GOING GLOBAL AVOIDING THE INADVERTENT FRANCHISE IN U.S. AND INTERNATIONAL EXPANSION

Transcription

1 GOING GLOBAL AVOIDING THE INADVERTENT FRANCHISE IN U.S. AND INTERNATIONAL EXPANSION TUESDAY, March 6, pm Eastern 11 pm Central 10 am Mountain 9 am Pacific Kenneth Costello, Partner Nicole Simonian, Partner Jonathan Solish, Partner

2 WHY DOES FRANCHISE STATUS MATTER?

3 Legal terms often have specialized meanings that can surprise even a sophisticated party. The term franchise, or its derivative franchisee, is one of those terms. To-Am v. Mitsubishi Caterpillar Forklift America, 152 F.3d 658 (7th Cir. 1998).

4 It is surprisingly easy for a trademark license... to constitute a franchise. Companies that are unaware of franchise laws or misinformed about their scope may unwittingly establish trademark license, or distribution arrangements that are subject to franchise laws, thereby becoming inadvertent franchisors who have failed to comply with the franchise laws. Mark I. Feldman, Franchising Law: The Danger of IP Agreements Inadvertently Creating a Franchise (1996).

5 While trademark owners must exercise adequate quality control over licensed products, too much control over the activities of the licensee may result in the establishment of a franchise and trigger application of various federal and state disclosure and relationship laws. Gilson on Trademark Protection & Practice, (Matthew Bender & Co. 1999).

6 No trademark or copyright licensing scheme should be designed without considering whether and how the franchise laws apply. California Intellectual Property Handbook, Introduction to California Intellectual Property Laws, Introduction, 8, (Matthew Bender & Co. 1999).

7 Many franchise contracts can be legally characterized as a skeleton of a trademark license fleshed out with many duties and restrictions imposed upon the franchisee. McCarthy on Trademarks (4 th Ed. 1999), 18:65, p

8 Risks of Inadvertent Franchise Rescission rights Liability for individual officers May invalidate Contractual Right to Terminate Damages Criminal prosecution for a felony Administrative injunction, restitution, asset freeze, cease and desist order Inventory repurchase Attorneys fees

9 WHAT IS A FRANCHISE?

10 The Inadvertent Franchise is always a potential risk when a trademark is licensed. Generally, there must be a fee. Marketing suggestions or economic dependency is all it takes to create a franchise.

11 If the Elements of a Franchise Exist Franchise laws apply. The relationship is an unregistered franchise. The licensee has rescission right and damages claims. It may be impossible to end the relationship.

12 Trademark Licensing was historically viewed as a fraud on consumers. Lanham Act allowed trademark licensing as long as controls were imposed. These controls may create ancillary problems like inadvertent franchise and joint employer status

13 Naked Trademark Licenses Lanham Act allows a trademark to be licensed. To avoid consumer deception, restrictions must be imposed on trademark usage to ensure that the trademark is, in fact, subject to quality control standards. Failure to impose sufficient controls can lead to abandonment and loss of trademark protection.

14 Joint Employer Employment status is identified by control. A trademark owner must control licensees. This control has recently led some courts to mistake licensing arrangements for employment relationships.

15 Top 10 Excuses Why an Agreement Can t be a Franchise 10. Everyone else in our industry does it this way 9. We grant licenses, not franchises 8. They came to us 7. Fees were just to cover our costs 6. We don t tell them how to operate their business 5. They use their own trade name, not ours 4. They buy products from our affiliate, not us 3. They sell other products besides ours 2. We never intended it to be a franchise 1. We didn t know about the law when we signed the contract

16 What Parties Call the Arrangement is Irrelevant License Dealership Distributorship Strategic alliance Co-Branding Partner Partner

17 Elements of a Franchise in U.S. SIGNIFICANT ASSISTANCE OR CONTROL or TRADEMARK + MARKETING PLAN + REQUIRED FEE or COMMUNITY OF INTEREST

18 Inadvertent Franchises Apparel and retail stores Girl Scouts Product and vehicle dealers and distributors Certification programs Insurance agency Software distributor Office supplies company Cell phone company Joint ventures Turnkey cafeteria location Sports leagues

19 Fee Money must flow to licensor The fee can be hidden in any payment The fee can be hidden in the cost of goods Advertising fees may be considered to be franchise fees Need not be up front Royalties are franchise fees Even nickels and dimes for manuals or marketing materials may be hidden fees May include optional fees Exception: Bona Fide Wholesale Prices

20 Marketing Plan Ad funds Training Marketing suggestions Promotions Suggested pricing Restrictions on sales Defined territories Providing advertising collateral Significant control or assistance

21 No Defense to Statutory Violations Even if Violation is inadvertent Violation is unintentional Seller lacks knowledge of the law Competitors don t comply Buyer agreed to waive compliance

22 Franchise Risk Assessment Depends on Which Law Applies Federal law applies to all franchise sales in US State law jurisdiction varies according to domicile and location of units: New York law Some state laws require that licensee has a place of business in state Tests for jurisdiction, definitions, exemptions, exclusions vary

23 States with Franchise Sales Laws California Hawaii Illinois Indiana Maryland Michigan Minnesota New York North Dakota Rhode Island South Dakota Virginia Washington Wisconsin

24 States Requiring Pre-Sale Filing or Registration

25 States with Relationship Laws Substantive (good cause; substantial change) Procedural cure/notice period

26 Key Points About Relationship Laws Some states relationship laws broadly define protected party and apply to arrangements that may not qualify as a franchise under federal law Many states have laws that regulate dealers and distributors in specific industries (alcohol distribution; motor vehicles; farm equipment; construction equipment) Statutes always trump contract provisions to the contrary Typical provisions: Venue and choice of law Good cause requirements - statutory and case law Written notice; cure rights Remedies Some relationship laws go beyond termination, cancellation and non-renewal without good cause

27 Business Opportunity (Bus/Op) Laws (aka Seller Assisted Marketing Plans ) Goods / Services + $$$ to Promoter (Amount Varies) + + Start, Maintain or Operate Business + Representations

28 Business Opportunity (Bus/Op) Laws (aka Seller Assisted Marketing Plans ) Less costly investments Triggering representations Miscellaneous exemptions and exclusions Entrance fee under $500 Federal or state TM registration Some states exclude operators already in business or same line of business Compliance with federal franchise sales laws Similar regulatory system Pre-sale registration/disclosure laws No Bus/Op relationship laws

29 States with a Business Opportunity Law Alabama Alaska California Connecticut Florida Georgia Illinois Indiana Iowa Kentucky Louisiana Maine Maryland Michigan Minnesota Nebraska New Hampshire North Carolina Ohio Oklahoma South Carolina Texas Utah Virginia Washington

30 Countries with Franchise Laws Albania Australia Belarus Brazil Canada China Estonia France Georgia Indonesia Italy Japan Kazakhstan Kyrgyzstan Korea (South) Lithuania Malaysia Mexico Moldova Romania Russia Saudia Arabia (pending) South Africa Spain Sweden Taiwan Ukraine United States Venezuela Vietnam

31 China Franchise Franchisor allows the franchisee to use franchisor s operational resources, e.g., trademark, logo, patent, know-how Franchisee undertakes business under the unified business format in accordance with the contracts, and Pays franchise fees (includes product purchases)

32 Brazil Franchise A system where franchisor licenses the use of a trademark or patent Grants exclusive or semiexclusive right to distribute products or services Includes use of technology to establish and manage a business or operating system, and direct or indirect compensation (includes product purchases)

33 Mexico Franchise License to use a trademark, Technical knowledge or assistance to enable the licensee to produce or sell goods or services in a uniform manner, and Licensor establishes operating, commercial, and administrative methods to maintain quality, prestige, and image No fee required

34 Exclusions from Federal Amended FTC Rule (No State Preemption) Employment Relationships General Partnerships Cooperatives Certification and Testing Services Single Trademark Licenses

35 Exemptions from Federal Amended FTC Rule (No State Preemption) Frequently used exemptions: No fee over $570 in first six months Large franchisee (>$5,715,000 net worth) Large transaction (invest >$1,143,100 to launch) Fractional franchise (<20% total revenue/brand) Often no counterpart in state franchise sales law Not applicable to state franchise relationship laws Bona fide wholesale price of reasonable inventory is not a fee (not applicable in a number of international laws)

36 Examples of State Law Exemptions Large franchisor Fractional franchise (2 yr. experience + 20% of total revenue; but some states apply test annually) Sophisticated or large franchisee Franchise sales to insiders Sales by franchisee for own account (if franchisor involvement is limited to approving buyer) Check franchise sales law to determine if exemption excuses both registration and disclosure

37 STRATEGIES FOR DRAFTING LICENSES AND DISTRIBUTION AGREEMENTS TO AVOID INADVERTENT FRANCHISES

38 Structuring to Avoid Accidental Franchises Eliminate fee or marketing plan Not all jurisdictions have the same elements Is the solution consistent with business goals? Bite the bullet and register

39 Questions? Kenneth Costello Nicole Simonian Jonathan Solish