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The Unintentional Franchisor: How a License Agreement may Subject You to Franchise Regulation

“Franchising” has been and remains one of the most successful vehicles for the multi-unit expansion of a business. However‚ for many entrepreneurs looking to expand their business and brand‚ “franchising” is too often disregarded as a viable business model. For these entrepreneurs‚ the establishment of a franchise system (unnecessarily) appears to be a daunting task and is disregarded in favor of “licensing”. That is‚ in an “attempted” effort to avoid franchise regulation‚ but nevertheless achieve brand growth‚ the entrepreneur (as a “licensor”) licenses his or her trade name and trademarks to third parties (known as “licensees”) who conduct their own business utilizing the licensed marks.

Read: Licensing vs. Franchising Guide

While “licensing” relationships‚ without question‚ possess a legitimate purpose‚ they are extremely limited and cannot serve as an “end-run” around franchise regulation. That is‚ license agreements cannot be used to create “franchise-type relationships” without the franchise regulation. The reason for this is simple: in the world of franchise regulation‚ “substance” matters more than “form”‚ labels do not matter and just because you call something a “license” does not mean that it is not a “franchise”. In short‚ your license agreement (no matter what you call it) may in fact be a franchise.

So‚ how do you determine if your license agreement “crosses the line”? You ignore titles such as “licensor”‚ “licensee”‚ “license fee” and “license agreement” and evaluate the “substance” of your business relationship. Under the federal Franchise Rule‚ the defining characteristics of a franchise include:

  1. Continuing Commercial Relationship. a “continuing commercial relationship”;
  2. Agreement. a written or oral “agreement”;
  3. License. the “license” of a trademark;
  4. Control / Obligation to Support. “significant control” over your “licensees/franchisees” methods of operation‚ or‚ an obligation to “support” those operations‚ and
  5. Fee. the payment of a “fee”.

Since‚ factors (1)‚ (2) and (3) are‚ by necessity‚ inherent to both franchise and license agreements‚ the determination as to whether or not your license agreement “crosses the line” into franchise territory‚ boils down to an evaluation of “control” and “fees”. That is:

  • Will you possess significant control over your “licensee’s” methods of operation‚ or‚ in the alternative‚ are you obligated to provide significant support to your “licensee’s” operations? and
  • Will you receive or be owed a fee as a condition for your “licensee” to commence its operations?

If the answer to both of these questions is “yes” or “possibly yes”‚ your “licensee” may actually be a “franchisee” and you may be subject to franchise regulation. When making this evaluation‚ you must go beyond labels and consider both the substance of the relationship that your are creating and the long-term goals that you are attempting to achieve.

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