes
goods that are produced by the franchisor and which bear the franchisor's
trademark, or are manufactured by the franchisee according to the
franchisor's specifications. (See, Federal Trade Commission, Informal
Staff Advisory Opinion 03-2.)
Whether a continuing commercial relationship is a "franchise" under the
Franchise Rule, is determined by whether the business relationship contains
the three definitional elements of a "franchise" set forth in the Franchise
Rule, and it does not matter what name the parties choose to assign to the
relationship. 44 Fed. Reg. 49,966 (August 24, 1979). In other
words, if it walks like a duck and quacks like a duck . . . .
Under the Franchise Rule, where the parties are in a continuing
commercial relationship there are three definitional elements of a
"franchise." The franchisor must:
- promise to provide a
trademark or other commercial symbol;
- promise to exercise
significant control or provide significant assistance in the operation of the business; and
- require a minimum
payment of at least $500 during the first six months of operations.
(16 C.F.R. Parts 436.2(a)(1)(i) and (2); 436.2(a)(iii)).)
According to the FTC, a franchise entails "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." The term "trademark" is intended to be read broadly to cover not only trademarks, but
any service mark, trade name, or other advertising or commercial symbol.
This is generally referred to as the "trademark" or "mark" element.
The franchisor need not own the mark itself, but at the very least must have
the right to license the use of the mark to others. Indeed, the right to use
the franchisor’s mark in the operation of the business – either by selling
goods or performing services identified with the mark or by using the mark,
in whole or in part, in the business’ name – is an integral part of
franchising. In fact, a supplier can avoid Rule coverage of a particular
distribution arrangement by expressly prohibiting the distributor from using
its mark." (FTC Franchise Rule Compliance Guide, May 2008.)
SIGNIFICANT CONTROL OR ASSISTANCE
The Franchise Rule covers business arrangements where the franchisor
"will exert or has 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."
When Is Control or Assistance Significant? The more franchisees
reasonably rely upon the franchisor’s control or assistance, the more likely
the control or assistance will be considered "significant." Franchisees’
reliance is likely to be great when they are relatively inexperienced in the
business being offered for sale or when they undertake a large financial
risk. Similarly, franchisees are likely to reasonably rely on the
franchisor’s control or assistance if the control or assistance is unique to
that specific franchisor, as opposed to a typical practice employed by all
businesses in the same industry. Further, to be deemed "significant,"
the control or assistance must relate to the franchisee’s overall method of
operation – not a small part of the franchisee’s business. Control or
assistance involving the sale of a specific product that has, at most, a
marginal effect on a franchisee’s method of operating the overall business
will not be considered in determining whether control or assistance is
Significant types of control include:
- site approval for unestablished businesses;
- site design or
- hours of
campaigns requiring franchisee participation or financial
- restrictions on
- locale or area of
Significant types of assistance include:
- formal sales,
repair, or business training programs;
management, marketing, or personnel advice;
- selecting site
- furnishing systemwide networks and website; and
- furnishing a
detailed operating manual.
To a lesser extent, the following factors will be considered when
determining whether "significant control or assistance" is present in a relationship: a
requirement that a franchisee service or repair a product (except warranty
work); inventory controls; required displays of goods; and on-the-job
assistance with sales or repairs.
The FTC interprets the term "payment" broadly, capturing all sources of
revenue that a franchisee must pay to a franchisor or its affiliate for the
right to associate with the franchisor, market its goods or services, and
begin operation of the business. Often, required payments go beyond a simple
franchisee fee, entailing other payments that the franchisee must pay to the
franchisor or an affiliate by contract – including the franchise agreement
or any companion contract. Required payments may include:
- initial franchise
- equipment and
supplies (including such purchases from third parties if the franchisor or its affiliate receives payment as a result of the
- escrow deposits;
- equipment rental;
royalties on sales.
Payments which, by practical necessity, a franchisee must make to the
franchisor or affiliate also count toward the required payment. A common
example of a payment made by practical necessity is a charge for equipment
that can only be obtained from the franchisor or its affiliate and no other
A. Wholesale Inventory Exemption
The "payment" element of the franchise definition does not include
"payments for the purchase of reasonable amounts of inventory at bona fide
wholesale prices for resale or lease." "Reasonable amounts" means
amounts not in excess of those that a reasonable businessperson normally
would purchase for a starting inventory or supply, or to maintain an ongoing
inventory or supply. The inventory exemption, however, does not include
goods that a franchisee must purchase for its own use in the operation of
the business, such as equipment or ordinary business supplies.
REMEDIES AVAILABLE TO PURCHASERS OF DISQ\GUISED FRANCHISES
Courts have held that the Franchise Rule does not provide a direct remedy
to franchisees. However, actions have been brought against franchisors
for violations of the Franchise Rule under state "little FTC acts," or
unfair trade or business practices acts which incorporate the Federal Trade
Commission Act. The remedies available under these acts vary from
state to state. Some are limited to rescission and restitution, while
others allow a plaintiff to be awarded damages, and in some cases the
trebling of damages, costs and attorneys’ fees. Additionally, it is
important to remember that franchisees or persons who entered into license
agreements without proper disclosure, may have remedies under their
respective states’ franchise laws. Such remedies can include
rescission, actual damages, the trebling of damages, attorney’s fees, and
costs of litigation.
Please consult a seasoned Franchise Law Attorney or lawyer to determine
if your "license" arrangement, is, in fact, a disguised franchise (i.e., a "duck").
Mario L. Herman
Law Offices of Mario L. Herman
5335 Wisconsin Ave. NW
Mr. Herman, licensed in Washington, D.C., represents franchisees
domestically and internationally in negotiation, mediation, arbitration, and
litigation with their franchisors. Mr. Herman affiliates with local
counsel on an as needed basis. He has practiced nationally and
internationally for twenty five years, has an excellent reputation, and has
very reasonable rates. He is available at
Manual For Franchise Buyers
Endorsed By American Association of Franchisees and Dealers.
you thinking about buying a franchise? There's a lot you need to know
before you invest if you want to be successful as a
franchisee. My guide,
Buyer's Manual, is a self-help tool that helps you decide whether or not
franchising is for you and teaches you how to get the information you really
need to choose the best franchise opportunity.
for more information.
Support Our Sponsors
Lead by eminent Franchisor Attorney