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Convert Your License System to a Franchise System

If your business has established a network of licensees who signed license agreements and who are selling products or services under your trademark or brand then chances are you have given some thought to franchising, whether or not your license system may really be a franchise and whether or not, legally, you need to convert your license system to a franchise system. This issue comes up often and, for a number of reasons, many successful and very well intentioned entrepreneurs (including those who followed and relied on the advice of their legal counsel) have found themselves exposed to franchise liability through the license agreements and license structure that they previously adopted.

If this is your situation then the next step is to evaluate your potential franchise liability, determine whether or not your license is or may be claimed to be a franchise and to then determine the right path forward in protecting your business, maintaining an avenue for continued growth and potentially converting your licensing system to a franchise. The good news is that this issue comes up often and, if approached correctly, is completely manageable and bin the long run can be extremely beneficial for your business.

How the Problem Typically Arises: "It Just Made Sense to Start off as a License"

For many unsuspecting entrepreneurs and their lawyers, licensing is a natural outgrowth of a successful business. You establish a profitable business, your have a great brand, products and services and people take notice. You want to expand and so you start by granting simple license agreements. Your licensees buy products or services from you, they expand your business by establishing new operating units, locations or dealerships using your brand and everything seems to work well. The reason you may have utilized a licensing model was because it just made sense and was a workable system as you grew. Another reason may be that you adopted a licensing structure legal advice or a mistaken belief that you could somehow could adopt licensing as an alternative to franchising.

Is Your License System Really a Franchise?

Chances are that it is. The reason why is because within every franchise is a license where the franchisor "licenses" to its franchisees the right for the franchisees to utilize the franchisor's trademarks and brand. When evaluating whether or not a legal relationship transcends the line from simple license to regulated franchise, state regulators ignore terms and terminology like "license", "licensee" and "licensor" and look to the substance of the relationship and whether or not:

  • a license has been issued for use of the trademark
  • licensee is operating an outlet or location in accordance with the licensor's standards and specifications, and;
  • whether or not there is payment of a fee.

Much more often than not state regulators will find that claimed license relationships are really disguised franchise relationships and are subject to franchise regulation.

Licensing versus FranchisingGET THE GUIDE: For complete detail about whether or not your license system is really a franchise and the tools and information that you can use in making this evaluation, download a fee copy of our extremely helpful guide Licensing verses Franchising.

When Does this Licensing verses Franchising Issue Typically Arise?

Consider than many improperly structured license systems (i.e., where the license system is really a franchise) operate without an issue ever being raised. That is, licensees are satisfied and there are no legal disputes, licensees do not complain to a state regulator and the state regulators themselves don't contact you. Even if this is the case, the problem is that you may very well be exposed to future liability and your licensee issue may be a "ticking time bomb" only to rise up later on as your system gets larger and larger or during third-party due diligence during an acquisition. Typically this issue arises where:

  1. Dispute with a Licensee – You have a dispute with a licensee and during the course of the dispute the licensee consults with a lawyer and the lawyer claims that your entire license agreement is an unauthorized franchise and that the licensee has been harmed because you did not properly disclose him or her with a Franchise Disclosure Document. Basically, whether you have been right or wrong, the licensee and his or her attorney use this as leverage over you.
  2. Licensee or a Competitor Files a Complaint with a State Regulator – If or your licensee is located in a franchise registration state or a state that actively regulates franchising, if a licensee or, even, a competitor, files a complaint with the state regulator they could trigger an investigation. That is, the state regulator will make inquiries about your license agreements and may determine that your license agreements constitute franchises and that you have violated the state franchise laws.
  3. Due Diligence During an Acquisition – A third party is interested in buying your business and during the pre-acquisition due diligence process the potential acquiring company and their lawyers raise an issue about your license system and whether or not your license agreements are even enforceable.

What's the Potential Legal Exposure?

If you sell licenses that turn out to have met the criteria of a franchise then you will have violated the franchise laws. The violation is an extremely technical one (i.e., your license is really a franchise, you did not satisfy franchise disclosures mandated by the franchise laws and therefore you have sold illegal franchises) that creates substantive legal and business issues. Basically, your license agreements become unenforceable by you but your licensees may nevertheless enforce the license agreement plus other rights that will be afforded to them under the franchise laws. Your licensees will be afforded the opportunity to rescind their license agreements and seek damages, including reimbursement for their business expenditures.

Although the liability potential is very real, if approached properly there are methods for mitigating licensing liability and for converting your license system to a franchise. It may take some time but it is definitely achievable. Also, an honest and direct approach with state franchise regulators will prove beneficial in the long run.

What Are The Next Steps

The next step or steps has more to do with your business and the facts surrounding your licensing system. Before jumping any gun, the first step is to evaluate your existing license agreement and licensing structure to determine if your license system has even transcended the line into franchising territory. If it has, then the next steps will involve an assessment of your current licensee relationships, whether or not you are involved in litigation or threatened litigation with a licensee and whether or not you have been contacted by a state regulator inquiring about your licenses.

  • Are You Being Proactive? - If things are going well and there are no current legal issues (i.e., licensees are not threatening you and you have not received a regulatory notice from a state claiming that you are illegally selling franchises) then the next step is to evaluate your license system, whether or not your license is really a franchise and, if it is a franchise, to implement an effective plan to convert your license system to a franchise system.
  • Has There Been a Legal Threat? – If a licensee has threatened you or a state regulator has sent you a notice claiming that you are selling illegal franchises then your next steps needs to be accelerated with a focus on mitigating potential licensee claims and addressing state regulators.

The positive news is that if you are dealing with a licensing problem, there are extremely realistic and achievable goals that can be reached in successfully converting your license system to a franchise system and resolving regulatory issues involving claimed franchise violations. The solution may take some time but it is achievable.

Services for Converting Your License System to a Franchise

We have worked with many successful entrepreneurs who, like you, were faced with the need to evaluate their existing license system, convert their license system to a franchise, address licensee legal claims and resolve state regulatory claims.

Our Licensing Evaluation and Franchise Conversion Services

Evaluating and Assessing Existing License Agreements

We will evaluate your existing licensing structure, including your license agreements and other related agreements like licensee training agreements and other agreements involving the licensees sale of products and services. We will provide you with a confidential assessment regarding your licensing structure that will include, if available, recommended modifications to the licensing structure and recommendations for potential conversion to a franchise system. Our review will include evaluation of the applicable franchise laws and regulations in your state and the states where your licensees are located.

Litigation Defense and Responses to Regulators

If a dispute has arisen with a licensee claiming an illegal franchise or franchise violations, we offer litigation services focused on defending your systems against franchise violations. If you already have legal counsel we will work with them on an as needed basis. If you have received a notice from a state regulator either requesting information about your system or claiming that your license is an illegal franchise then on your behalf we will work with the state regulator in resolving the claim.

Convert Your License System to a Franchise System

We successfully convert license systems into franchise systems. Our services not only include a complete franchise development process but also includes a strategic plan that we implement to convert licensees to franchisees, achieve state franchise registrations (even in states that claim you illegally sold franchises) and resolve state regulator claims through negotiated agreements that are commonly referred to "Assurances of Discontinuance".

Our franchise conversion services are focused on preserving and protecting the existing business and network that you have already built and laying the foundation for continued expansion and growth.

Charles Internicola

by Charles Internicola
National Business and Franchise Lawyer

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