Franchising is a common business model used across the U.S. in a large number of fields. Franchises allow a company to profit off the power of its trademark and brand while letting independent business owners carry out operations and hold much of the liability associated with such operations. While there are many advantages to the franchise relationship, franchises are incredibly complex legal instruments, which means that you need an experienced franchise lawyer to help you fully understand what you’re getting into. Priori's legal marketplace can connect you with a top, experienced franchise lawyer on-demand.
Franchising is type of licensing arrangement. A franchise is created when a business owner or IP holder, known as the "franchisor," distributes or markets a trademarked product or service through affiliated dealers or "franchisees." Franchisees own their own franchise establishments, but typically share some operational responsibilities with the franchisor. While technically any license of a trademarked product or service could be considered a franchise, they generally are defined by complex contracts known as franchise agreements and are regulated by the U.S. Federal Trade Commission (FTC).
Franchises According to the FTC
Franchises come in many forms, but the FTC Franchise Rule defines them as specific business relationships with three elements:
- Trademark License. The franchisee is given the right to distribute defined goods and services that bear the franchisor's trademark, logo, name, service mark or other recognizable commercial symbol.
- Significant Control or Assistance. The franchisor has significant control over the use of the trademark licensed or provides significant assistance in marketing the goods or services. Some common examples of this include:
- Requirements for business site operations and/or appearance;
- Adherence to specific training programs or procedures;
- Required operations procedures;
- Required accounting and reporting practices; and
- Compulsory participation in promotional campaigns.
- Required Fees or Payment. The franchisee must pay the franchisor at least $500 before opening the franchise and then generally is required to continue to pay fees throughout the business relationship, such as franchise fees, royalties, training fees, payments for services and payments from the sale of products.
Because franchises can constitute incredibly complex legal relationships, franchise law can be correspondingly complex. In addition to contract law that applies to the franchise agreement itself, there are three categories of law that apply to franchises: disclosure laws, registration laws and relationship laws.
Before a franchise relationship can start, franchisors are required to provide a lengthy, detailed disclosure statement either in the form of a federal U.S. Franchise Disclosure Document as required by the FTC or a Uniform Franchise Offering Circular, which combines elements required in the federal disclosure, as well as state requirements. This disclosure contains detailed financial audits and profitability analyses, as well as the requirements of operating a franchise and required sales practices. This disclosure must be given to potential franchisees at least 14 days before money can change hands.
While there is no federal requirement to register franchises, franchises must be registered in many states. These registration laws lay out the process and cost of registration. In addition to registering the franchises themselves, many states also require the registration of any person selling or advertising franchise opportunities. This is regulated by state entities and registration laws.
What is and is not allowed in a franchise relationship is determined by state law. Some states have almost no regulations, allowing the franchise agreement to determine the nature of the relationship. Other states have designated franchise relationship laws to determine the limitations of certain key provisions that define the franchisor-franchisee relationship. The following are some of the provisions that can be regulated by state law:
- Termination. When and how a franchise relationship can be ended, as well as associated penalties;
- Non-Renewal. The process of a renewing a franchise agreement after the initial term is over;
- Repurchase Obligations. When and if the franchisor must repurchase some or all of the franchisee's furnishings, equipment, inventory, supplies or other assets at the end of the franchise relationship;
- Transfer. When and if a franchise agreement can be transferred or assigned to a third party;
- Non-Compete. Limitations on the franchisee’s ability to directly compete after termination of the franchise relationship;
- Encroachment. Limitations on the franchisor’s ability to license competing franchises in the area; and
- Required Purchases. The extent to which the franchisor can require that supplies, inventory, goods and services be purchased from the franchisor or other designated sources.
The franchise agreement is the contract that defines the relationship between the franchisee and the franchisor. This agreement determines all the responsibilities of both parties and lays out the exact control that the franchisor maintains after issuing the trademark license. If there is a business plan that must be followed, marketing requirements or any associated documentation, it will be included as an addendum to this contract. All franchises are governed by detailed franchise agreements, so if you are planning on participating in a franchise relationship, you must get a franchise lawyer to look over the agreement on your behalf.
Depending on your needs and whether you are a franchisee or a franchisor, the legal costs associated with drafting and negotiating the required documents can run a broad range. Priori lawyers offer transparent flat fee packages for various portions of this work. Typically, hourly rates for these types of lawyers range from $225 to $450 per hour. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and free price quote from one of our lawyers.
What is the difference between a community of interest and a marketing plan in terms of franchises?
Under state laws, the definition of a franchise differs from the federal definition given by the FTC. This varies from state to state, but in 17 states, a franchise does not just require “substantial control or assistance,” it requires a more defined business model to be considered a franchise. In California, Illinois, Indiana, Iowa, Maryland, Michigan, North Dakota, Oregon, Rhode Island, Virginia, Washington and Wisconsin, the goods or services must be sold by the franchisee under a marketing plan or system “substantially prescribed” by the franchisor. In Hawaii, Minnesota, Mississippi, Nebraska and South Dakota, there must be a “ community of interest in the marketing of goods or services.”
The two definitions require more specificity than simply significant control, but they differ in what is specified. A marketing plan requires more specific elements of control in how the business operates on a daily basis. A community of interest requires more specificity in terms of who is marketed to and the customer base. These do not supplant the requirements under the FTC definition, but rather add to it.