In laymen’s terms, a franchise is an arrangement between two parties whereby one party, the “franchisor,” grants the other party, the “franchisee,” a license, or right, to operate a business using the franchisor’s methods and processes and under the franchisor’s trademarks and other intellectual property, such as the franchisor’s trade name and logos. Fast food chains are a common example of franchises, as most individual fast food locations are separately owned by individual owners, however all locations generally use the same name and logos, offer the same food and at similar prices, and generally look and feel like any other location you might visit.
Although the legal definition of a franchise may differ from state to state, the Federal Trade Commission’s (“FTC”) Trade Regulation Rules define a “franchise” as “any continuing commercial relationship or arrangement, whatever it may be called” that includes the following three elements:
(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.
16 CFR 436.1(h)
Franchises are generally governed by a written agreement called a Franchise Agreement, which governs the relationship between a franchisor and franchisee by including written provisions governing items such as, among other things, the initial and monthly franchise fees, the intellectual property rights granted to the franchisee, franchise location requirements, franchisee operation and marketing requirements, the franchise term, and termination rights. Franchise Agreements are generally lengthy, detailed documents, and typically grant broad rights in favor of the franchisor.
A license agreement is an arrangement whereby a property owner, the “licensor,” grants to another party, the “licensee,”the right to use the licensor’s property without transferring ownership of the licensed property. License agreement also generally place restrictions on the rights granted to the licensee, such as by licensing the property for a specific purpose, or by limiting the amount of time, or geographic area, to which the right applies. Although license agreements can apply to numerous types of property, such as musical arrangements, movie scripts, and software programs, license agreements are commonly used to license intellectual property such as patents and trademarks--a type of license agreement that is often confused with a franchise agreement.
Although license agreements, including those for trademark licenses, generally require a fee in exchange for the license, they are generally not as detailed as Franchise Agreements, and are typically more narrow in terms of the restrictions they place on a licensee in relation to using the license granted.
As noted above, because Franchise Agreement and License Agreements are similar in that they both grant the right to use another party’s property (in particular, trademarks) in exchange for a fee, it can be difficult to distinguish a franchise agreement from a license agreement. However, the distinction is important as franchise agreements are subject to certain federal and state requirements that licenses are not, such as Franchise Disclosure Documents (FDDs), waiting periods, and registrations—requirements that are designed to help protect potential franchisees from bad deals by ensuring they are provided with time and information necessary to make an informed decision before entering into a franchise arrangement.
Despite such franchise requirements, franchisors, whether mistakenly or intentionally, occasionally try to avoid such requirements by labeling or disguising franchise agreements as license agreements. However, doing so is risky, as failing to comply with federal and state franchise requirements may subject a party to significant penalties or other legal ramifications. In any event, because determining whether or not a franchise relationship exists turns on whether the three elements discussed above are met, the label placed on a written agreement, or disclaimers included in a written agreement, is not conclusive as to whether or not an arrangement is a franchise or license agreement.
Because Franchise and License Agreements generally both involve a fee paid in exchange for the right to use specific goods such as trademarks, determining whether an arrangement is a franchise or a license typically turns on the element of control: the greater the control reserved to a property or trademark owner, the more likely the arrangement is to be considered a franchise. To help with the analysis, the FTC has provided guidance listing certain factors that may suggest that the level of control or assistance involved rises to that of a franchise (available at: https://www.ftc.gov/business-guidance/resources/franchise-rule-compliance-guide). Such factors include
- Requiring site approval for unestablished businesses, or selecting site locations;
- Mandating site design or appearance requirements;
- Mandating certain hours of operation;
- Requiring adherence to certain production techniques;
- Mandating specific accounting practices;
- Requiring adherence to specific personnel policies;
- Requiring participation in and or financial contributions to promotional campaigns
- Placing certain restrictions on customers;
- Designating or restricting the locale or area of operation of the business.
- Requiring or providing formal sales, repair, or business training programs;
- Establishing uniform accounting systems;
- Furnishing management, marketing, or personnel advice;
- Furnishing system-wide networks and website; and
- Furnishing a detailed operating manual or program.
Although the above-listed factors are helpful in distinguishing licenses from franchises, all franchise and license agreements should be carefully reviewed to help ensure such agreement is properly tailored and correctly categorized to fit the expectations of the parties involved.
