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In a recently filed federal suit, one party to a licensing agreement sued the other claiming the other violated state and federal franchising law.  The agreement at issue gave the buyer the exclusive rights to sell products as an identified licensee in a specific territory in exchange for the payment of an “Area Development Fee” of $25,000. In addition, the buyer agreed to only sell specific product and was required to purchase that product from the seller, licensor. The agreement required the buyer to prominently display the seller’s name in each store. Finally, the seller had its chef attend the buyer’s grand opening and provide suggestions as to store set-up and marketing.

When the buyer learned that the seller was selling the product for less money to the general public, the buyer sued the seller alleging that an unenforceable franchise relationship had been formed. Although the Court has yet to rule on the issue, careful attention should be paid when drafting agreements to avoid implication of franchise laws if the parties do not desire to create a franchise relationship.

Although state laws may vary from state to state, in general a franchise relationship is created when all of the following exist in a relationship:

  1. the other has the right to use the franchisor's mark in selling its goods or services;
  2. the party granting the right to use a name or product has the authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance with the method of operation; and
  3. a party makes a required payment to the other for certain rights.

The FTC has issued an advisory opinion which stated that a business relationship is deemed to be a franchise-based not on what the parties call the relationship, but rather on if the three elements are met.

Under the FTC Franchise Rule, a franchisor must provide to prospective franchisees a complete and accurate basic disclosure document containing information relating to the franchisor and its existing franchisees. A franchisor's failure to disclose that information is an unfair or deceptive trade practice that violates § 5 of the Federal Trade Commission Act.

Given the elements of what it takes to create a franchise relationship, proper case and guidance is required.

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