Franchisors in a Jam: Vicarious Liability and Spreading the Blame.

• Author: Emerson, Robert W.

1. INTRODUCTION 573 A. A Roadmap for the Article 573 B. Franchising: Background and Legal Definitions 573 C. Franchise Legislation: A Way Forward? 577 II. TRADEMARKS 580 A. Trademarks and Agency 580 1. Dealing with Problematic Franchisees 587 2. Joint and Several Liability for Licensees and the Licensor 592 3. Social Insurance: Balancing Consumer Expectations 593 4. "Strict" Franchisor Liability 596 B. Disclaimers 600 1. Expectations From Franchisee Display of the Franchisor's Trademarks 600 2. Meeting Standards in Order to Issue a Disclaimer or Otherwise Avoid Liability 603 3. A Presumption of Non-Liability 605 4. The Apparent Manufacturer Doctrine 607 5. Trademark-Based Liability and Disclaimers 609 III. TECHNOLOGY IN FRANCHISE LAW 611 A. Website and Social Media Usage 611 B. Deep Linking 614 IV. PROPOSALS AND CONCLUSION 621 APPENDIX 623 Public Survey - Franchising and Trademarks 623 Website Survey - Franchising and Trademarks 625 I. INTRODUCTION

   1. A Roadmap for the Article

      For franchised businesses, developments in trademark usage and technology have created new methods to allocate blame. Franchising has grown, and so too have the battles about imposing vicarious liability on franchisors for the actions or inaction of their franchisees.

      Part I of this Article progresses through the various statutory and common law approaches to defining a franchise and the grounds for imposing liability. It considers legislation as a means to reform the law and empower franchise parties seeking to foster better standards and practices. Part II delves deeper into some fundamental vicarious liability issues in franchise law, focusing on complications that arise when franchisors authorize a franchisee to use its marks and identify itself to customers. Trademark-based liability may better serve the public by placing the burden on the franchisor, which has historically had more power in the franchise relationship. The use of disclaimers may absolve some liability, but, as indicated by a survey conducted for this Article, many customers remain unaware of the differences between a franchisor and a franchisee, especially when they use the same trademark. Since the franchisor has a unique interest in protecting its brand, state and FTC regulations can incentivize consumer protections before an injury occurs.

      Part III further develops the distinct issues of website, social media use, and deep linking, all of which have become increasingly prevalent as franchise networks are entirely hidden from the public. Websites can be connected with the click of a link, sending the customers to another website without realizing that they ever left the first site. The main website may have some sort of control or a common theme that induces customers to believe they are still dealing with the same entity, regardless of a party's actual status (whether franchisor or franchisee). Injuries could be blamed on distributors and resellers who deep-link to a manufacturer or seller of products. The injured customers may be positioned to impose liability on the principal as well as the agent under the agency theory of apparent authority, modified to the deep linking context. The author believes that there should be an affirmative duty, enforced by the state or the FTC, to monitor information on the internet and what is placed on a franchisor's site. That will lead to a reduction in consumer injuries and a concomitant diminution in franchisor liability for a franchisee's actions.

   2. Franchising: Background and Legal Definitions

      Even with the economic tailspin precipitated by COVID-19, franchising remains a popular form of doing business. In the United States, franchised businesses have long accounted for at least one-third of all retail sales. (1) The pandemic has compelled the closure of about 4% of all franchised units, (2) bringing total units down to about 750,000. (3) However, it is expected that an economic recovery will lead to a percentage rise in the number of franchises far exceeding any percentage increase in employment at the franchised locations. (4) Furthermore, with well over 3,200 different franchisors in 225 or more distinct business categories, (5) franchising, directly and indirectly, accounts for at least 16.1 million private jobs in the United States. (6) This pervasiveness stems in part from the relatively inexact definition of a franchise, which requires only three main elements: substantial association with a trademark, ongoing fee payments by the franchisee, and--depending on the jurisdiction--some form of community of interest or a prescribed marketing plan from the franchisor. (7)

      The first requirement, "substantial association," pertains to the heart of franchising: the franchisee's use of a well-known or famous trademark. (8) The trademark allows the franchisee to tap into the reputation associated with the mark or name and develop the business without having to start from scratch. (9) Additionally, the franchise agreement is nothing more than a contract, with the trademark serving as a major part of the consideration. The franchisor receives the benefit of expanding the trademark's recognition without having to invest her own money into the development. (10)

      The second requirement, ongoing fee payments, pertains to the royalties and initial fees a franchisee pays to the franchisor in exchange for using the trademark. (11) The category may be expanded to include any necessary fee for the right to operate the franchise. (12)

      The third requirement in the definition of a franchise generally consists of three possible standards: (1) the franchisor provides material and opportunity to promote the franchise (a marketing plan); or (2) the franchisees and their franchisor have a "community of interest"; or (3) the franchisor wields control over its franchisees (the FTC standard for purposes of its disclosure requirement, also useful in states with no state franchise statute).

      Unfortunately, whether a marketing plan is present is subjective (13) and contributes to the ambiguity of whether a true franchise exists. Common factors among the jurisdictions include the contract itself, the parties' course of dealing, and industry customs. (14) Some states, such as California, allow the marketing factor to be satisfied by granting exclusive territories, requiring supplier approval, imposing uniform requirements, and other actions to ensure consistency among its franchisees. (15)

      The states that do not mandate a marketing plan instead require a community of interest. This community standard considers how long the parties have been involved with each other, the nature and extent of their obligations, the relative amount of time and revenue attributable to franchisees' selling of the franchisor's products or services, and the percentage of revenues received from licensors' products or services, among other concerns. (16)

      Proving a community of interest necessitates an inquiry into how much financial dependence exists between the two parties. Overall, this community of interest requirement relates to the final requirement imposed by the FTC, the control requirement. (17) One state that requires the community of interest is New Jersey. (18) The Supreme Court of New Jersey stated

      [C]ommunity of interest exists when the terms of the agreement between the parties or the nature of the franchise business requires the licensee, in the interest of the licensed business's success, to make a substantial investment in goods or skills that will be of minimal utility outside the franchise. (19) In a more articulate manner, the requirements to find a community of interest are that (1) the distributor's investments must have been substantial, franchise-specific investments, and (2) the distributor must have been required to make these investments by the parties' agreement or the nature of the business. (20) Other courts focus on how the franchisor benefits from the franchisee's marketing and how the franchisee benefits from the franchisor's marketing. (21) Indeed, these community of interest issues between franchisors and franchisees often pertain to goodwill. In Beilowitz v. General Motors Company, (22) for example, the court examined the parties' circumstances to determine whether a community of interest existed between the franchisor and franchisee. (23) The standard the court implemented was "the reputation and goodwill of the network, created . . . by the efforts of each . . . individual franchisee [that] passes back to the franchisor without compensation to the franchisee." (24) The franchisee sponsored local events, prominently displayed the franchisor's intellectual property, hosted automotive clinics, and provided excellent customer service. (25) The court also considered monetary investments into inventory and the physical premises. (26) Based on the monetary investments and goodwill development, the court found that there was a community of interest between the franchisor and franchisee. (27)

      The final possible standard, provided in the Code of Federal Regulations, is that the franchisor must "exert a significant degree of control over the franchisee's method of operation." (28) But what defines a "significant degree of control" remains unclear and often varies between jurisdictions. (29) However, a franchisor's demand for adherence to a large number of standards, policies, and manuals may be sufficient to demonstrate a significant degree of control. (30) Additionally, the franchisor's right to inspect and audit the franchisee's accounts, books, records, and tax returns at any reasonable time may also be sufficient to demonstrate a significant degree of control. (31)

      An example of additional factors may be found in Safe Step Walk-In Tub Company v. CKH Industries, Incorporated. (32) In this case, the parties contracted that there was no franchise relationship. (33) Nonetheless, the court had to determine whether a franchise relationship...