Hidden Franchises
| Jurisdiction | Colorado,United States |
| Citation | Vol. 45 No. 1 Pg. 25 |
| Pages | 25 |
| Publication year | 2016 |
Articles
Business Law
Hidden Franchises
By Craig Knobbe.
Business Law articles are sponsored by the CBA Business Law Section to apprise members of current substantive law. Articles focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, and securities law.
About the Author
Craig J. Knobbe is a partner at Moye White LLP. He represents franchisers regarding franchise registration and disclosure laws, corporate matters, mergers and acquisitions, general business issues, and real estate matters.
Attorneys address a variety of important issues when forming new business relationships or counseling clients on existing commercial arrangements. This article illustrates how a commercial arrangement, such as a license agreement, joint venture, or consulting agreement, could be a "franchise" subject to regulation under the complex network of federal and state franchise laws.
Ongoing business relationships can be created through a variety of arrangements, including license agreements, distributorships, joint ventures, and consulting agreements. Under these arrangements, legal and business questions must be addressed at the outset by the attorney and client to ensure the relationship complies with applicable law and to increase the probability that the business relationship will be successful and profitable. Although an attorney will tackle many legal questions when the relationship is formed, it is entirely possible that even an experienced practitioner will fail to recognize that the business relationship being created, whether a joint venture, consulting agreement, or licensing agreement, is actually a "franchise" subject to regulation under federal and state law. This issue can be missed or overlooked due to the confusing and far-reaching network of federal and state franchise laws. In fact, it is irrelevant that the parties do not call the business relationship a franchise[1] and never intended to create a franchise relationship. If the business relationship satisfies the elements of the federal or state definition of a franchise, it is a franchise and subject to regulation.
Regulation of Franchise Relationships
Franchise relationships are regulated through a complex combination of federal and state laws. The following is an introduction to the federal and state regulations that govern franchise relationships.
Federal Franchise Regulation
In July 2007, the Federal Trade Commission (FTC) adopted the "Disclosure Requirements and Prohibitions Concerning Franchising" (FTC Franchise Rule) to amend the original franchise disclosure rule that was promulgated in 1978 to regulate the franchise sales process.[2] The purpose of the FTC Franchise Rule is to regulate the pre-sale process by requiring the franchisor to make disclosures to the prospective franchisee. The idea is that these disclosures will allow the prospective franchisee to make an informed investment decision. Under the FTC Franchise Rule, the franchisor must provide the prospective franchisee with certain material information about the franchisor and the franchise opportunity in the form of a franchise disclosure document (FDD) before a sale is closed.[3] The form and content of the FDD is described in the FTC Franchise Rule and, if applicable, state franchise laws. All proposed agreements between the parties, including the franchise agreement, lease, and purchase agreement, [4] must be included as part of the FDD, but the FTC does not regulate the continuing relationship of the parties. The FTC Franchise Rule does not require the franchisor to register or file the FDD with the FTC.
State Franchise Sales Regulations
The FTC Franchise Rule does not preempt state franchise laws, except to the extent a state’s franchise laws fail to provide equal or greater protection than the FTC Franchise Rule.[5] As such, the FTC Franchise Rule sets a minimum federal standard for franchise disclosures, and states are allowed to provide greater protection and require more extensive disclosures if desired. Currently, 15 states[6] regulate franchise sales through franchise registration and/or disclosure laws. In 14 of these states (often referred to as "Registration States"[7]), a franchisor must register its offering with the appropriate state regulatory authority, or obtain an exemption from registration, prior to the offer or sale of franchises in the state. Colorado is not among the Registration States, meaning that the FTC Franchise Rule is the regulation that would apply to a business relationship formed in Colorado. But caution is advised, as the broad jurisdictional scope of certain state franchise laws could result in the application of a state’s franchise laws to a transaction in another state that does not have its own franchise laws. For example, Maryland’s franchise laws could apply to a transaction in a state that does not regulate franchises if one of the parties is a Maryland resident.[8]
Applicability
As discussed in detail below, determining whether the state and federal franchise laws apply to a business relationship depends on whether the elements of the franchise definition are satisfied. The FTC Franchise Rule and the state franchise disclosure and registration laws include franchise definitions. Additionally, many states have "relationship laws" that regulate certain substantive terms of the franchise relationship, such as termination, nonrenewal, and assignment. Although relationship laws do not address pre-sale disclosure or registration, certain state relationship laws include a franchise definition.[9] This is important because a party in a private action could refer to the definition in the state’s relationship law to support the argument that a business relationship is a franchise. Colorado does not have a relationship law, and a relationship law does not currently exist at the federal level. As such, this article does not include an in-depth discussion of the state franchise relationship laws.
Business Laws
Until 2007, the FTC regulated the sale of business opportunities, along with franchises, under the original version of the FTC Franchise Rule. However, in July 2007, the FTC’s amendments to the original FTC Franchise Rule included the creation of a separate regulation applicable to the sale of business opportunities called the "Disclosure Requirements and Prohibitions Concerning Business Opportunities" (FTC Business Opportunity Rule).[10] The FTC Business Opportunity Rule is similar to the regulation of business opportunities under the original FTC Franchise Rule and was finally adopted by the FTC in December 2011. In addition to the federal business opportunity regulation, 26 states[11] have business opportunity laws and two additional states[12] and the District of Columbia have consumer protection laws that cover business opportunities. (Colorado is not among these states.) The business opportunity laws are relevant in various states because the definition of a "business opportunity" sometimes includes traditional franchises. An in-depth discussion of the federal and state business opportunity regulations is beyond the scope of this article. But suffice to say that under many state business opportunity laws, a franchisor is exempt from the business opportunity registration process if it complies with the federal franchise laws.[13] In other states, a franchise program is exempt from the business opportunity laws if the program includes a "federally registered trademark" or a "registered trademark."[14]
Definition of a "Franchise" Under Federal Law
The FTC Franchise Rule defines a "franchise" as:
any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that: (1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark; (2) The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and (3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate. [15]
A business relationship is within the scope of regulation under the FTC Franchise Rule if each of the three elements of the franchise definition are satisfied. However, a business relationship that satisfies all three definitional elements may not be regulated under the FTC Franchise Rule if the relationship satisfies an exemption or exclusion specifically described in the FTC Franchise Rule.
> Trademark element. The trademark element of the franchise definition is intended to be read broadly.[16] This element is often satisfied when the goods or services the franchisee distributes are associated with the franchisor’s mark or when the franchisee must conform to the franchisor’s quality standards for the goods or services it distributes.[17] Illustrating the broad manner in which the trademark element is interpreted, an FTC informal staff advisory opinion explained that it would be inappropriate to find that the trademark element of the definition was not met when the written agreement between the parties was silent as to whether the buyer had authority to use the seller’s marks. [18] In this opinion, it was determined that the issue of whether the buyer was given implied or apparent authority to use the...
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