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But Is It a Franchise?

Spring 2007Cole Schotz Docket

A company develops a new distribution concept for its products.  A service provider comes up with a new way to expand its servicing network.  A manufacturer wants to cancel the contract it has with its distributor.  A seller wants to transfer its business without needing the consent of its supplier.  To implement any of these transactions, one of the first issues to consider is - “But is it a franchise?” 

Most people can identify “McDonald’s” and “Burger King” as franchises.  But the variety of laws governing franchising cover so many other types of businesses and offer so many types of restrictions and protections, that it is often necessary for a careful analysis to be made of applicable laws and regulations in light of the specific details of the agreement and course of dealing between the parties.  The mere fact that the agreement does not use the term “franchise,” “franchisor” or “franchisee” has no bearing on the issue.

To fall within the Rule published by the Federal Trade Commission (“FTC”), a business must be either a “package and product franchise” or a “business opportunity venture.”  Each of these categories requires three characteristics.  One characteristic common to both categories is that the “franchisee” be obligated to pay at least $500 to the “franchisor” at any time within six months of its commencing business.  In addition, to qualify as a “package or product franchise”:  (1) The franchisee must (a) offer to sell or distribute goods or services which are identified by a trademark, tradename, service mark or other commercial symbol (a “mark”) identifying the “franchisor” or (b) operate its business under the mark and be directly or indirectly required or advised to meet certain quality standards set by the franchisor; and (2) the franchisor must (a) exercise or have authority to exercise a significant degree of control over the franchisee’s methods of operation or (b) give significant assistance to the franchisee in its methods of operation. 

To qualify as a “business opportunity venture,” on the other hand, (1) a franchisee must be required to sell goods or services supplied by the franchisor, its affiliate, or a specific supplier; and (2) a franchisor or its designee must secure retail outlets, accounts or locations for the franchisee. 

In addition to the federal law whose main thrust is to impose disclosure requirements, virtually every state has some sort of law that deals with “franchises” or “business opportunities.”  For the most part, the federal law does not pre-empt state laws since they often provide greater or additional protections.  Some state statutes or regulations require additional disclosures.  Some impose different requirements on when disclosures must be given.  Some require registration with a state agency and some require approval by that agency.  Some impose limitations on termination, transfer and other aspects of the relationship.  And some have variations on all of the above.  To further complicate matters, each of those state statutes contain variations on what is covered by the term “franchise.” 

New Jersey’s Franchise Practices Act does not deal with disclosures or registration, but does deal with important aspects of the relationship between a franchisor and a franchisee.  It provides restrictions and protections on the termination or renewal of a franchise, the sale or transfer of a franchise, the giving of releases, the ability of franchisees to freely associate, a franchisee’s decision to change management, and the imposition of unreasonable standards of performance on a franchisee. 

New Jersey’s Act also has a definition of “franchise” that differs somewhat from the FTC rule.  It defines a “franchise” as a written arrangement in which a person grants to another person a license to use a mark or related characteristics and in which there is a community of interest in the marketing of goods or services at wholesale, retail, by lease agreement or otherwise.  Of course, each of the key words used in this definition (e.g., “license,” “related characteristics,” “community of interest”) have been interpreted by the courts. 

Whether a business is developing a concept for the distribution of its goods or services or wants to terminate or is being terminated from a business relationship, careful review of all applicable statutes and regulations is a necessity.  The fact that the relationship does not involve the sale of hamburgers, does not mean that the relationship does not have the “fixins’” to be deemed a “franchise.”

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