Is Your Business A Franchise By Accident?
Ohio and Colorado Franchise Law
Franchises are highly regulated under federal law and the law of many states. Colorado does not generally regulate franchise relationships. In fact, the Colorado’s Attorney General’s consumer protection webpage states flatly, concerning Colorado franchise law,: “Franchises and business opportunities are not regulated in Colorado.” In contrast, Ohio has enacted laws that apply to any “business opportunity plans” which would include franchises. That being said, no matter what states’ laws may apply to franchises, federal law also regulates any franchise agreement or arrangement. The Federal Trade Commission (FTC) has promulgated regulations applicable to all franchise relationships.
Because franchises are so stringently regulated, some would-be franchisors have attempted to circumvent the regulations by naming their relationship something other than a “franchise”–such as a “business opportunity.” However, the FTC’s regulations apply broadly no matter what name is used. The FTC defines a franchise as:
…any continuing commercial relationship or arrangement, whatever it may be called, 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.
As the definition above makes clear, it does not matter what you call the business relationship, it matters whether it meets the conditions above–namely, 1.) the license of a trademark by the franchisor to the franchisee, 2.) control of the franchisee by the franchisor, and 3.) payment from the franchisee to the franchisor. Think fast food restaurants as a good example, since many of them are franchises. McDonald’s, as the franchisor, licenses its trademarks to a franchisee of its restaurants–meaning the franchisee can use McDonald’s trademarks including its name, name of food items, symbols, etc. Second, McDonald’s exerts a significant amount of control over the franchisee–how the franchisee operates its restaurant, how it prepares the food, what food items are sold, where the franchisee purchases its supplies and ingredients from, etc. This is done for many reasons, including so that McDonald’s can maintain a high level of quality control. Under the franchise agreement, McDonald’s can ensure that its franchisees are relatively consistent in their product offerings and that the quality and ingredients used in those food products are substantially similar across the country–if not the world. Finally,the franchisee pays McDonald’s a fee–whether it’s an upfront fee, percentage of sales, or some combination thereof.
An Accidental Franchise?
The factors above are extremely important to consider. Sometimes parties have agreements or business arrangements in place, such as say a distribution agreement or a supplier-distributor relationship, in which the parties did not necessarily intend to enter into a franchise relationship when they unknowingly did. For this reason, the business relationship may be a franchise by accident.
Take for instance a beverage distributor that enters into a distribution agreement with a supplier/manufacturer of alcoholic beverages. The supplier/manufacturer wants to terminate the relationship under the existing agreement but the distributor claims that their relationship is a franchise and the regulations applicable to franchises apply to their relationship. If a court finds for the distributor–that the arrangement was in fact a franchise–the distributor maybe entitled to protections under the law that the agreement itself did not provide.
In fact, this is what happened in a recent case in Missouri between the biggest alcoholic beverage distributor in the state, Major Brands, and Diageo, manufacturer/supplier of brands such as Guinness, Smirnoff, and Johnnie Walker. (Major Brands v. Diageo). Major Brands argued that its relationship with Diageo was a franchise and, thus, it was entitled to protection under Missouri’s franchise law–namely that Diageo could only terminate their agreement/relationship with cause. The court agreed with Major Brands on this issue, determining that a franchise relationship was established under state law. Importantly, because the court found the relationship to be a franchise, Diageo had to give cause as to why it was terminating the agreement or relationship–meaning Diageo could not simply cancel the agreement at its own convenience, it had to supply a reason as to why the agreement should be terminated.
It is important to determine if your business has unwittingly entered into a franchise because the parties’ intentions not to enter into a franchise does not determine whether the relationship is in fact a franchise. For this reason, parties are strictly liable even if they did not intend to be franchisor/franchisee–if it meets the elements of a franchise, it’s a franchise. If a court or regulatory agency determines that the business relationship is a franchise, there are some serious implications that attach, including substantial penalties and monetary damages, termination of the agreement, and even an injunction to stop the termination of the agreement.
The Ohio and Colorado Business Attorneys of LaszloLaw
The Ohio and Colorado Business Attorneys of LaszloLaw have over 30+ years of counseling businesses with their numerous legal needs. Contact our Ohio and Colorado business attorneys at 303-926-0410 or online today to discuss your business and individual needs.