Trademarks are valuable assets for businesses for several reasons. Aside from protecting your brand and business from unfair competition, trademarks can also be a great source of revenue through licensing. Licensing registered trademarks can provide growth opportunities for trademark owners. On the flip side, entrepreneurs can reduce the risks of starting a business by taking advantage of an established and recognized brand. However, before you enter into a license agreement, you should carefully consider the notion of an “accidental franchise” to protect yourself and your business.
What is a franchise?
A franchise is an agreement, or license, between two legally independent parties. A Franchise Agreement gives one party (the “Franchisee”) the right to use the other party’s (the “Franchisor”) proprietary information, name, brand or logo to sell certain products or services. The Franchisee pays a fee for these rights while the Franchisor maintains and exerts control over the usage to preserve the quality and reputation of the brand. It’s essentially a synergistic relationship.
How can you accidentally franchise?
Franchising can be a big investment risk for entrepreneurs. For that reason, it’s become a highly regulated business model. Under Federal and New York state law, franchises can be legally created if certain elements are satisfied. If the elements are created, then the business owner must abide by all applicable rules and regulations. In other words, a licensing agreement can actually qualify as a franchise agreement in certain cases. Note that you don’t need intent to establish a franchise.
Federal franchising is governed by the Federal Trade Commission (“FTC”) and has 3 elements:
- Control: Are you providing significant help to the other party? Do you have the authority to control how they use your mark, logo or brand?
- Fee. Did the other party pay you a fee for the license?
- Trademark. Are you allowing the other party to use your trademark for its business?
If the answer to each of these questions is yes, then it’s likely that you have established the necessary elements and created a federal franchise.
Here’s the catch! In New York, franchising is governed by the New York Franchise Sales Act and has only 2 elements:
- The party paid a fee, and
- The business owner provided a trademark or a marketing plan for the other party.
This means that in New York, you don’t need to show that you had control over the other party to be considered a Franchisor. New York business owners should be wary because such a broad definition of a franchise puts them at a higher risk of creating an accidental franchise.
What’s the risk?
Accidental franchises can have devastating effects on a business because franchises are subject to many rules and regulations that if violated, carry significant consequences. In other words, everyone you have incorrectly done business with is entitled to rescind their transaction and demand repayment of all fees paid throughout your relationship.
In addition to private liability, failing to abide by FTC Franchise rules is a violation of the Federal Trade Commission Act and can therefore result in civil penalties of up to $10,000. In New York, you can even be guilty of a misdemeanor if you willfully violated the state’s franchising laws.
Knowing what makes up the various types of franchises helps to protect you and your business by avoiding potential significant and unexpected sanctions and fines.