The Fundamentals of Franchise Law in the U.S.
Before you decide to open or purchase a franchise, it’s essential to understand how to play the legal field
The issue of what constitutes a franchise is a muddled affair. When it comes to franchises, most people think of fast food chains or massive entertainment giants, like Marvel or DC Comics. Yet, despite the fuzzy understanding of “franchise” held by most people, the world of franchising is hardly a two-stop department.
From storage and warehousing, to eyeglass stores and weight-loss centers, to the trucking companies that transport everything in between, franchised businesses have an incontrovertible presence in the daily workings of nearly every civilized country on earth.
And, as is the fate of all commerce-exchange fields, franchising quickly sprouted an accompanying legal limb that sanctions and regulates active franchises, the small businesses seeking to expand their market reach, and the entrepreneurs looking to acquire existing franchises.
What should I know about Franchise Law?
There are several key points of franchise law that arise frequently throughout franchise negotiations. Namely, there are three main elements of the definition of a “franchise” under federal law, and most state franchise laws. These elements distinguish entrepreneurs’ different options when they first begin to consider franchising. Those include, in descending commonplace use:
- Substantial Association with Trademark
- Payment of a Fee
- Marketing Plan/Community of Interest/Significant Control.
The statutory language distinguishing the three categories is significant, so having a business attorney in your wing to help further define them is critical:
Substantial Association with Trademark.
While this legal policy drifts substantially into a franchise law spin-off known simply as Trademark Law, “substantial association with trademark” has an important function in the initial franchising process far before conversations of trademarking begin.
With this model, a business must be, by legal definition, “substantially associated” with the franchisor’s trademark or other commercial symbol for the business to be a franchise. This agreement determines if a business can financially associate, for instance, the Victoria’s Secret store with its sports apparel descendant, Victoria’s Secret Sport. Making this connection usually requires the form of a license to use the franchisor’s name. Because franchise laws were enacted to remedy perceived abuses in the treatment of franchisees, courts will often interpret the legal definitions broadly in the best interest of the market economy.
Payment of a Fee.
This occurs when an entrepreneur has purchased a franchise from its progenitor. The entrepreneur is required to make both an up-front franchise fee payment and then pay ongoing royalty fees to the franchisor throughout the life of their business.
Ongoing royalty payments, or a share of the profit or product reserved by the grantor, as well as other catalogued payments such as consulting fees, training fees, or site assistance fees, help connect two businesses into a single umbrella franchise.
Marketing Plan/Community of Interest/Significant Control.
This model is used when there is a “marketing plan” present; in other words, when the franchise model is coupled with an advertising campaign, and the motivation for franchising is not simply to develop more locations.
Qualifying questions for this model include, Does the licensor provide promotional materials? Is there an operations manual? Is the franchisee free to make most decisions without first obtaining the licensor’s consent?
The types of controls that the licensor exerts must be substantial, and not just with respect to a small part of the business.
Why do I need a lawyer when developing a franchise?
The goals of different entrepreneurs, and the goals they hold for their businesses, shift with immense variance depending on the personality and desires of the entrepreneur themselves. However, there are a number of common questions everyone considering a franchise will have to ask at one point or another:
- Will I purchase the franchise by myself or with partners, and how will we allocate responsibility and business shares?
- Am I interested in pursuing a particular field, and do I need special licensing in order to qualify for that field?
- Would I like to own several outlets, or just one?
- Will I take my franchise outside the U.S., and how does international jurisdiction function?
While you may have an answer prepared for each, a wrong move in the process of following out your vision can quickly become a legal nightmare if you’re found in violation of state registration laws, or relationship statutes that may give rise to administrative enforcement proceedings. Additionally, if you intend to enter a franchise with a partner, having a legal mediator present during business model negotiations can be a relationship savior. The seeds of encroachment, controversial system-wide change proposals, antitrust issues, and vicarious liability issues, unbeknownst to either party, introduce long-term corrosive factors into the business relationship.
Need Help Starting or Purchasing a Franchise? Ask the Lawyers!
Franchise law is a complicated legal field that requires a knowledgeable and trustworthy business law attorney. If you need help with an idea involving any of the issues we’ve discussed here today, don’t hesitate to ask the lawyers.