Franchise Lawyer Blog

Does It Have to Be a Franchise?

Occasionally a prospective client will come into our office and describe a desire to exponentially expand their business without having to deal with the expense and bother of franchise registration. What they usually have in mind is some sort of licensing arrangement. In some cases they will have already set up one or more outposts of their business, operating under their name, or they have negotiated with individuals and promised them the right to operate a location under their valuable brand name.

Our answer is invariably the same. If you are attempting to set up a business and it occurs to you that you want to avoid being a franchise, it is probably too late. You already are a franchise. This is because there are simple elements to the definition of a franchise that are almost unavoidable in establishing an expandable and replicable business model.

Generally speaking, a franchise exists when the owner licenses a trademark or tradename for use in connection with a business system in exchange for a fee for that right. Most states utilize this “three prong test.” The rule in New York is even broader, requiring only two of the three prongs. A franchise exists in New York when there exists either (i) a marketing plan or system and a fee; or (ii) the use of a trademark and a fee.

The client who wishes to replicate their business model will invariably be licensing the use of a brand name, usually a registered trademark. They will be charging a fee, in one form or another. Changing the nature or manner of the fee doesn’t avoid the definition. And the client will typically have a business system or model that they will want to see utilized in order to establish control over the quality of the developed businesses. There is no sensible way to avoid any of these criteria, they are all essential elements of a successful business development plan.

So the discussion inevitably turns to the requirements for franchising: the creation of the Franchise Disclosure Document (“FDD”) and, where necessary, registration. We will be discussing both the form of the FDD and the registration requirements in future entries.

In some cases, clients already have one or more operations on the ground and running by the time they get to us. In these cases, the licensor/franchisors are exposed to liabilities created by the federal and state laws on franchising. These previously established branches will be considered to be franchises that have been sold without proper adherence to the state and federal requirements regarding FDD’s. The client may be subject to damages for any losses suffered by these operators and may be required to offer rescission of the contract to those operators. In those cases, in order to properly initiate a franchise system, the previously established businesses will have to be negotiated with, in order to extricate the franchisor from the prior agreements and offer those operators an appropriate FDD.

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