The sales and operation of franchises are heavily regulated under both federal and state law, but do you know what makes the business relationship between two companies a franchise?
There are three criteria that establish whether a contract is a franchise agreement. All three criteria must be present for there to be a franchise relationship:
1. The franchisor grants the franchisee the right to engage in a business of offering goods or services under a marketing plan or system prescribed by a franchisor. This requirement is satisfied if the franchisor prescribes in a substantial way how the franchisee must operate its business. For example, McDonald’s franchisees operate their restaurants in the same way. A Big Mac is the same from one store to the next.
2. The franchisor grants the franchisee the right to use a trademark, service mark, tradename, logo or other symbol designating the franchisor and its affiliates. The McDonald’s golden arches are a well-known example.
3. The franchisee is required to pay a franchise fee, either directly or indirectly. This is typically an up-front fee and/or monthly royalty payments. However, it can include “indirect franchise fees” when the franchisee is required to pay other amounts to the franchisor, such as being forced to buy goods in excess of a bona fide wholesale price, being forced to buy products beyond the franchisee’s needs, or being forced to buy tickets to events.
Whether the business relationship between two companies constitutes a franchise often becomes the focus of the parties’ attention when there is a dispute. There can be serious consequences for a company that is determined to be a franchisor if it failed to comply with the complex federal and state franchise laws.
Before two companies enter into a business relationship, each side should consider whether the relationship constitutes a franchise agreement. If it is a franchise agreement, then the parties need to consult with an attorney that is familiar with franchise laws.
This article was written by Mark S. Demorest, Managing Member of Demorest Law Firm. Click here to view his professional resume.
