A Franchising Primer
Franchising in the U.S. (according to the International Franchise Association) creates over 21 million jobs at nearly a million business locations nationwide – adding approximately $2.5 trillion in economic output each year. Particularly for fledgling businesses, franchises offer the appeal of independent (entrepreneurial) ownership along with immediate (positive) brand recognition. In addition, most franchisees access training, coaching, business planning, and marketing services as part of their affiliation.
Although some entities call themselves elsewise – a license, joint venture, marketing agreement, or dealership, for instance – IF such business arrangement has all of the markings of a franchise, it is one – along with a host of federal and state regulations designed to protect franchisees and their customers.
Three main elements clearly constitute a “franchise” under federal franchise laws:
- Shared identity – the business must be substantially associated with the franchisor’s trademark or other commercial symbols. This usually takes the form of a license to use the franchisor’s name.
- Ongoing fees – by way of continuing royalty payments, service fees, consulting fees, training fees, etc., as long as they are for the right to operate the business.
- Common marketing and business objectives, along with substantial control – does the franchisor prescribe marketing and operational systems? Is there required training? Is the licensee free to make most decisions without the licensor’s consent?
Franchising as a viable business strategy came into its own in the early 1970’s – along with a slew of federal and state regulations. Since 1979, the Federal Trade Commission (FTC) has promulgated rules regulating franchise offerings. These rules mandate written disclosure to prospective franchisees through a uniform (23 part) Federal Disclosure Document (FDD). Many states further regulate franchises through an annual registration and review process. Moreover, some states have enacted “relationship laws” restricting the upper hand of franchisors over franchise terminations, renewals, transfers, and other key aspects of the franchise relationship.
As franchising continue to proliferate, so have legal disputes between franchisors and franchisees. Such litigation usually involves:
Encroachment. Franchisors retain the right to deliver the goods and services associated with the brand through alternate channels of distribution, such as the Internet, mail order, catalog sales, or sales of branded products at supermarkets.
Systemwide Change. Generally, the right of franchisors to make changes in their systems has been upheld.
Not a Fiduciary Relationship. Courts have consistently held that the franchise relationship is not a fiduciary relationship.
Vicarious Liability. Generally, franchisors are not liable for franchisee misdeeds if they do not control the day-to-day operations of the franchised location.
Violation of Brand Standards. Where franchisees fail to adhere to minimum brand standards, franchisors may bring suit to terminate the franchise, and disallow continued use of trademarks thereafter.
Trade Secrets and Trade Dress. Franchisors may enforce their rights to protect trade secrets and trade dress, during and following the term of the franchise agreement.
Transfer of System by the Franchisor. Franchisors generally retain an unlimited right to sell their franchise systems.
These and other matters regarding the offering, sale, and fulfillment of franchise agreements may inadvertently cross paths (and conflict) with the duties and daily activities of commercial real estate practitioners – particularly in the highly specialized field of business brokerage.
Commercial agents are routinely engaged to assist franchisors and franchisee in suitable site selection. The franchisor’s real estate requirements are (or should be) clearly spelled out in either their FDD or Operations Manual (part of the franchise documentation that can change in-term. While clearly delineated, site and building requirements may also be even more restrictive. A better understanding of these requirements is always advised before undertaking any “agency” role for franchise buyers, sellers, landlords or tenants.
Of even greater concern are situations involving the sale of the business itself (apart from any real estate transfer). Most states require registration of all personnel and outside contractors who offer a franchised business opportunity, along with serious penalties (criminal and civil) for any violators. Additionally, some states have rules regarding the proper promotion of franchise offerings, including written pre-approval of all advertising materials.