Accidental Franchises-what You Don't Know Can Hurt Your Client

• Publication year: 2020
• Author: Barry Kurtz and Katherine L. Wallman

Accidental Franchises-What You Don't Know Can Hurt Your Client1

Barry Kurtz and Katherine L. Wallman

Barry Kurtz, a Certified Specialist in Franchise and Distribution Law by the California State Bar Board of Specialization, is the Chair of the Franchise & Distribution Law Practice Group at Lewitt Hackman in Encino, California. Barry may be reached at bkurtz@lewitthackman.com.

Katherine L. Wallman is an Associate in Lewitt Hackman's Franchise & Distribution. She prepares and reviews domestic and international franchise registration and disclosure documents; provides counsel regarding regulatory compliance, acquisitions, and dispositions of franchised and independent units and businesses; and handles commercial transactions involving franchisors and franchisees - domestically and globally. Kate may be reached at kwallman@lewitthackman.com.

Why should all business attorneys be concerned about franchise laws? Businesspeople and attorneys often are unaware that franchise laws impact a variety of business relationships. Under federal law, as well as in California, it does not matter whether you call a business arrangement a "partnership," a "license," a "dealership," a "joint venture" or something else when you draft the agreement, or whether the agreement disclaims the existence of a franchise; if the elements of a franchise are present, it is a franchise. Franchising is a highly complex area of the law that lends itself to specialization. Knowing the following basics can help you identify franchise arrangements and prevent your business clients from becoming accidental franchisors, or from inadvertently contracting with an accidental franchisor.

What is a Franchise Under California Law?

Under California law, a business relationship is a "franchise" if: (1) the business will be substantially associated with the franchisor's trademark; (2) the franchisee will directly or indirectly pay a fee to the franchisor for the right to engage in the business and use the franchisor's trademark; and (3) the franchisee will operate the business under a marketing plan or system prescribed in substantial part by the franchisor. The Department of Business Oversight (DBO) regulates the offer and sale of franchises in California, and it interprets the three elements of a franchise broadly.

If a business uses another company's trademark to identify itself, or in its advertising, it can be argued that the business is "substantially associated" with the franchisor's trademark. Courts have broadly interpreted the "substantially associated" element. For example, in Kim v. ServoSnax, 10 Cal. App. 4th 1346 (1992), a California appellate court held that the trademark element was satisfied in a licensing arrangement even though the licensor's trademark was not communicated to the public or to customers. In fact, the licensee did not use licensor's mark in its business. However, the court found there was substantial association with a trademark because the licensor's brand name was important to third-party facility owners in deciding whether to permit franchised locations to operate on their premises.

The "fee" element is also easily satisfied. Just about any payment to the licensor or its affiliate for licensing or distribution rights can fulfill the "fee" element, regardless of what the parties call it in their agreements. However, payments that do not exceed the bona fide...